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Form 10-K VITESSE SEMICONDUCTOR For: Sep 30

December 4, 2014 4:10 PM EST


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
�______________________________________
Form�10-K
x
ANNUAL REPORT UNDER SECTION�13 OR 15(d)�OF THE SECURITIES EXCHANGE ACT OF�1934
For the fiscal year ended September�30, 2014
OR
o
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�1-31614
�______________________________________

VITESSE SEMICONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
77-0138960
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
4721 Calle Carga
Camarillo, California 93012
(Address of principal executive offices)(zip code)
Registrants telephone number, including area code: (805)�388-3700
�______________________________________
Securities registered pursuant to Section�12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, $0.01 par value
NASDAQ Global Market
Securities registered pursuant to Section�12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule�405 of the Securities Act.�Yes�o� No�x
Indicate by check mark if the registrant is not required to file reports pursuant to Section�13 or 15(d) of the Act.�Yes�o� No�x
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�o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule�405 of Regulation�S-T (�232.405 of this chapter) during the preceding 12�months (or for such shorter period that the registrant was required to submit and post such files).Yesx� No�o
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
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
��Large�accelerated�filer�o
Accelerated�filer�x
Non-accelerated�filer�o
Smaller�reporting�company�o
(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule�12b-2 of the Act).�Yes�o� No�x
As of March�31, 2014, the aggregate market value of the voting and non-voting common equity held by non-affiliates was $240.2 million, based on the closing price on that date. As of November�28, 2014, there were outstanding 67,903,274 shares of the registrants Common Stock, $0.01 par value.
Documents Incorporated By Reference
Portions of the issuers Proxy Statement for its 2015 Annual Meeting of Stockholders are incorporated by reference into Part�III of this Annual Report.




VITESSE SEMICONDUCTOR CORPORATION
2014 ANNUAL REPORT ON FORM�10-K
TABLE OF CONTENTS
PART I
Item�1.
Business
Item�1A.
Risk Factors
Item�1B.
Unresolved Staff Comments
Item�2.
Properties
Item�3.
Legal Proceedings
Item�4.
Mine Safety Disclosures
PART II
Item�5.
Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
29
Item�6.
Selected Financial Data
Item�7.
Managements Discussion and Analysis of Financial Condition and Results of Operations
33
Item�7A.
Quantitative and Qualitative Disclosures about Market Risk
Item�8.
Financial Statements and Supplementary Data
Item�9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item�9A.
Controls and Procedures
Item�9B.
Other Information
PART III
Item�10.
Directors, Executive Officers and Corporate Governance
Item�11.
Executive Compensation
Item�12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item�13.
Certain Relationships and Related Transactions and Director Independence
Item�14.
Principal Accountant Fees and Services
PART IV
Item�15.
Exhibits and Financial Statement Schedules
Signatures


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PART I

SPECIAL NOTE REGARDING FORWARDLOOKING STATEMENTS
This Annual Report on Form�10-K (Annual Report), in particular the discussion in Business and Managements Discussion and Analysis of Financial Condition and Results of Operations contains forwardlooking statements that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statements that do not directly relate to any historical or current fact. Forward-looking statements can be identified by words such as anticipates, believes, estimates, expects, intends, plans, predicts, potential, and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forwardlooking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled Risk Factors under Part I, Item 1A. of this Annual Report. We assume no obligation to revise or update any forwardlooking statements for any reason, except as required by law.

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ITEM 1. BUSINESS

Overview
Vitesse Semiconductor Corporation (Vitesse, the Company, us, we, and our) is a leading supplier of high-performance integrated circuits (ICs), associated application and protocol software, and integrated turnkey systems solutions used in Carrier, Enterprise and Industrial Internet of Things (IoT) Ethernet networking applications. With these solutions, we enable networking industries to transition from legacy networks to standards-based, ubiquitous Ethernet Everywhere networking. For over 30 years, starting from Enterprise networks, revolutionizing Carrier networks, and now penetrating Industrial-IoT networks, we have been a leading innovator in networking and connectivity IC solutions.
Our customers include original equipment manufacturers (OEMs) and original design manufacturers (ODMs) in our core Carrier and Enterprise markets, as well as a fast-growing base of customers across an increasingly diversified range of markets defined within Industrial-IoT. In fiscal year 2014, we had over 500 customers worldwide, nearly 300 of which purchased our new products. Our customers include leading networking OEMs such as Alcatel-Lucent, Ciena, Cisco Systems, Dell, Ericsson, Fiberhome, Hewlett-Packard, Juniper Networks, Nokia Networks, Samsung, Tellabs, and ZTE; ODMs such as Accton, Delta Networks, Pegatron, and Rubytech; Industrial networking vendors such as Belden/Hirschmann, General Electric, Kyland, and Moxa; as well as many integrators, contract manufacturers, and sub-contractors in the Industrial Process Control, Smart-Grid Energy Distribution, Transportation, and Factory Automation sectors. Lastly, we count leading processor and specialized system-on-a-chip (SoC) IC companies as customers of our Gigabit Copper physical layer IC (Cu PHY) and Ethernet switch engine Intellectual Property (IP) cores.
Vitesse was incorporated in the state of Delaware in 1987. Our corporate headquarters is located at 4721 Calle Carga, Camarillo, California, and our phone number is (805)�388-3700. As of September�30, 2014, we operated domestic design centers at our corporate headquarters and in Austin, Texas and four international design centers in Denmark, Germany, India, and Taiwan. Our common stock trades on the NASDAQ Global Market under the ticker symbol VTSS.

Industry Background
The communications industrys defining characteristic over the past decade is the exponential traffic growth on public and private communications networks worldwide. These networks include those used by long-distance, local exchange service providers and wireless service providers (Carriers), those used by corporations, government, schools, and other Enterprises, and most recently new networks being created to connect billions of sensors, meters, appliances, vehicles, and other machines in both existing Industrial applications and emerging consumer applications in what is now being called the Internet of Things, or IoT.
Traffic growth is driven by the rapid adoption by consumers, businesses, institutions, and governments of data-intensive applications and services such as Internet access, web-delivered content, video conferencing, Voice Over Internet Protocol (VOIP) phones and television, Cloud storage and computing, financial transactions, Software-as-a-Service (SaaS), and Infrastructure-as-a-Service (IaaS). The growth of sophisticated mobile devices has created the need for high-bandwidth, secure connectivity to the public Internet and to corporate networks over global 4G/LTE networks and next-generation WiFi technologies. Adding to this exploding demand from consumers and businesses is the emerging connectivity of more and more things. Industry analysts expect that these new applications will actually outstrip the more traditional uses of the Internet within a few years, driving more than 50 billion connections by the year 2020.
As a result of this growth over the last decade, networks have evolved from legacy or semi-proprietary protocols to Internet Protocol (IP) as the language to deliver high-bandwidth services. IP is most efficiently transported and switched using Ethernet networking technologies. Ethernet now dominates in all broad-based network deployments, including small and large Enterprise networks, residential and business Access networks, mobile base stations and backhaul, WiFi networks, and the service delivery from public and private Cloud data center networks used by providers such as Google, Facebook, Amazon, and Netflix. As the new networking technology in all of these applications, Ethernet creates the necessary economies of scale, and guarantees that everyone and everything can connect to everything else using the same language.
Just as Ethernet has come to dominate new deployments of both Carrier and Enterprise networks, we are seeing the beginnings of a similar transition within Industrial-IoT networks. These networks, which exist today for Industrial Process Control, Smart-Grid Energy Distribution, Transportation, and Factory Automation applications, are migrating to standards-based Ethernet. These networks will expand over time connecting billions of things in both industrial and consumer applications. As with other communications networks, Ethernet will become the dominant technology. This transition within Industrial-IoT networks represents a new, large, fast-growing market for Vitesse.

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In addition, we anticipate similar transitions to standards-based Ethernet networking to occur for Storage applications, where legacy technologies will be substantially replaced by Ethernet. Although a nascent market today, many industry analysts anticipate this transition to occur rapidly over the next several years. In one of the largest electronics markets, Automotive, the trend is to the connected car. There will be opportunities to connect the car and driver to the Internet, as well as to dozens or hundreds of cameras, sensors and appliances within the vehicle. Over the last two years, the industry has debated the appropriate technologies for these applications. It is now clear that, as with most other markets, the choice will be Ethernet. Every leading automotive manufacturer and all of the leading OEMs providing automotive electronics now support Ethernet as the best alternative for the increasingly complex networking requirements within automobiles.
Because of the growing applications for Ethernet, the technology itself has undergone a profound transformation during the last five years, from a simple, best effort networking technology to a highly-sophisticated, highly-standardized universal networking protocol in Enterprise, Carrier, and Industrial-IoT networks. This complexity poses significant barriers to entry for any company seeking to enter the Ethernet networking market, and consequently, few IC suppliers dominate this market.
It is our view that the great majority of all networks will migrate to Ethernet, leading to our vision: Ethernet Everywhere.
Carrier Networking
The telecommunications service provider Carrier network, which includes networks delivering voice, data and video communication services to business, residential and mobile customers, is now a vastly complex combination of interconnected networks. Since the 1990s, these networks have been based on Synchronous Optical Network (SONET/SDH), which was designed to carry only voice traffic over a fixed circuit network. Just as the Enterprise local area network (LAN) evolved from IBMs TokenRing, FDDI, and other early networking technologies, the same transition is occurring in wide-area networks (WAN) as legacy protocols such as T1/E1 PDH, ATM and SONET/SDH give way to IP, packet-based networks designed to efficiently carry voice, data and video.
To accelerate packet-based IP network deployment, the industry has developed standards to upgrade traditional Ethernet to Carrier Ethernet. Effectively, it is an adaptation of Ethernet to provide similar service, synchronization, and security functions traditionally provided by SONET/SDH. As Carrier Ethernet standards continue to evolve, the majority of legacy service provider networks will be upgraded with equipment using Ethernet networking technology.
We expect the pace of growth in bandwidth demand and the deployment of revenue-generating support services to accelerate well into the future, prompting Carrier network evolution in two notable areas: (1) the migration from wireline to wireless communication, particularly Mobile Access networks for 4G/LTE deployments; and (2) the migration of traditional Enterprise information technology (IT) networks into the Cloud, requiring upgrades from T1/E1 connectivity to secure high-bandwidth service delivery to business over Ethernet. These networks, collectively called the IP Edge, will see large investments and drive the transition to Carrier Ethernet.
Mobile Infrastructure and Access: With the explosion of data and video traffic from smartphones and tablet devices for both personal and business use, and the introduction of 4G/LTE networks worldwide, Mobile Infrastructure and Access dominate the IP Edge. These networks demand Ethernet technologies that enable the delivery of differentiated services, rather than just connectivity. They are also becoming more distributed, with macro and small cell base stations and mobile backhaul networks being the primary growth drivers.
Business Services: As businesses migrate from T1/E1 to Ethernet services, they increasingly turn to equipment compliant with the Metro Ethernet Forum Carrier Ethernet 2.0 (MEF CE 2.0) specifications. MEF CE 2.0-certified equipment guarantees scalable, manageable and secure Ethernet services with multiple classes of services to customers.
Software Defined Networking: As carriers try to optimize operational efficiencies and operationalize and deliver new services to customers in days, instead of months or even years, they increasingly consider software defined networking (SDN) and network function virtualization (NFV) solutions that can abstract service creation from the underlying hardware, and move from OEM-specific network management systems to open-source controller solutions that can run on virtualized servers in the Cloud.
We deliver highly-integrated Ethernet ICs and applications software solutions that allow OEMs and ODMs to design Carrier networking products in both wireless and wired infrastructure applications. Our target applications include Carrier Ethernet switches and routers, macro and small cell base stations, fiber and microwave backhaul systems, and Ethernet Access Devices (EADs). Based on industry market projections and internal estimates, we expect the addressable market for our new portfolio

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of low-power, Carrier Ethernet switch engines and physical layer IC (PHY) products, with integrated software to grow to over $800�million by 2018, a four-year compound annual growth rate (CAGR) of 20%.
Enterprise Networking
Enterprise networks range from large, complex networks for financial institutions, retailers and other large businesses, to LANs for the home and small office and include voice, data and video communications equipment deployed in these settings. Typical categories are large Enterprise, data center switching, small-medium enterprise (SME), small-medium business (SMB) and small office/home office (SOHO).
Similar to Carrier networks, Enterprise networks and data centers must evolve to provide more bandwidth, mobility, reliability, interoperability, and scalability. The advent of Cloud services will increasingly move Enterprise IT applications and data into secure hosted applications in the Cloud, where multiple locations, devices and technologies can access those applications. Cloud services will escalate the need for Enterprises and data centers to provide secure high-bandwidth, high-reliability networks to interconnect elements of the Cloud, collectively called Cloud Access.
We deliver highly-integrated Ethernet ICs and applications software solutions that allow OEMs and ODMs to design Enterprise networking products that can support secure wired and wireless (both 4G/LTE and WiFi) access to private networks and public and private Clouds. Our target applications include Enterprise SME/SMB and Cloud Access switches, routers and gateways, and data center connectivity between servers, switches and storage. Based on industry market projections and internal market growth estimates, we expect our products addressable market in this segment to approach $450�million by 2018 with a CAGR of 18%.
Industrial-IoT Networking
Increasingly, things as well as people are connected to the Internet. This network is made possible by the growth of machine-to-machine (M2M) communications, increased and improved sensor technology, and the acceleration of wireless technology. As the IoT creates new networking opportunities, there are literally hundreds, perhaps thousands of companies now participating in this emerging networking market. As many of these companies do not specialize in networking, we see a growing need to make Ethernet simple. So, we have developed and now provide a broad range of turnkey silicon and software solutions for this fast growing market.
While there is considerable excitement and hype around the potential of billions of devices for the IoT on the consumer side, the market for Industrial-IoT networking is very real today. Networks for Industrial Process Control, Smart-Grid Energy Distribution, Transportation, and Factory Automation applications are all undergoing rapid transformation and growth, with a market that could ultimately approach 700 million devices a year. New requirements within Industrial-IoT are spurring a transition from legacy, proprietary technologies such as PROFINET and EtherCAT to Ethernet.
We are benefiting from this transition. Many of the Carrier Ethernet capabilities that we developed for Carrier networking, including low power, accurate time synchronization and security, are key requirements for networks within Industrial-IoT applications as well.
In addition to the existing and expanding applications within Industrial-IoT networking, there are increasing opportunities within the consumer market. Home automation, security, surveillance, and other markets are creating future requirements for secure high-bandwidth connectivity, all based on Ethernet. This transition is just beginning and will occur over many years. Morgan Stanley forecasts 75 billion devices will connect to the IoT by 2020, translating to 9.4 devices for every one of the eight billion people in the world.
Because of the synergies with our traditional Enterprise and Carrier markets, Industrial-IoT is an obvious adjacent market for us to address. Many of our existing products are ideal for this market segment as we provide both silicon and software solutions that make transitioning to Ethernet simple. No other IC vendor provides this comprehensive solution for Industrial-IoT networks. Our target applications include industrial-class Ethernet switches, security cameras and video distribution, LCD signage, intelligent sensors, and metering equipment. Growing at a CAGR of 45%, we expect Industrial-IoT to add nearly $400 million to our addressable IC market within the next four years.
Other Networks Evolving Towards Ethernet
There are a few other networks that have not completed the evolution from legacy protocols to standards-based Ethernet technology, but soon will. Two examples are Storage networking and Automotive networking.

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Storage Networking
Storage networking is expected to undergo a transition to Ethernet. Traditionally, storage is block- and file-based using protocols such as Small Computer System Interface (SCSI), Serial Attached SCSI (SAS), Serial Advanced Technology Attachment (SATA), and Fibre Channel. There is now an emerging transition to object-based storage that more directly addresses data on disk drives via IP addresses using Ethernet technology. Storage disk drive companies such as Seagate Technology recently introduced disk drives with an Ethernet interface instead of the traditional SAS interface. Any equipment designed to communicate with these disk drive arrays will do so with standards-based Ethernet switch and connectivity technologies.
Automotive Networking
Potentially the largest future networking electronics market is Automotive. Major automotive companies are now driving a transition from the many proprietary networks present in cars today towards a unified Ethernet connectivity. This transition has already started in Infotainment equipment such as backup cameras, video displays and audio systems. The migration will soon extend to diagnostics, driver assist technology, the main systems bus interconnecting engine control, and eventually, to the fully autonomous vehicle. To accomplish this, the industry is adopting low-power, low-cost Ethernet PHY technologies, and time deterministic Ethernet switching technologies. An estimated 117 million vehicles will be in production in 2019, with eight to 35 Ethernet ports per car. By 2020, analysts expect Automotive Ethernet ports to exceed all other LAN/WAN Ethernet networking ports combined.
Although Storage and Automotive networking are in their infancy today, we see significant growth opportunities and expect them to contribute over $700�million to our addressable market by 2020.
Strategy
Attack Large Growth Markets Transitioning to Ethernet
Our strategy is to focus on high-growth markets that have a high probability of benefiting from our differentiated Ethernet technologies, are addressable with our product portfolio, and are seeing significant investment and growth. We concentrate our research and development (R&D) as well as our sales and marketing efforts on three primary markets on the cusp of major investment cycles: Carrier IP Edge, Enterprise Cloud Access, and Industrial-IoT. As more networking markets, such as Storage and Automotive, transition to Ethernet, we will be able to leverage our technology and solutions into those markets with only incremental R&D efforts, further expanding our addressable market and growth opportunities.
Vitesse develops Ethernet switch engines (Switches) and PHYs, bundled turnkey applications software implementing standards-based applications protocols, and complete reference design solutions. Our silicon and software solutions provide a simple path to take OEMs or ODMs to market in record time. Because of the wide applicability of Ethernet Switches and PHYs in a rapidly increasing number of networking applications, our addressable market is large and growing.
In addition to our Switch and PHY products developed specifically for Carrier, Enterprise, and Industrial-IoT applications, we have several products that address high-speed signaling and connectivity issues in a broad variety of systems. As bandwidth requirements continue accelerating, more systems require solutions for high-speed signal integrity problems within and between high-capacity computing and communications systems. Our products address a need to transport signals at ever increasing speeds across fiber, cable and copper backplane applications.
Overall, we estimate the served addressable market for our Ethernet-based IC solutions in our target markets to expand from $1�billion today (2015) to approximately $3.1�billion by 2020 with a CAGR of 25%.
Simplify the Transition to Ethernet with Differentiated Technologies
As we accelerate the transition to Ethernet Everywhere, we serve customers who face the challenge of providing products and services into highly dynamic markets based on evolving technologies and standards. We use our 30�years of design and systems expertise to introduce innovative products that solve both general industry needs, as well as our customers design challenges.
Unique technologies embedded within Vitesse silicon, software, and IP solutions are targeted at our customers most difficult challenges: service delivery, synchronization, security and software. Together, our solutions simplify adoption of standards-based Ethernet in all kinds of networks.
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Service delivery. Vitesse Service Aware Architecture, (ViSAA"), is the industrys only hardware-based switching solution that provides an efficient, low power implementation of complex Carrier Ethernet services. ViSAA enables networking equipment capabilities such as on-demand service creation, remote monitoring and trouble shooting. The

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hardware implementation of critical networking functionality provides higher bandwidth packet processing capability at half the cost and much lower power than competing switch and network processor solutions.
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Synchronization. VeriTime" is our patented timing and synchronization solution implementing enhancements to the IEEE 1588 packet timing standard. IEEE 1588 is forecasted to be the industrys most widely adopted standard for providing critical synchronization and timing for 4G/LTE networks. Integrated into our SynchroPHY" 1 Gigabit Ethernet (GE), 10 GE, and 10 GE Optical Transport Network (OTN) PHY products, VeriTime is the industrys only all-digital hardware-based implementation of IEEE 1588 time stamping in Ethernet switch and PHY silicon and is the only solution on the market today that meets and exceeds the new stringent ITU specifications for next-generation TD-LTE and LTE-Advanced (LTE-A) wireless networks.
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Security. Intellisec" is our patent-pending, flow-based encryption solution for transporting confidential communications over Ethernet networks. A simple, scalable, low power, and easy-to-upgrade implementation, Intellisec is unique in the industry in its abilities to scale IEEE 802.1AE MACsec from a point-to-point encryption solution to a network-wide security solution. In 2013, to address the increasing need for security across all networks, the so-called Snowden Effect, we introduced our 1 GE and 10 GE PHY solutions, combining both VeriTime and Intellisec. These solutions are the only secure 1588 merchant silicon products available today, that can encrypt without compromising timing accuracy. Intellisec is also the first and currently the only PHY-based 128/256-bit AES encryption technology that has passed the U.S. governments FIPS 197 certification for security solutions that can be deployed for government and national infrastructure networks.
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Software. CEServices" is the industrys only turnkey applications software for Carrier and Industrial-IoT applications provided by an Ethernet IC supplier. Our CEServices turnkey software package, in conjunction with our ViSAA-based Carrier Ethernet switch engines, allow customers to develop systems that will quickly and easily pass MEF CE 2.0 certification. CEServices also supports application programming interfaces that can readily be integrated into emerging software SDN and NFV environments.
These advanced solutions address major technology disruptions within multiple network markets. By providing a simplified, turnkey path that enables our customers to adopt these new networking technologies, we intend to exploit:
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A dramatic shift towards Ethernet Everywhere - Ethernet displacing legacy networking protocols across multiple high-growth market segments.
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An increase in the number of customers developing networking technologies for multiple markets, including IoT. Many of these customers have little or no networking expertise, and as a result, seek simple turnkey solutions in silicon and software.
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Increasing adoption of complex Ethernet services within both service providers and their Enterprise customers.
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New requirements for synchronization and security in all types of networks, particularly for Mobile Access and Industrial-IoT applications.
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A move to reduce power dissipation in Carrier and Enterprise network elements using latest-generation Energy Efficient Ethernet (EEE).
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Growing demand for higher bandwidth and higher capacity networks, particularly for Carrier and Enterprise mobility applications, requiring latest generation silicon technologies.
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A trend for customers to seek systems solutions that include compatible and proven ICs and software in reference designs, enabling much faster time-to-market.
Scale Solutions to a Large, Growing Customer Base by Making Ethernet Simple
Ethernet switching and PHY technologies can be complicated. The breadth of features, protocols, and standards can be overwhelming, delaying time-to-market because of the significant learning curve. In 2014, we introduced our CEServices Carrier Ethernet applications software. At over one million lines of code, and an estimated 400 man-years to replicate, it provides our customers a simple, proven path to execute complex networking equipment. For Carrier applications, we enable MEF CE 2.0 compliance. In Enterprise and Industrial-IoT applications, we provide a variety of standard features and protocols that expedite our customers time-to-market.
Through our silicon, software and reference designs, we offer turnkey solutions that customers can use off the shelf as the platform to develop their own branded networking equipment quickly and with minimum support from Vitesse. Our turnkey

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solutions reduce development time from over 1.5 years to less than six months. Providing turnkey solutions of both silicon and software is even more important in the Industrial-IoT market where many customers have limited expertise in developing their own networking solutions.
Expand Presence at Tier-1 Customers
Our Tier-1 customers are savvy buyers who carefully analyze and evaluate our ability to serve them reliably with products and technology, on a continuous basis, over the long-term. A key element of our strategy is to work closely with our customers product managers and systems design groups, as well as business units and corporate management teams allowing us to acquire a detailed understanding of our customers business and needs for technology advancements. Using this knowledge, we develop solutions that address the most compelling design challenges.
Leverage Intellectual Property
We offer a variety of technology cores for license. We count leading processor and consumer electronics IC vendors as customers of our IP cores. We anticipate future revenues from licensing our technology to systems suppliers and non-competing semiconductor suppliers, who would prefer to buy rather than develop this intellectual property. We believe our position as an innovator and low-power leader makes us a compelling supplier of these complex IP cores. In many cases, we can also leverage IP licensing partnerships to accelerate our partners product developments and extend our process technology roadmaps.
Create and sustain material barriers to entry
We believe that our future success will depend largely on our ability to continue improving our products and process technologies, to develop new technologies and to quickly execute complex and highly-integrated silicon and software products that implement ever evolving industry standards. We have over 15 years of experience in Ethernet networking technologies that provides us the systems and applications level expertise required.
Our silicon products are highly-complex VLSI digital designs combined with large, high-performance analog designs, so called mixed-signal designs. As such, they represent some of the most complex and challenging developments in the semiconductor industry. This complexity provides a substantial barrier to entry to competitors, as it is difficult to develop the capabilities in people, tools and processes to execute both VLSI digital design and well as high-performance analog design. In addition to silicon hardware design, we make substantial investments in the development of software to incorporate into our product portfolio.
Our CEServices software is over one million lines of code and would take approximately 400 man-years of effort to replicate. Today, Vitesse is the only company providing highly-integrated silicon and turnkey applications software in the Carrier and Industrial-IoT�Ethernet market that fully captures our long-standing systems, applications, and use case knowledge and expertise.
The combination of systems-level expertise, combined with the ability to execute highly-complex VLSI mixed signal designs and applications-level software required in Ethernet networking, creates a dramatic and sustainable �barrier to entry for any competitor.
Product Overview
While some of our products are targeted at specific markets, most find applications in multiple types of networking equipment across all of our focus markets. A recent history of new product introductions can be found on our website at www.vitesse.com. The information on our website is not incorporated by reference into, and is not made a part of, this report.
Our products fall into the following product lines:
Ethernet Switching Product Line
Our Ethernet Switching product line addresses 1 GE and 10 GE applications in our focus markets. This product line
consists of Carrier Ethernet switch engines, Enterprise Ethernet switches, 1 GE transceivers (Cu PHYs) and associated applications software.

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Carrier Ethernet Switch Engines:
Our ViSAA-based switch engines enable true Carrier Ethernet networking within our target markets. These products combine typical network processor packet processing features, Layer 2 and Layer 3 Ethernet switch functions, VeriTime timing and synchronization technology, and an on-board CPU into a single chip, at substantially lower cost and lower power than competing solutions. Combined with CEServices, our solutions meet MEF CE 2.0 requirements and dramatically reduce our customers time-to-market. In 2014, we introduced our fourth generation Carrier Ethernet switch engine families, Jaguar-2" and Serval-2", providing higher density and bandwidth, and even more enhanced features. These products address a broad range of applications in the Access and Edge of the networks, including Mobile Access equipment such as base stations, small cells, fiber and microwave wireless backhaul, and Cloud Access equipment such as EADs used for delivering business services. Additionally, CEServices is already integrated into one of the leading open-source SDN controllers, enabling easy integration into emerging Carrier SDN deployments.
Many of the value-added features designed into our Carrier Ethernet switch engines and software are broadly applicable to IoT applications as well.
Enterprise Ethernet Switches:
Our Enterprise Ethernet switches target Cloud Access as well as desktop, workgroup and LAN infrastructure within SME/SMB markets, and enable cost-effective migration of these systems to Gigabit Ethernet speeds. To date, we have shipped over 250�million Gigabit Ethernet ports into Enterprise applications. Our Enterprise Ethernet switches provide the highly-integrated, advanced features required in Cloud Access network equipment, significantly reducing the physical system size, power consumption, and material cost for our customers.
In 2014, we introduced our SparX-IV" Enterprise Ethernet switches, optimized for Cloud-managed Enterprise networking applications and equipment, such as Wave 2 802.11ac WiFi access points and aggregation routers. A leading Enterprise Cloud-managed switch OEM has already adopted our solutions.
Gigabit Ethernet Copper and Dual-media Copper PHYs with Timing and Security Functions:
Cu PHYs allow transmission of 10/100/1000 BASE-T data over Cat5 copper cable and fiber optic cabling. This technology is widely deployed in personal computing, home electronics, and LAN applications to Enterprise and data center applications, and more recently in Carrier networking applications. We offer a broad range of products in this category, including single, quad, and octal devices delivering a combination of low power, low cost and high integration. Our SimpliPHY" Cu PHYs provide industry-leading, low-power operation generally using power saving features such as ActiPHY", PerfectReach" and EEE technology that provide energy savings of up to 80%.
Our SynchroPHY Cu PHYs provide accurate packet timing and security with VeriTime IEEE 1588 timing technology and Intellisec 802.1AE MACsec technology.
As Carrier, Enterprise, and Industrial-IoT networks become more distributed, both timing and security become increasingly challenging. Our ICs with with VeriTime IEEE 1588 and Intellisec 802.1AE MACsec can equip industry-standard routers and switches with strong 128-/256-bit strong AES technology, while preserving timing and their ability to interface to any standard service provider network. We are the only provider of this type of solution. We anticipate that multiple Tier-1 OEMs will deploy Intellisec within service provider networks and Enterprise networks by the end of 2015.
Connectivity Product Line
Our Connectivity product line includes mixed-signal physical layer devices for connecting systems via optical fiber, copper cable, or backplanes. These devices, including PHYs, crosspoint switches and signal integrity devices, are deployed across a very wide range of applications and markets.
PHYs with Timing and Security Functions:
A PHY converts high-speed analog signals to low-speed digital signals in fiber optic, copper cable and backplane applications. We offer a broad line of PHY products for the Ethernet, SONET/SDH, and Fibre Channel markets at speeds ranging from
155 Mbps to 15 Gbps.
We offer a broad portfolio of 10 GE PHYs with different port counts and interface options which can be used in a wide variety of networking applications. Our PHY portfolio includes the 10 GE SynchroPHY family with VeriTime IEEE 1588 timing technology and Intellisec 802.1AE MACsec technology.

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Crosspoint Switches:
Our crosspoint switches provide asynchronous, unblocked switching matrices from 4x4 to 144x144 with industry-leading performance up to 11 Gbps. This range of speeds and package form factors enable a wide variety of solutions for SONET/SDH, switching, blade servers and data center switches, high-density routers, and HDTV video equipment.
Signal Integrity Devices:
We provide a broad portfolio of devices for generic signal integrity applications including the high-speed transmission of signals over backplanes and copper cables. Our EQNOX" signal integrity, repeater and re-timing ICs support data rates from 155�Mbps to 28 Gbps for protocols including Ethernet, Fibre Channel, SAS, and SATA. These products incorporate many industry-leading features such as FlexEQ", an adaptive equalization and electronic dispersion compensation technology that dramatically improves signal transmission and reception. Our products are deployed in a wide variety of systems in Carrier, Enterprise, data center, and HD video applications, both within systems and connecting between systems.
Transport Processing Product Line
Our Transport Processing product line addresses the needs of Carrier network providers as they migrate from SONET/SDH to Ethernet packet-based networks.
Framers and Mappers:
We offer a complete line of framers and mappers for SONET/SDH and Ethernet-over-SONET (EoS) applications. These products are targeted principally for systems in the Core and Metro segments of the Carrier networks.
Our most recent products address OTN applications at both the Core and Edge/Access segments of the Carrier network. Vitesse SynchroPHY OTN mapper/PHYs include VeriTime IEEE 1588 technology. Packet-based timing and synchronization support becomes critical as switches and routers add OTN mapping capability to their interfaces to directly interwork with Wavelength Division Multiplexing (WDM) transport systems, while also providing the precise packet timing capabilities required for advanced Mobile networks.
Market Overview
We classify product revenues into four markets: (1) Carrier Networking; (2) Enterprise Networking, (3) Industrial-IoT Networking, and (4) Non-core. These classifications reflect the major trends in our product lines and how they map into our customer base. We also report revenues from the licensing and sale of IP cores.
Our ability to achieve sustained revenue growth depends on several factors including, increasing demand from our end markets; our ability to capture and maintain market share in growing markets; the rate at which these new markets ramp into production; and the continuing trend by systems companies to outsource the designing and manufacturing of ICs to companies such as ours.
Carrier Networking
The global telecommunications Carrier network, which includes networks delivering voice, data and video services, has grown dramatically into a complex combination of networks. Carriers increasingly use Ethernet technology in their networks, particularly for Mobile and Cloud Access.
Broadly, Ethernet technology upgraded to meet these requirements is referred to as Carrier Ethernet. We provide a variety of products for newly emerging Carrier Ethernet applications, as well as for legacy SONET/SDH and EoS applications. Due to the Carrier network complexity, products sold into these applications have long design cycles typically ranging from two to four years from design start to production, and have long life cycles, typically five to 10�years or more.

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These products generally include:
Carrier Networking Products
Product Line
Vitesse Solutions
Ethernet Switching
Carrier Ethernet Switch Engines
Ethernet MACs
Gigabit Ethernet Copper and Dual-Media Cu PHYs
SynchroPHY Gigabit Ethernet Copper and Dual-Media Cu PHYs with VeriTime and Intellisec
CEServices Applications Software
Connectivity
PHYs, including 10GE PHYs
SynchroPHY 10 Gigabit Ethernet PHYs with VeriTime and Intellisec
EQNOX Signal Integrity Devices
Crosspoint Switches
Transport Processing
SynchroPHY 10G OTN Mapper/PHYs with VeriTime
10G SONET/SDH Framers and Mappers
10G EoS Framers and Mappers
Enterprise Networking
Enterprise networks generally include equipment dedicated to the communication of voice and data services within large Enterprise organizations. Increasingly, Enterprise networks also include broadband connections to Carrier networks for the broader communication of voice and data outside of the Enterprise, particularly for access to Cloud services. Enterprise networks are usually classified into groups depending on their size and complexity: large Enterprise switch and routers, data center switching, Cloud-managed switches, and Layer 2 and Layer 3 managed Ethernet switches. The complexity of products within the Enterprise networks varies dramatically based on the market segment. Products at the low-end of the network, in SOHO and SME applications, typically have fast design cycles on the order of six to 12�months and short life cycles, on the order of three to five years. Products sold into applications at the high-end of Enterprise, such as Layer-2 and Layer-3 stackable switches have longer design cycles, typically one to two years from design start to production and long life cycles, typically three to seven years or more.
We provide a variety of products into Enterprise networking applications. These products generally include:
Enterprise Networking Products
Product Line
Vitesse Solutions
Ethernet Switching
Ethernet Switches with integrated Cu PHYs
Stackable Ethernet Switches
Ethernet MACs
Gigabit Ethernet Copper and Dual-Media Cu PHYs
SMBStaX" Applications Software
Connectivity
10 Gigabit Ethernet PHYs
EQNOX Signal Integrity Devices
Crosspoint Switches
Industrial-IoT Networking
Networks for Industrial Process Control, Smart-Grid Energy Distribution, Transportation, and Factory Automation applications are all undergoing rapid and massive transformation. The Industrial-IoT market used to be characterized by many legacy and semi-proprietary protocols, but increasingly these networks are transitioning to Ethernet technology. Most of our products for both Enterprise and Carrier applications can be used in this market. Products sold into these applications have long design cycles typically ranging from one to two years from design start to production, and have long life cycles, typically five to 10�years or more.
These products generally include:

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Industrial-IoT Networking Products
Product Line
Vitesse Solutions
Ethernet Switching
Carrier Ethernet Switch Engines
Gigabit Ethernet Copper and Dual-Media cu PHYs
SynchroPHY Gigabit Ethernet Copper and Dual-Media Cu PHYs with VeriTime and Intellisec
SMBStaX, CEServices Applications Software
Connectivity
SynchroPHY 10 Gigabit Ethernet PHYs with VeriTime and Intellisec
EQNOX Signal Integrity Devices
Crosspoint Switches
Customers
We market and sell our semiconductor products directly to leading OEMs�and ODMs, and through third-party electronic component distributors and manufacturing service providers. Sales to distributors accounted for approximately 56.6%, 52.7% and 51.6%, of our product revenues for fiscal years 2014, 2013 and 2012, respectively. For fiscal years 2014, 2013 and 2012, distributor WPG Holdings accounted for 25.1%, 18.1% and 11.7% of our product revenues, respectively. For fiscal year 2012, distributor Nu Horizons Electronics accounted for 14.6% of our product revenues.
Product revenues from direct customer sales were $44.6 million or 43.4% of product revenues in fiscal year 2014 compared to $47.9 million or 47.3% of product revenues in fiscal year 2013 and $53.2 million or 48.4% of product revenues in fiscal year 2012. Our top five OEM customers for fiscal year 2014 were Alcatel-Lucent, Cisco, Ericsson, Hewlett Packard, and Huawei. Our sales to these customers accounted for approximately 23.2% of our fiscal year 2014 net revenues. Our top five OEM customers for fiscal year 2013 were Alcatel-Lucent, Cisco, Hewlett Packard, Huawei, and Tellabs. Our sales to these customers accounted for approximately 31.3% of our fiscal year 2013 net revenues. Our top five OEM customers for fiscal year 2012 were Alcatel-Lucent, Cisco, Ciena, Huawei Technologies, and ZTE. Our sales to these customers accounted for approximately 27.5% of our fiscal year 2012 net revenues.
Our customer base is widely dispersed geographically. Sales to customers located outside the United States have historically accounted for a significant percentage of our revenues, a trend we expect to continue. On a bill-to basis, international sales constituted 76.7%, 72.6% and 65.2% of our net revenues in fiscal years 2014, 2013 and 2012, respectively. 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. The Significant Customers, Concentration of Credit Risk and Geographic Information footnote in the accompanying consolidated financial statements (note 9) provides more specific data on revenues by geographic area.
In fiscal 2014 we added over 130 new customers. Future sales of our products will be based on, among other elements, expansion into growing adjacent markets; continued expansion of our product line; the acceptance of our products; our customer service levels; expansion into additional domestic and international markets; and our ability to maintain a competitive position against other technology providers.
Manufacturing and Operations
Wafer Fabrication
Our products make use of the state-of-the-art complementary-symmetry metal-oxide-semiconductor (CMOS) technology and other semiconductor technologies, such as silicon-germanium (SiGe). As a fabless semiconductor company, wafer fabrication for our products is outsourced to third-party silicon wafer foundries, primarily Taiwan Semiconductor Manufacturing Corporation (TSMC), and to a lesser extent, GlobalFoundries, IBM, and TowerJazz Semiconductor. This outsourcing eliminates the high costs of owning, operating and upgrading fabrication facilities, and focuses our resources on design and test applications, where we believe we have greater competitive advantages.
Probe, Assembly and Final Test
The highest complexity wafers pass through wafer sort to determine which of the die on the wafer meet functional and performance specifications. This step in the manufacturing process determines the yield of good die per wafer versus the scrap of non-functioning die.
Approved probed die are assembled into packages by our outsourced IC packaging subcontractors. Following assembly, packaged products go through final testing in packaged form to ensure that they meet all functional, performance and quality requirements. This step in the process determines the final yield.

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We outsource the majority of our probe and test functions in order to reduce our manufacturing cycle times, better address customer requirements, increase inventory turns, and reduce our overall fixed cost of probe and testing. For most products, we maintain the capability to probe and test products in small volumes at our own facilities. Like our subcontractors, we use advanced automated testers and high-performance bench test equipment.
Engineering, Research and Development
Continually evolving industry standards, rapid advancements in process technologies, and increasing levels of functional integration characterize the market for our products. We believe that our future success will depend largely on our ability to continue improving our products and our process technologies, to develop new technologies, and to adopt emerging industry standards. Vitesse has a dedicated engineering team who integrates industry standards development, technology changes, and the product directions of our customers, in an effort to provide forward-looking guidance to the development teams in the form of a product roadmap. We work closely with our customers to co-specify and/or co-develop products.
All of our targets markets use Ethernet today, or are migrating to Ethernet, allowing us to focus our development resources on this single technology. With each generation, we create a number of platform developments and then execute derivative developments from these platforms to address growing additional market opportunities. In many cases, additional markets can be addressed with simple changes, often just with new software features.
The majority of our developments are a combination of highly-complex VLSI digital designs combined with large, high-performance analog designs, so called mixed-signal designs. As such, they represent some of the most complex and challenging developments in the semiconductor industry. This complexity provides a substantial barrier to entry to competitors, as it is difficult to develop the capabilities in people, tools, and processes to execute both VLSI digital design and well as high-performance analog design.
In addition to silicon hardware design, we make substantial investments in the development of software to incorporate into our product portfolio. Today, we believe Vitesse is the only company providing both silicon and turnkey applications software in the Carrier Ethernet market. This provides a substantial competitive advantage, particularly at customers that do not have the resources or technical sophistication to develop their own software solutions.
We have significant silicon research, engineering, and product development resources located in two design centers in the United States, combined with four international design centers in Asia and Europe. We have dedicated software systems, architecture, development, and software quality assurance teams in these locations.
Sales and Customer Support
We have a direct sales, applications and customer support organization as well as a network of distributors and sales representatives worldwide. In 2014, we invested to grow our internal marketing, sales, and applications organization to provide additional technical support, particularly for software and complex Ethernet applications within Carrier and Industrial-IoT markets.
Due to the significant engineering effort required in the sale of high-performance ICs, we provide our customers with both field engineering and application engineering support prior to the sale. Common for our industry, our sales cycle is typically lengthy, often six to 12�months or more, and requires the continued participation of salespeople, field engineers, application engineers, and senior management. The steps in our typical product sales cycle are as follows:
Design Opportunity Phase
"
Sales, technical marketing, and executive management engage with their respective peers at our customer.
"
Product samples, evaluation boards and/or systems are provided to the customer and our field applications engineers assist in bringing the product to a working-level in the customers lab to determine the viability and performance of our product in addressing their needs and specifications.
Design Win Phase
"
We use multiple elements to determine a design win. These might include firm commitment from a customers engineering and/or purchasing organizations, pre-production orders, or other indications that the customer selected us over our competitors for use in their system application. In most cases, we are the sole-source supplier to our customers, and typically cannot be easily replaced once we have secured a design win and it goes into production.

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"
We support the customer with technical support as they go through system-level qualification and testing. This support typically includes hardware and software development support.
Production Phase
"
Once the customer has completed system development and qualification efforts, they may move their product into the production phase. It typically takes our customer from six to 48 months to go from design win to production.
Our sales and customer support are based in our corporate headquarters. We have additional sales, field application and customer support offices in the United States, Canada, China, Europe, India, and Taiwan.
Intellectual Property
As of September�30, 2014, we held 87 United States patents and 22 foreign patents, and had 17 patent applications pending in the United States and 30 patent applications pending in foreign jurisdictions. Our intellectual property strategy involves filing additional patent applications in our strategic focus markets on a regular basis. We also generally enter into confidentiality agreements with our employees, consultants and business partners, and typically control access to and distribution of our proprietary information. Despite these precautions, it is possible that competitors or other unauthorized third-parties may obtain and copy, use or disclose our technologies and processes, develop similar technology independently, or design around our patents. As such, any rights granted under our patents may not provide us with meaningful protection. In addition, we may not be able to successfully enforce our patents against infringing products in every jurisdiction. See Risk Factors under Item�1A of this Report for further discussion of the risks associated with patents and intellectual property.
Competition
The markets for our products are highly competitive and subject to rapid advancement in design technology, wafer manufacturing techniques and alternative networking technologies. We must identify and capture future market opportunities by developing and deploying value-added products to offset the fast price erosion that characterizes our industry.
We compete for market share based on our customers selection of our components over our competitors during the design phase of their systems. In addition, many of our large customers have their own internal design teams, which we also compete against when our customers consider a make vs. buy decision. Our ability to compete is dependent on the needs of our customers, how well our products address those needs, our corporate relationships, and a variety of other factors.
Competition is particularly strong in the market for communication ICs, partially due to the markets historical growth rate, which attracts larger competitors, and also to the number of smaller companies focused on this area. The trend in the industry has been, and continues to be, to outsource more designs to companies such as ours. While we expect this trend to continue, we view internal design efforts by our customers as a significant competitive threat. Larger competitors in our market have acquired both mature and early-stage companies with advanced technologies. These acquisitions could enhance the ability of larger competitors to obtain new design wins that we may have otherwise won.
Our competitors include Applied Micro Circuit, Broadcom, InPhi, Marvell Technology Group, Maxim Integrated Products, Micrel, PMC-Sierra, Semtech, and Texas Instruments. These companies, individually and collectively, represent future competition for design wins and subsequent product sales.
Cyclicality
The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence, price erosion, evolving technical standards, short product life cycles, and wide fluctuations in product supply and demand. These factors and others, together with changes in general economic conditions, cause significant upturns and downturns in the industry and within our business. In addition, our operating results are subject to substantial quarterly and annual fluctuations due to a number of factors, such as demand for network infrastructure equipment, the timing of receipt, reduction or cancellation of significant orders, fluctuations in the levels of component inventories held by our customers and distribution partners, the gain or loss of significant customers, market acceptance of our products and our customers products, our ability to develop, introduce, and market new products and technologies on a timely basis, the availability and cost of products from our suppliers, new product and technology introductions by competitors, intellectual property disputes and the timing and extent of product development costs.

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Backlog
Our sales are made primarily pursuant to standard purchase orders for delivery of products. Product quantities to be delivered and delivery schedules are frequently revised to reflect changes in customer needs. For these reasons, our backlog, as of any particular date, is not necessarily representative of actual sales for any succeeding period. We, therefore, do not believe that backlog alone is a reliable indicator of future revenues.
We generally use the sell-through model of accounting when using our distribution network. The sell-through model recognizes revenue only upon shipment of the merchandise from our distributor to the final customer. By using the sell-through methodology, we may have variability in our revenues from quarter-to-quarter as customers have substantial flexibility to reschedule backlog with most of our distribution partners as part of the terms and conditions of sale.
Environmental Management
We monitor the environmental impact of our products. Environmental concerns bring increased attention to the need for lead-free solutions in electronic components and systems within the semiconductor industry. Many companies are moving toward compliance with the Restriction of Hazardous Substances Directive (RoHS), the European legislation that restricts the use of a number of substances, including lead, effective July 2006. We believe that our products are compliant with the RoHS directive. Additionally, some of our subcontractors may be required to register processing materials as required by Registration, Evaluation, Authorization and Restriction of Chemicals (REACH) European Union Regulation, EC/2006/1907.
There are other international environmental directives, regulations, and initiatives that are currently evolving in the electronics industry, such as the halogen-free initiative, which may also impact material suppliers and processing sub-contractors. We believe our parts will be compliant and that materials will be available to meet these emerging regulations. However, it is possible that unanticipated supply shortages or delays may occur as a result of these environmental factors.
Employees
As of September�30, 2014, we had 356 employees worldwide, including 195 in R&D. The balance of employees are listed in population size order: operations, marketing and sales, and finance and administration. Our ability to attract and retain qualified personnel is essential to our continued success. None of our employees are represented by a collective bargaining agreement, nor have we ever experienced a work stoppage. We believe our employee relations are good.
Available Information
We maintain a web site, www.vitesse.com, where we regularly post copies of our press releases and other company information. Our filings with the Securities and Exchange Commission (SEC), including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act), are posted on and available free of charge through the Investor Relations section of our web site and are accessible as soon as reasonably practicable after being electronically filed with or furnished to the SEC.
Interested persons can subscribe on our web site to receive automated email alerts generated when we issue press releases, file our reports with the SEC, or post certain other information to our web site. Information accessible through our web site does not constitute a part of this Annual Report. Copies of this Annual Report are also available free of charge, upon request to our Investor Relations Department, 4721 Calle Carga, Camarillo, California, 93012. Additionally, our Board Guidelines, Code of Business Conduct and Ethics, other corporate policies and written charters for the various committees of our Board of Directors are accessible through the Corporate Governance tab in the Investor Relations section of our web site.
You may read and copy materials that we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC maintains a web site that contains reports, proxy statements and other information we file with the SEC. The address of the SECs web site is www.sec.gov.

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ITEM 1A. RISK FACTORS
You should carefully consider the risks described below before investing in our securities. We organize our risks into the following categories:
"
Risks Relating to Our Business; and
"
Risks Relating to an Investment in Our Common Stock.
Risks Relating to Our Business
We have experienced losses from operations and may experience future losses from operations.
For the year ended September�30, 2014, we had a net loss of $18.1 million. Due to general economic conditions and slowdowns in purchases of networking equipment, it continues to be difficult for us to predict the purchasing activities of our customers. We expect that our operating results will fluctuate substantially in the future and we may experience future losses from operations. In order to achieve and sustain profitability, we must achieve a combination of substantial revenue growth and/or a reduction in operating expenses.
If we are unable to accurately predict our future sales and to appropriately budget for our expenses, our operating results could be materially and adversely affected.
The rapidly changing nature of the markets in which we sell our products limits our ability to accurately forecast quarterly and annual sales. Our sales cycle is often lengthy, particularly for larger transactions. As a result, we devote substantial time and effort and incur significant upfront expense in our sales efforts without any assurance that our efforts will result in a customer purchase. Therefore, it is often difficult to predict when, or even if, we will make a sale with a potential customer. Additionally, we make investment decisions and budget our expense levels based primarily on sales forecasts. Because a substantial portion of our expenses are fixed in the short term or are incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any shortfall of sales. Our operating results will be adversely affected if revenues fall below our expectations in a particular quarter, which could cause the price of our common stock to decline significantly.
Our quarterly revenues and operating results have fluctuated in the past and may fluctuate and be difficult to predict in the future, and such fluctuations could adversely affect our stock price.
Our quarterly revenues and operating results have fluctuated significantly in the past and we believe they may continue to do so. As a result, you should not rely on the results of any one quarter or fiscal period as an indication of future performance and period-to-period comparisons of our revenues and operating results may not be meaningful. This variability and unpredictability could result in our failure to meet our or our investors or securities analysts expectations for a particular period, resulting in a decline in the trading price of our common stock.
Our quarterly operating results may fluctuate as a result of a variety of factors, including, among others, those described elsewhere in this section and those listed below, many of which are outside of our control.
"
Fluctuations in demand for network infrastructure equipment;
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The timing of receipt, reduction or cancellation of significant orders and shipments;
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Fluctuations in the levels of component inventories held by our customers and distribution partners;
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The gain or loss of significant customers;
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Significant changes in the type and mix of products being sold;
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Increased competition from current and future competitors;
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Market acceptance of our products and our customers products;
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Our ability to develop, introduce and market new products and technologies on a timely basis;
"
The availability and cost of products from our suppliers;
"
Reductions in the selling prices of our products;

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"
Design changes to our products made by our customers;
"
New product and technology introductions by competitors;
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Failure by third-party foundries and other subcontractors to manufacture, assemble, test, and ship products on time;
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Changes in third-party foundries and other subcontractors manufacturing capacity, utilization of their capacity and manufacturing yields;
"
Intellectual property disputes; and
"
The timing and extent of product development costs.
Our operating results may be adversely impacted by economic conditions and uncertainties in the markets we address, including the cyclical nature of and volatility in the semiconductor industry. As a result, the market price of our common stock may decline.
We operate primarily in the semiconductor industry, which is cyclical and subject to rapid change and evolving industry standards. From time-to-time, the semiconductor industry has experienced significant and extended downturns. These downturns are characterized by decreases in product demand, excess customer inventories and accelerated erosion of prices. These factors could cause substantial fluctuations in our revenues and in our results of operations. Any downturns in the semiconductor industry may be severe and prolonged and any failure of the industry or wired and wireless communications markets to fully recover from downturns could seriously impact our revenues and harm our business, financial condition and results of operations. The semiconductor industry also periodically experiences increased demand and production capacity constraints which may affect our ability to manufacture and ship products. Accordingly, our operating results may vary significantly as a result of the general conditions in the semiconductor industry, which could cause large fluctuations in our stock price.
The lengthy life cycle of our products as well as the short life cycles of some of the end products for which our products are designed may leave us with obsolete or excess inventories, which could have an adverse impact on our operating profit and net income results.
Many of our products have very long life cycles, often exceeding 10 years or more. These life cycles may be longer than what is typically supported by wafer and/or assembly manufacturers. Accordingly, we are sometimes subjected to end-of-life notices on certain materials and/or products provided by these manufacturers. This longer life cycle may impact our ability to continue to support certain products, forcing us to cease offering these products if we cannot obtain a replacement source of material. This longer life cycle may impact revenues and/or require us to incur additional costs to obtain alternative sources for these materials.
Further, the life cycles of some of our products depend heavily upon the life cycles of the end products for which our products are designed. Products with short life cycles require us to manage production and inventory levels closely. Write-offs of obsolete or excess inventories resulting from unanticipated changes in the estimated total demand for our products and/or the estimated life cycles of the end products for which our products are designed may negatively affect our operating profit and net income results.
We have limited control over the indirect channels of distribution we utilize, which makes it difficult to accurately forecast orders and could result in the loss of certain sales opportunities.
A portion of our sales is realized through independent resellers and distributors that are not under our control. For the year ended September�30, 2014, 56.6% of our product revenues were through these entities. These independent sales organizations generally represent product lines offered by several companies, and thus, could reduce their sales efforts applied to our products or terminate their representation of us. Our revenues could be adversely affected if our relationships with resellers or distributors were to deteriorate or if the financial condition of one or more significant resellers or distributors were to decline.
In addition, as our business grows, there may be an increased reliance on indirect channels of distribution. There can be no assurance that we will be successful in maintaining or expanding these indirect channels of distribution. This uncertainty could result in the loss of certain sales opportunities. Furthermore, our reliance on indirect channels of distribution may reduce visibility with respect to future business opportunities, thereby making it more difficult to accurately forecast orders.
Further, we generally use the sell-through accounting policy model which recognizes revenues only upon shipment of the merchandise from our distributor to the final customer. Because we use the sell-through methodology, we may have variability

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in our revenues from quarter-to-quarter as customers have substantial flexibility to reschedule backlog with most of our distribution partners as part of their terms and conditions of sale.
Order or shipment cancellations or deferrals could cause reductions in our revenues or unplanned inventory growth resulting in excess inventories, which may adversely affect our operating results.
We sell, and expect to continue selling, a significant number of products pursuant to purchase orders that customers may cancel or defer on short notice without incurring a significant penalty. If a customer cancels or defers product shipments or refuses to accept shipped products, we may incur unanticipated reductions or delays in recognizing revenues and be required to hold excess inventories. Holding excess inventories could reduce our profit margins by reducing sales prices or requiring inventory write-downs or write-offs for excess or obsolete inventory.
Our international sales and operations subject us to risks that could adversely affect our revenues and operating results.
Sales to customers located outside the United States account for a significant percentage of our revenues. International sales constituted 76.7%, 72.6% and 65.2% of our net revenues in fiscal years 2014, 2013 and 2012, respectively. Development and customer support operations located outside the United States have historically accounted for a significant percentage of our operating expenses, and we anticipate that such operations will continue to account for a significant percentage of our expenses. International sales and operations involve a variety of risks and uncertainties, including risks related to:
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Reliance on strategic alliance partners;
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Compliance with changing foreign regulatory requirements and tax laws;
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Difficulties in staffing and managing foreign operations;
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Reduced protection for intellectual property rights in some countries;
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Longer payment cycles to collect accounts receivable in some countries;
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Political and economic instability and potential hostilities and changes in diplomatic and trade relationships;
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Economic downturns in international markets and disruptions in capital and trading markets;
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Wage inflation;
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Currency risks;
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Existing or future environmental laws and regulations;
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Cultural differences in the conduct of business;
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Natural disasters, acts of terrorism and war;
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Changing restrictions imposed by United States export laws, including increasing restrictions based on security concerns; and
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Competition from companies based in North America that have established significant international operations.
Failure to successfully address these risks and uncertainties could adversely affect our international sales and operations, which could in turn, have a material and adverse effect on our results of operations and financial condition.
If we are unable to develop and introduce new products successfully, keep abreast of the rapid technological changes in our market or achieve market acceptance of our new products, our revenues and operating results will be adversely affected.
Our future success will depend on our ability to develop and timely introduce new, high-performance ICs and IC systems for existing and new markets and our success in developing and delivering these new products will depend on various factors, including our ability to:
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Accurately predict market requirements, changes in technology and evolving industry standards;
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Accurately define new products;
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Expand our software capabilities in order to provide customers with complete product solutions;

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"
Complete and introduce new products in a cost-effective and timely manner;
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Qualify and obtain industry interoperability certification of our products and our customers products into which our products will be incorporated, including the related software content included in our products or with which our products integrate;
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Work with our wafer foundry, assembly, and probe and test subcontractors to achieve high manufacturing yields;
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Convince leading communications equipment manufacturers to select these products; and
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Gain market acceptance of our products and our customers products.
We may not have sufficient resources to make the substantial investment in R&D in order to develop and bring to market new and enhanced products or to improve and further develop the software content included in our products or their compatibility with systems in which our products integrate. Furthermore, we are required to continually evaluate expenditures for planned product development and to choose among alternative technologies based on our expectations of future market growth. We may be unable to timely develop and introduce new or enhanced products, our products may not satisfy customer requirements or achieve market acceptance, or we may be unable to anticipate new industry standards and technological changes. We also may not be able to respond successfully to new product announcements and introductions by competitors.
There can be no assurance that we will be successful in developing and marketing these new or other future products. Our inability to develop and introduce new products successfully and in a timely manner could negatively affect our business and results of operations.
Demand for our products is dependent on demand for our customers products.
Our success will also depend on the ability of our customers to successfully develop new products and enhance existing products for the Carrier, Enterprise and Industrial-IoT networking markets. These markets may not develop in the manner or in the time periods that our customers anticipate. If they do not, or if our customers products do not gain widespread acceptance in these markets, our revenues and operating results may be materially and adversely affected.
Failure to accurately forecast market and customer demand for our products, or to quickly adjust to forecast changes, could adversely affect our business and financial results or operating efficiencies.
Product introductions, as well as plans for future products, are based on our expectations regarding market demand and direction. If our expectations regarding market demand and direction are incorrect, the rate of development or acceptance of our current and next-generation solutions do not meet market demand and customer expectation, the sales of our legacy or current Carrier, Enterprise and Industrial-IoT networking products decline more rapidly than we anticipate, or if the rate of decline continues to exceed the rate of growth of our new products, our revenues and operating results could be materially and adversely affected.
Our ability to accurately forecast customer demand may also be impaired by the delays inherent in our lengthy sales cycle. After we have developed and delivered a product to a customer, our customers need time to test, evaluate and adopt our products and additional time to begin production of the equipment that incorporates our products. Due to this lengthy cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenues from these products. It is possible that we may never generate any revenues from these products after incurring such expenditures. Even if a customer selects our product to incorporate into their equipment or devices, we have no assurance that the customer will ultimately bring our product to market or that such effort by our customer will be successful. If we incur significant research and development expenses, marketing expenses and investments in inventory in the future that we are not able to recover, and our operating results could be adversely affected.

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We are dependent on a small number of customers in a few industries for a significant amount of revenues. A decrease in sales to or the loss of one or more significant customers could adversely impact our revenues and results of operations.
We focus our sales efforts on a small number of customers in the Carrier and Enterprise networking markets that require high-performance ICs. We intend to continue doing so in the future. Some of these customers are also our competitors. If any of our major customers were to delay orders of our products or stop buying our products, our business and financial condition would be severely affected. Additionally, if any of our customers are impacted by consolidation, experience financial difficulty, or are impacted by adverse economic conditions that would delay networking infrastructure upgrades, build-outs or new installations, we could experience increased competition for our products and downward pressure on the pricing of our products.
We depend on third-party wafer foundries and other suppliers and subcontract manufacturers to manufacture and test substantially all of our current products and any delays in materials or packaging, availability of manufacturing capacity, or failure to meet quality control requirements could have material adverse effects on our customer relationships, revenues and cash flows.
Wafer fabrication for our products is outsourced to third-party silicon wafer foundry subcontractors, primarily TSMC and, to a lesser extent, GlobalFoundries, IBM, and TowerJazz Semiconductor. We depend on these third-party wafer foundries to allocate a portion of their manufacturing capacity sufficient to meet our needs and to produce wafers of acceptable quality in a timely manner. There are significant risks associated with our reliance on third-party foundries, including:
"
Lack of assured wafer supply, the potential for wafer shortages and possible increases in wafer prices;
"
Limited control over delivery schedules, manufacturing yields, product costs, and product quality; and
"
Unavailability of, or delays in, obtaining access to key process technologies.
These risks and other risks associated with our reliance on third-party wafer foundries could materially and adversely affect our revenues, cash flows, operating results, and relationships with our customers.
Our third-party wafer foundries fabricate products for other companies and, in certain cases, manufacture products of their own design. Historically, there have been periods in which there has been a worldwide shortage of wafer foundry capacity for the production of high-performance ICs such as ours. Instead of having long-term agreements with any of our third-party foundries, we subcontract our manufacturing requirements on a purchase order basis. As a result, it is possible that the capacity we may need in the future may not be available to us on acceptable terms, if at all.
A significant portion of the manufacturing operations required for our products are located in Asia. These areas are subject to natural disasters including earthquakes, tsunamis and floods, such as the earthquake and tsunami that occurred in Japan and the floods that occurred in Thailand, that disrupted the global supply chain for components manufactured in those countries. A significant natural disaster or other catastrophic event could significantly disrupt our foundries production capabilities and could result in our experiencing a significant delay in delivery or substantial shortage of wafers and possibly in higher wafer prices. Any supply disruption or business interruption could materially and adversely affect our business, financial condition and results of operations.
If any of our foundries do not have adequate available capacity for us for any reason, we may encounter supply delays or disruptions, and we may need to qualify an alternative foundry. Our current foundries need to have new manufacturing processes qualified if there is a disruption in an existing process. We typically require several months to qualify a new foundry or process before we can begin shipping products from the new foundry. If we cannot accomplish this qualification in a timely manner, we may experience a significant interruption in supply of the affected products.
In addition to third-party wafer foundries, we also depend on third-party subcontractors in Asia and the United States for the assembly, wafer probe and package testing of our products. As with the wafer foundries, any difficulty in obtaining parts or services from these subcontractors could affect our ability to meet scheduled product deliveries to customers, which could in turn have a material adverse effect on our customer relationships, revenues and operating results.
These third-party subcontractors purchase materials used in the assembly process based on our forecast. In the event we fail to meet our obligations by placing purchase orders that are inconsistent with our forecast, we may be required to pay for material forecasted, but not ordered. This obligation may have an adverse effect on operating results and cash flows.
As with wafer fabrication, worldwide assembly and testing capacity for our products is limited, and we are dependent on our suppliers to provide enough capacity in the correct mix to address all of our requirements. The master service agreements with our assembly subcontractors have provisions for the subcontractors to maintain inventory stocks based on forecasts, but these

21


agreements do not include any guaranteed capacity provisions. As a result, it is possible that the capacity we will need in the future may not be available to us on acceptable terms, if at all, and we could experience shortages or assembly problems in the future. As part of our test outsourcing agreement, we consigned testing equipment to our test subcontractor. The availability of assembly and test services from these subcontractors could be materially and adversely affected in the event a subcontractor experiences financial difficulties or suffers any damage to their facilities.
If we do not achieve satisfactory manufacturing yields or quality, our business will be harmed because of increases in our business expenses.
The fabrication of ICs is a highly complex and technically demanding process. Defects in designs, problems associated with transitions to newer manufacturing processes, and the inadvertent use of defective or contaminated materials can result in unacceptable manufacturing yields and performance. These problems are frequently difficult to detect in the early stages of the production process and can be time-consuming and expensive to correct once detected. Even though we procure all of our wafers from third-party foundries, we may be responsible for low yields when these wafers are tested against our quality control standards. In addition, defects in our existing or new products may require us to incur significant warranty, support and repair costs, and could divert the attention of our engineering personnel away from the development of new products.
In the past, we have experienced difficulties in achieving acceptable probe and/or final test yields on some of our products, particularly with new products, which frequently involve new manufacturing processes and smaller geometry features than previous generations. Decreased yields can result in higher unit costs, shipment delays and increased expenses associated with resolving yield problems. Because we also estimate yields to value work-in-process inventory, yields below our estimates may require us to increase the value of inventory and related reserves reflected on our financial statements. Poor manufacturing yields, defects or other performance problems with our products could adversely affect our ability to provide competitively priced products and our operating results.
Defects, errors, or failures in our products could result in higher costs than we expect and could harm our reputation and adversely affect our revenues and level of customer satisfaction.
Due to the highly complex nature of our products, on occasion an undetected defect, error, or failure may occur when one of our products is deployed in the field. The occurrence of defects, errors, or failures in our products could result in cancellation of orders, product returns, increased warranty expense, and the loss of, or delay in, market acceptance of our IC solutions. Our customers could, in turn, bring legal actions against us, resulting in the diversion of our resources, legal expenses and judgments, fines or other penalties, or losses. Any of these occurrences could adversely affect our business, results of operations and financial condition.
We face significant emerging and existing competition and, therefore, may not be able to maintain our market share or may be negatively impacted by competitive pricing practices.
The markets for our products are intensely competitive and subject to rapid technological advancement in design technology, wafer manufacturing techniques and alternative networking technologies. Our competitors have increasingly frequent opportunities to supplant our products in next-generation systems because of shortened product life and design cycles in many of our customers products. Our customers may substitute use of our products in their next-generation equipment with those of current or future competitors. Our customers may choose to internally design and develop products for themselves.
Our competitors include Applied Micro Circuit, Broadcom, InPhi, Marvell Technology Group, Maxim Integrated Products, Micrel, PMC-Sierra, Semtech, and Texas Instruments. Larger competitors in our market have acquired both mature and early stage companies with advanced technologies. These acquisitions could enhance the ability of larger competitors to obtain new business that we might have otherwise won. In addition, we are aware of smaller privately-held companies that focus on specific portions of our range of products. Over the next few years, we expect additional competitors, some of which may have greater financial and other resources than we have, to enter the market with new products. These companies, individually and collectively, represent future competition during the design stage and in subsequent product sales.


22


We must keep pace with rapid technological change and evolving industry standards in order to grow our revenues and our business.
We sell products in markets that are characterized by rapid technological changes in product technologies, process technologies and software, including evolving industry standards, frequent new product introductions, short product life cycles, and increasing demand for higher-levels of integration, smaller process geometries, and increasing levels of software content. We believe that our success, to a large extent, depends on our ability to adapt to these changes, to continue to improve our product technologies, and to develop new products and technologies to maintain our competitive position. Our failure to accomplish any of these objectives could have a negative impact on our business and financial results. If new industry standards emerge, our products or our customers products could become unmarketable or obsolete, and we could lose market share. We may also have to incur substantial unanticipated costs to comply with these new standards.
Development costs for new product technologies continue to increase. We may incur substantially higher research and development costs for next-generation products, as these products are typically more complex and must be implemented in more advanced wafer fabrication processes and assembly technologies.
Our operating results may be adversely impacted by worldwide political and economic conditions and uncertainties. As a result, the market price of our common stock may decline.
Recent general worldwide economic conditions have included slower economic activity, an increase in bankruptcy filings, concerns about inflation and deflation, increased energy costs, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions, liquidity concerns in the wired and wireless communications markets, international conflicts, terrorist and military activity, and the impact of natural disasters and public health emergencies. These conditions make it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and these conditions have caused, and may continue to cause, United States and foreign businesses to slow spending on products such as ours, which delays and lengthens sales cycles. We cannot predict the timing, strength or duration of any slowdown or subsequent recovery in the worldwide economy, the semiconductor industry or the wired and wireless communications markets. If the economy or markets in which we operate do not return to historical levels, our business, financial condition and results of operations will likely be materially and adversely affected.
Our business is subject to environmental regulations that could increase our operating expenses.
We are subject to a variety of federal, state, local and country-specific environmental regulations relating to the use, storage, discharge, and disposal of toxic, volatile and other hazardous chemicals used in our design process. In some circumstances, these regulations may require us to fund remedial action regardless of fault. Consequently, it is often difficult to estimate the future impact of environmental matters, including the potential liabilities associated with chemicals used in our design process. If we fail to comply with these regulations, we could be subject to fines or be required to suspend or cease our operations. In addition, these regulations may restrict our ability to expand operations at our present locations in the United States and worldwide or require us to incur significant compliance related expenses.
Laws and regulations have been enacted in several jurisdictions in which we sell our products, including various European Union (EU), member countries. For example, the RoHS directive, an EU regulation, restricts the use of certain hazardous substances, including lead, used in the construction of component parts of electrical and electronic equipment. We believe that our products comply with the RoHS directive; however, if we fail to comply with these regulations in the future, we may be forced to recall products and cease their manufacture and distribution, and we could be subject to civil or criminal penalties. We may incur increased manufacturing costs, and some products may be subject to production delays to comply with future legislation which implements this directive, but we cannot currently estimate the extent of such increased costs or production delays, if any. To the extent that any such cost increases or delays are substantial, our operating results could be materially adversely affected. Also, we are aware that lead times for new, compliant components are longer and that older, non-compliant components are being discontinued at a fast pace. We or our customers may be impacted by shortages if parts that comply with the RoHS directive are not available.
Similar legislation may be enacted in other countries or regions where we sell our products. We will need to ensure that we comply with these laws and regulations as they are enacted, and that our subcontractors also comply with these laws and regulations. If we or our subcontractors fail to comply with the legislation, our customers may refuse or be unable to purchase our products, which could harm our business, operating results and financial condition. If we have to make significant capital expenditures to comply with environmental laws, or if we are subject to significant expenses in connection with a violation of these laws, our business, operating results and financial condition could be materially and adversely affected.

23


Our success depends on our ability to attract and retain qualified personnel.
A small number of key executive officers manage our business. Their departure could have a material adverse effect on our operations. We believe that our future success will also depend, in large part, on our continued ability to attract and retain highly-qualified technical sales and marketing personnel, design and application engineers, as well as senior management. We believe that there is, and will continue to be, intense competition for qualified personnel in the semiconductor industry as the emerging broadband wireless and wire line communications markets develop, and we cannot assure you that we will be successful in retaining our key personnel or in attracting and retaining highly-qualified manufacturing personnel, technical sales and marketing personnel, design and application engineers, as well as senior management. The loss of the services of one or more of our key employees or our inability to attract, retain and motivate qualified personnel could have a material effect on our ability to operate our business. We do not presently maintain key-man life insurance for any of our key executive officers.
If we are not successful in protecting our intellectual property rights, our ability to compete or maintain market share may be harmed.
We rely on a combination of patent, copyright, trademark, and trade secret protections, as well as confidentiality agreements and other methods, to protect our proprietary technologies and processes. For example, we enter into confidentiality agreements with our employees, consultants and business partners, and control access to, and distribution of our proprietary information. As of September�30, 2014, we held 87 United States patents and 22 foreign patents, and had 17 patent applications pending in the United States and 30 patent applications pending in foreign jurisdictions for various aspects of design and process innovations.
However, despite our efforts to protect our intellectual property, we cannot assure you that:
"
Steps we take to prevent misappropriation or infringement of our intellectual property will be successful;
"
Any existing or future patents will not be challenged, invalidated or circumvented;
"
Any pending patent applications or future applications will be approved;
"
Others will not independently develop similar products or processes to our, or design around our, patents; or
"
Any of the measures described above will provide meaningful protection.
Further, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. It may be possible for a third-party, including our licensees, to misappropriate our copyrighted material or trademarks. It is possible that existing or future patents may be challenged, invalidated or circumvented and effective patent, copyright, trademark, and trade secret protection may be unavailable or limited in foreign countries. It may be possible for a third-party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents in the United States and in other jurisdictions. It is also possible that some of our existing or new licensing relationships will enable other parties to use our intellectual property to compete against us. Legal actions to enforce intellectual property rights tend to be lengthy and expensive and the outcome often is not predictable. As a result, despite our efforts and expenses, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business. In addition, practicality also limits our assertion of intellectual property rights. Patent litigation is expensive and its results are often unpredictable. Assertion of intellectual property rights often results in counterclaims for perceived violations of the defendants intellectual property rights and/or antitrust claims. Certain parties, after receipt of an assertion of infringement will cut off all commercial relationships with the party making the assertion, thus making assertions against suppliers, customers, and key business partners risky. If we forgo making such claims, we may run the risk of creating legal and equitable defenses for an infringer.
Certain of our software (as well as that of our customers) may be derived from so-called open source software that is generally made available to the public by its authors and/or other third parties. Open source software is made available under licenses that impose certain obligations on us in the event we were to distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public, and/or license such derivative works under a particular type of license, rather than the forms of license customarily used to protect our intellectual property. While we believe we have complied with our obligations under the various applicable licenses for open source software, in the event that the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work if the license is terminated.

24


We may be subject to claims of infringement of third-party intellectual property rights or demands that we license third-party technology, which could result in significant expense and loss of our proprietary rights.
The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights. As is common in the industry, from time-to-time, third parties have asserted patent, copyright, trademark, and other intellectual property rights to technologies that are important to our business and have demanded that we license their patents and technology. To date, we have not believed it necessary to license any of the rights referred to in such claims. We expect, however, that we will continue to receive such claims in the future, and any litigation to determine their validity, regardless of our merit or resolution, could be costly and divert the efforts and attention of our management and technical personnel. We also may be required to defend and indemnify customers against claims of infringement of third-party intellectual property rights, which could result in significant expense. Our recent efforts to license our intellectual property to third-parties may also increase the potential for others to initiate claims against us. We cannot assure that we would prevail in such disputes given the complex technical issues and inherent uncertainties in intellectual property litigation. The resolution or compromise of any litigation or other legal process to enforce such alleged third-party rights, including claims arising through our contractual indemnification of our customers, or claims challenging the validity of our patents, regardless of its merit or resolution, could be costly and divert the efforts and attention of our management and technical personnel. If such litigation were to result in an adverse ruling we could be required to:
"
Pay substantial damages;
"
Discontinue the use of infringing technology, including ceasing the manufacture, use or sale of infringing products;
"
Expend significant resources to develop non-infringing technology;
"
Pay substantial damages to our customers or end users to discontinue use or replace infringing technology with non-infringing technology; or
"
License technology from the party claiming infringement, which license may not be available on commercially reasonable terms.
Litigation resulting in any of the above could materially and adversely affect our business, financial condition and operating results.
Our critical information systems, necessary for the operation of our business, are subject to interruptions, failures and attacks
We rely on information systems to provide products and services, process orders, manage inventory, process shipments to customers, keep financial, employee and other records, and operate other critical functions, some of which may be owned by us or by third-party cloud-based service providers. These systems are maintained and proprietary information is transmitted from our offices and research and development facilities throughout the world, including at facilities outside of the United States. Our systems, including those of our service providers, are subject to damage or interruption from a number of potential sources, including natural disasters, accidents, power disruptions, telecommunications failures, acts of terrorism or war, computer viruses, physical or electronic break-ins, cyber attacks, sabotage, vandalism, or similar events or disruptions. Our security measures may not detect or prevent such security breaches. Any such compromise of our information security could result in the theft or unauthorized use of our confidential business information or intellectual property, result in the unauthorized release of customer, supplier or employee data, result in a violation of privacy or other laws, expose us to a risk of litigation or damage our reputation. In addition, our inability to use or access these information systems at critical points in time could unfavorably impact the timely and efficient operation of our business, which could negatively affect our business and operating results.
We are subject to United States Customs and Export Regulations.
We are subject to United States Customs and Export Regulations, including United States International Traffic and Arms Regulations and similar laws, which collectively control import, export and sale of technologies by United States companies. Failure to comply with such regulations may result in civil and criminal enforcement, including monetary fines and possible injunctions against shipment of product, which could have a material adverse impact on our results of operations and financial condition.

25


Risks Relating to an Investment in Our Common Stock
Our executive officers, directors and their affiliates hold a large percentage of our stock and their interests may differ from other stockholders.
Our directors, executive officers and individuals or entities affiliated with our directors as a group beneficially own approximately 23.5% of our outstanding common stock at November 28, 2014. The interests of these stockholders may differ substantially from the interests of other stockholders. If these stockholders choose to act or vote together, they will have the power to significantly influence the election of our directors, and the approval of any other action requiring the approval of our stockholders, including any amendments to our certificate of incorporation and mergers or sales of substantially all of our assets. In addition, without the consent of these stockholders, we could be prevented from entering into transactions that could be beneficial to us or our other stockholders. Also, third parties could be discouraged from making a tender offer or bid to acquire us at a price per share that is above the then-current market price.
Our operating and financial flexibility is limited by the terms of the agreements governing our Term A and Term B Loans.
As of September 30, 2014, we had outstanding $17.2�million in original principal of our senior term loans (the Term A Loan and Term B Loan, which we collectively refer to as our Term A and B Loans) maturing on August 31, 2016, with certain lenders for which Whitebox VSC,�Ltd. serves as agent. We have the right to optionally prepay the Term A and B Loans in whole or in part, at any time and from time to time, subject to the payment of a prepayment fee. The loan agreement governing our Term A and B Loans contains financial and other covenants that may limit our ability to, or prevent us from, taking certain actions that we believe are in the best interests of our business and our stockholders. For example, the loan agreement contains covenants that limit our ability, among other things, to:
"
incur additional indebtedness;
"
pay dividends or make distributions to our stockholders;
"
repurchase or redeem our stock;
"
make investments;
"
grant liens;
"
make capital expenditures;
"
enter into transactions with our stockholder and affiliates;
"
enter into hedging agreements;
"
sell assets;
"
maintain less than $8.0 million of unrestricted cash;
"
allow consolidated revenues for any fiscal quarter to be less than $10.0 million; and
"
acquire the assets of, or merge or consolidate with, other companies.
A breach of any of these covenants could result in a default under the loan agreement, in which event our lenders could elect to declare all amounts outstanding to be immediately due and payable. If the lenders require immediate repayment, and we do not have sufficient funds to repay them in full, substantially all of our assets secure our obligations under the Term A and B Loans, and assets may be sold to pay those obligations, which could severely harm our business.

26


The price of our common stock may fluctuate significantly.
The price of our common stock is volatile and may fluctuate significantly. There can be no assurance as to the prices at which our common stock will trade or that an active trading market in our common stock will be sustained in the future. The market price at which our common stock trades may be influenced by many factors, including:
"
Our operating and financial performance and prospects, including our ability to achieve sustained profitability;
"
The depth and liquidity of the market for our common stock which can impact, among other things, the volatility of our stock price and the availability of market participants to borrow shares;
"
Investor perception of us and the industry in which we operate;
"
The level of research on our company;
"
Changes in earnings estimates or buy/sell recommendations by analysts;
"
The issuance and sale of additional shares of common stock;
"
General financial and other market conditions; and
"
Domestic and international economic conditions.
In addition, public stock markets have experienced, and may in the future experience, extreme price and trading volume volatility, particularly in the technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to or disproportionately impacted by the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock.
Provisions in our organizational documents and Delaware law will make it more difficult for someone to acquire control of us.
Our restated certificate of incorporation, our amended and restated bylaws and the Delaware General Corporation Law contain several provisions that would make more difficult an acquisition of control of us in a transaction not approved by our board of directors. Our restated certificate of incorporation and amended and restated bylaws include provisions such as:
"
The ability of our board of directors to issue shares of our preferred stock in one or more series without further authorization of our stockholders;
"
A prohibition on stockholder action by written consent; and
"
A requirement that stockholders provide advance notice of any stockholder nominations of directors or any proposal of new business to be considered at any meeting of stockholders.
In addition to the provisions in our restated certificate of incorporation and amended and restated bylaws, Section�203 of the Delaware General Corporation Law generally provides that a corporation shall not engage in any business combination with any interested stockholder during the three-year period following the time that such stockholder becomes an interested stockholder, unless a majority of the directors then in office approves either the business combination or the transaction that results in the stockholder becoming an interested stockholder or specified stockholder approval requirements are met.
Our ability to use our net operating losses (NOLs) and other tax attributes to offset future taxable income is limited and could be limited further by an ownership change and/or decisions by California and other states to suspend the use of NOLs.
We have significant NOLs and R&D tax credits available to offset our future United States federal and state taxable income. Our ability to utilize our NOLs and other tax attributes are subject to significant limitations under Section 382 of the Internal Revenue Code (and applicable state law) resulting from ownership changes and may in the future be subject to additional limitations under Section 382 if we undergo further ownership changes. Section 382 imposes an annual limitation (based upon our value at the time of the ownership change, as determined under Section 382 of the Internal Revenue Code) on the amount of taxable income a corporation may offset with pre-ownership change NOLs. Section 383 also limits our ability to use R&D tax credits. In addition, if the tax basis of our assets exceeded the fair market value of our assets at the time of an ownership change, Section 382 could also limit our ability to use amortization of capitalized R&D and goodwill to offset taxable income for the first five years following an ownership change. Any unused annual limitation may be carried over to later years until

27


the applicable expiration date for the respective NOLs. As a result, our inability to utilize these NOLs, credits or amortization as a result of any ownership changes could adversely impact our operating results and financial condition.
In addition, California and certain states have suspended use of NOLs for certain taxable years and other states are considering similar measures. As a result, we may incur higher state income tax expense in the future. Depending on our future tax position, continued suspension of our ability to use NOLs in states in which we are subject to income tax could have an adverse impact on our operating results and financial condition.
The market price for our common stock has experienced significant price and volume volatility and is likely to continue to experience significant volatility in the future. This volatility may impair our ability to finance strategic transactions with our stock and otherwise harm our business.
Our stock price is likely to experience significant volatility in the future as a result of numerous factors outside our control. Significant declines in our stock price may interfere with our ability to raise additional funds through equity financing or to finance strategic transactions with our stock. We have historically used equity incentive compensation as part of our overall compensation arrangements. The effectiveness of equity incentive compensation in retaining key employees may be adversely impacted by volatility in our stock price. In addition, there may be increased risk of securities litigation following periods of fluctuations in our stock price. Securities class action lawsuits are often brought against companies after periods of volatility in the market price of their securities. These and other consequences of volatility in our stock price which could be exacerbated by the recent worldwide financial crisis could have the effect of diverting managements attention and could materially harm our business.
The effectiveness of disclosure controls is inherently limited.
We do not expect that our disclosure controls and procedures, or our internal control over financial reporting, will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system objectives will be met. The design of a control system must also reflect applicable resource constraints, and the benefits of controls must be considered relative to their costs. As a result of these inherent limitations, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Failure of the control systems to prevent error or fraud could materially adversely impact our financial results and our business.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
Our headquarters which includes our principal R&D and sales facilities, is located in Camarillo, California and is leased pursuant to a non-cancellable operating lease with a term that expires in December 2015. The total space occupied in this building is approximately 64,000 square feet. We also lease an additional 16,000 square foot facility in Camarillo, which is leased through January 2016. We also lease space for our domestic and international offices in Austin, Milpitas, New Jersey, Massachusetts, China, Denmark, Germany, India, and Taiwan. As of September�30, 2014, we lease total space of approximately 181,000 square feet. Our current space is sufficient to accommodate current operations.
ITEM 3. LEGAL PROCEEDINGS
From time-to-time in our normal course of business, we are a party to various legal claims, actions and complaints. Although the ultimate outcome of these matters cannot be determined, management believes that, as of September�30, 2014, the final disposition of these proceedings will not have a material adverse effect on the financial position, results of operations, or liquidity.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.

28


PART�II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is listed on the NASDAQ Global Market under the symbol VTSS. The table below sets forth, for the periods indicated, the high and low sales prices of our common stock on the NASDAQ Global Market.
High
Low
Fiscal Year Ended 2014
October�1 through December�31, 2013
$
3.13

$
2.42

January�1 through March�31, 2014
4.69

2.89

April�1 through June�30, 2014
4.54

3.11

July�1 through September�30, 2014
3.85

2.76

High
Low
Fiscal Year Ended 2013
October�1 through December�31, 2012
$
2.48

$
1.75

January�1 through March�31, 2013
2.36

1.84

April�1 through June�30, 2013
2.98

1.96

July�1 through September�30, 2013
3.09

2.46

Holders of Record
As of November 28, 2014, there were approximately 927 stockholders of record of our common stock, and the closing price of our common stock was $3.32 per share as reported by the NASDAQ Global Market. The number of holders of record of our common stock does not include the number of stockholders whose shares are held in nominee or street name accounts through brokers and other institutions.
Dividends
We have never paid cash dividends and presently intend to retain any future earnings for business development. Further, our existing loan agreement limits the payment of dividends without the consent of the lenders.


29


Five-Year Stock Performance Graph
The following performance graph compares the cumulative total stockholder return for our common stock with the NASDAQ Composite Index, the NASDAQ Stock Market-United States Index and the NASDAQ Electronics Components Index from market close on the last trading day in September 2009 through the last trading day in September 2014. The graph is based on the assumption that $100 was invested in each of our common stock, the NASDAQ Composite Index, the NASDAQ Stock Market-United States Index and the NASDAQ Electronics Components Index on the last trading day in September 2009. The stock price performance on this graph is not necessarily an indicator of future price performance.
The stock price performance graph depicted below shall not be deemed to be filed for the purposes of Section�18 of the Exchange Act, or otherwise subject to the liabilities of such section, nor shall such graph be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing.



30


ITEM 6. SELECTED FINANCIAL DATA
The table below sets forth selected consolidated financial data for the five years in the period ended September�30, 2014 that has been derived from our audited consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with Item�7., Managements Discussion and Analysis of Financial Condition and Results of Operations and the audited consolidated financial statements and notes thereto included in Item�8., Financial Statements and Supplementary Data of this Annual Report on Form�10-K.
As of and for the years ended September 30,
2014
2013
2012
2011
2010
(In thousands, except per share data)
Consolidated Statements of Operations Data:
Product revenues
$
102,751

$
101,334

$
109,920

$
132,742

$
165,633

Intellectual property revenues
5,746

2,439

9,563

8,225

357

Net revenues
108,497

103,773

119,483

140,967

165,990

Restructuring and impairment




(1,424
)
3,656

854

(Loss) income from operations
(9,774
)
(15,474
)
1,635

(10,934
)
4,118

Loss from continuing operations
(18,075
)
(22,078
)
(1,112
)
(14,812
)
(20,176
)
Income from discontinued operations, net of tax








121

Net loss
(18,075
)
(22,078
)
(1,112
)
(14,812
)
(20,055
)
Fair value adjustment of Preferred Stock-Series B








126

Net loss available to common stockholders
$
(18,075
)
$
(22,078
)
$
(1,112
)
$
(14,812
)
$
(20,181
)
Net (loss) income per share:
Basic and diluted:
Continuing operations
$
(0.30
)
$
(0.55
)
$
(0.04
)
$
(0.61
)
$
(0.96
)
Discontinued operations








0.01

Net loss per share
$
(0.30
)
$
(0.55
)
$
(0.04
)
$
(0.61
)
$
(0.95
)
Fair value adjustment of Preferred Stock-Series B








(0.01
)
Net loss per common share available to common stockholders
$
(0.30
)
$
(0.55
)
$
(0.04
)
$
(0.61
)
$
(0.96
)
Weighted average shares outstanding: basic
60,887

40,311

25,121

24,315

21,074

Balance Sheet Data:
Cash and short-term investments
$
71,903

$
68,863

$
23,891

$
17,318

$
38,127

Working capital
40,471

69,363

28,694

26,659

48,037

Total assets
104,824

98,961

56,616

60,994

97,529

Long-term compound embedded derivative liability




2,899

7,796

15,476

Other long-term obligations, including debt
16,651

61,157

58,947

58,107

66,824

Total stockholders equity (deficit)
$
31,258

$
15,908

$
(24,015
)
$
(28,459
)
$
(21,206
)
Fiscal Year 2014
In June 2014, we raised $26.6 million, net of offering expenses of $2.1 million, from the registered public sale of 8,582,076 shares of common stock at $3.35 per share.
In November 2013, we amended the credit agreement for our Term A and B Loans, which amendment extended the maturity dates of the Term A Loan and Term B Loan from February 4, 2014 and October 30, 2014, respectively, to August 31, 2016, and also provides that the Term A and B Loans will bear interest at 9.0% per annum. In addition, in November 2013, we repurchased and cancelled $13.7 million of our convertible subordinated debentures (2014 Debentures).
Subsequent to fiscal year 2014, we repaid the outstanding principal of $32.8 million of our 2014 Debentures, plus accrued interest, on October 30, 2014, the maturity date of the debentures.
Fiscal Year 2013
In December 2012, we raised $17.1 million, net of offering costs of $1.6 million, from the registered public sale of 10,651,280 shares of common stock at $1.75 per share, which was a discount to the market price of our common stock.
In June 2013, we raised an additional $37.4 million, net of offering expenses of $2.8 million, from the registered public sale of 18,720,000 shares of common stock at $2.15 per share, which was a discount to the market price of our common stock.

31


Fiscal Year 2012
In the fourth quarter of fiscal year 2012, we determined that it was unlikely that we would be able to sublease our secondary Camarillo leased office and warehouse space for the remaining lease term through December 2015. Therefore, we decided that we would reoccupy the exited facility upon the expiration of our main Camarillo facility lease in January 2014 instead of locating to a new facility as originally planned. Accordingly, we reversed the lease termination reserve of $1.4 million.
Fiscal Year 2011
On January�18, 2011, we paid $8.0�million against the principal balance of our Senior Term Loan. On February�4, 2011, we exchanged our existing Senior Term Loan for two new term loans (the Term A and B Loans), each in the principal amount of $9.34�million. As of February�4, 2011 the net carrying amount of the Senior Term Loan was $18.7�million, which included the remaining outstanding principal of $17.0�million, and a payment-in-kind balance of $1.7�million. We recognized a $3.9�million loss on the debt exchange. Included in the loss calculation was the remaining balance of the unamortized costs of $0.6�million on the original Senior Term Loan. In July 2011, we repaid $1.5�million of the Term A Loan.
In fiscal year 2011, in order to reduce costs and streamline the product design process, we implemented a planned reduction in workforce in one of our U.S. design centers. We also consolidated our operations at our headquarters in Camarillo, California and implemented a reduction in personnel across multiple departments. In fiscal year 2011, we incurred approximately $3.7�million of costs and charges associated with these activities. These activities are presented as restructuring and impairment charges on the consolidated statements of operations.
Fiscal Year 2010
In October 2009, we completed a debt restructuring transaction. The debt restructuring resulted in the conversion of 96.7% of our 2024 Debentures into a combination of cash, common stock, Series�B Preferred Stock and 2014 Debentures. With respect to the remaining 3.3% of the 2024 Debentures, we settled our obligations in cash. Additionally, we repaid approximately $5.0�million of our $30.0�million Senior Term Loan, the terms of which were amended as part of the debt restructuring transactions. Under the terms of the debt restructuring transactions, we:
"
Paid $3.6�million in cash to satisfy our obligations to the holders of the 2024 Debentures who did not participate in the transaction;
"
Paid $6.4�million in cash consideration to the holders of the 2024 Debentures who participated in the transaction;
"
Issued $50.0�million in aggregate principal amount of 2014 Debentures to the holders of the 2024 Debentures who participated in the transaction; and
"
Issued to the holders of the 2024 Debentures who participated in the exchange 8,646,811 shares of common stock, and to some of those holders, an aggregate of 771,000 shares of a new Series�B Preferred Stock, which are convertible into common stock on a five-to-one basis and have a dividend preference relative to the common stock.
In May 2010, $3.5�million of 2014 Debentures were converted into 777,778 shares of common stock, based on a conversion price of $4.50 per share. We elected to make a make-whole payment (pursuant to the terms of the Indenture for the 2014 Debentures) in shares of common stock, and on June�7, 2010 we issued 91,753 shares of common stock valued at $6.20 per share, the fair value per share on the date of settlement.
In October 2009, in an effort to reduce costs and shorten manufacturing time, we eliminated test activities at our headquarters and outsourced testing to a third-party facility. This restructuring plan was approved during October 2009 with implementation efforts starting immediately and full transition of testing to the third-party by the third quarter of the fiscal year ending September�30, 2010. In connection with this restructuring, the Company recorded restructuring charges totaling $0.9�million for severance costs for the fiscal year ended September�30, 2010. This activity is presented as restructuring and impairment charges on the consolidated statements of operations.

32


ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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.
Overview
Vitesse is a leading supplier of high-performance networking ICs, application software, and integrated turnkey systems solutions that are used primarily by manufacturers of equipment for Carrier, Enterprise and Industrial-IoT networking applications. For over 30 years, we have been a leading innovator in networking and connectivity IC solutions. During the last decade, our markets have gone through a dramatic transformation. We have responded with an aggressive transition strategy to address the emerging opportunities within these markets.

Affirmation of Our Transition Strategy
Several years ago, we strategically re-invented Vitesse to exploit the dramatic ongoing transformation of our target networking markets. Our vision was simple: Ethernet Everywhere. We went all in on the idea that all networks, in all markets, would eventually transition to Ethernet. We re-positioned our R&D team and invested over $200 million to enter new and expanding markets. We developed dozens of new products, captured growing market share, and are continuing to add new customers at an increasing rate. Ethernet Everywhere is becoming a reality and we believe this exponentially expands our potential for success as well as the size of our serviceable markets, allowing us to create substantial revenue growth.
We define a set of products introduced since 2010 as our new products. These products largely address the transition of our core markets to Ethernet technology. Growing at a CAGR of 78% from fiscal year 2012 to fiscal year 2014, and reaching 57% of total product revenues in the fourth quarter of fiscal year 2014, the consistent revenue growth in our new product portfolio over the last three years validates our strategy. With continued growth in our Carrier and Enterprise markets, combined with early growth in new markets including Industrial-IoT, we anticipate our new product revenues will continue to increase at a rate between 50% and 75% in fiscal year 2015. To date, the growth of our new products has largely been offset by the decline in our legacy products that we identify as end-of-life (EOL) and Mature. We anticipate that as the legacy products decline and become a smaller portion of revenues, and our new products continue to grow, we will achieve overall revenue growth.
In addition to our new product revenue growth, our customer engagements and number of design opportunities and wins have consistently increased since 2010. We believe that design wins are a good leading indicator for future revenues. In 2014, the number of design wins for our new products grew over 50% from 2013, including wins from market leaders such as Adtran, Alcatel-Lucent, Alstrom, Belden-Hirschman, Cisco, Dragonwave, Ericsson, Juniper, Samsung, and ZTE. While many of these wins represented additional business at our most important customers, what we call same-store-sales, many others are wins at new customers, and reflect our growing market share in multiple markets. In fiscal year 2014, we had over 500 customers worldwide, nearly 300 of which purchased our new products. We added over 130 new customers in fiscal year 2014.
We intensified our focus in the Industrial-IoT market. This rapidly growing market provides substantial new growth opportunities for both revenues and diversification of our customer base. Partially as a result of this new market segment, in fiscal year 2014, we increased the number of first-time design wins from new customers by nearly 100% compared with fiscal year 2013. In fiscal year 2014, Industrial-IoT represented 33% of our total new customers and now represents 28% of our customer base for new products.
In fiscal year 2014, we introduced the fourth-generation of both our Switch and PHY products, adding substantial new features and capabilities to our product portfolio, significantly increasing our addressable markets in Carrier, Enterprise and Industrial-IoT networking. We invested to provide our customers a complete, turnkey application software package. We are the only company today providing these types of integrated Carrier Ethernet silicon and software solutions, making it simple for existing customers to migrate to our new solutions and for new customers to engage with Vitesse to quickly and efficiently bring their new products to market.
We have accelerated our efforts to increase our product gross margins, which has substantially improved our operating leverage. Average margins vary widely within the markets we serve, with the Industrial-IoT and Carrier networking markets

33


having the highest average margins and the Enterprise networking market having the lowest average margins. Based on our strengthening turnkey solutions mix and our aggressive cost reduction efforts, our overall gross margin profile is steadily improving. Product gross margin increased to 56.7% in fiscal year 2014 compared with 53.9% in fiscal year 2013. Based on estimated gross margins on our new product design wins, we anticipate that our product gross margins will continue to increase in fiscal year 2015, underscoring the value that Vitesse brings to these markets.
To effectively serve these large, growing markets without increasing our operating expenses, we must be very efficient with our R&D resources. The products we develop for Carrier and Enterprise markets sell equally well into Industrial-IoT markets, creating tremendous synergy and cost savings, in terms of R&D effort, to provide products into these emerging adjacent markets.
To address these growing opportunities, in 2014 we invested in our marketing, sales and applications organization, adding critical industry expertise in hardware and software, as well as additional sales representatives and distributors. With the expansion in resources, we immediately realized an increase in sales opportunities. Because our customers take anywhere from six to 48 months to go from design win to production, we believe design opportunities and design wins are a strong leading indicator for future revenue growth.
Over the past two years, we have raised approximately $81 million to fund our transition strategy which included introducing our new product platforms, decreasing our debt and providing adequate working capital for future operations. In October 2014, we repaid in full the remaining $32.8 million in principal of our 2014 Debentures, eliminating cash interest payments and interest expense related to this debt from the results of operations.
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 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 managements most difficult, subjective and complex judgments.
Revenue Recognition
Product Revenues
We recognize product revenues 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 prevents 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, our accounting policy generally uses the sell-through model for sales to our distributors. The sell-through model recognizes revenue upon shipment of the merchandise from our distributor to the final customer. As such, we may have variability in our revenues from quarter-to-quarter as customers have substantial flexibility to reschedule backlog with our distribution partners as part of the terms and conditions of sale. Our distributor sales were 56.6%, 52.7% and 51.6% of product revenues in 2014, 2013 and 2012, respectively.
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.

34


Intellectual Property Revenues
We derive intellectual property revenues from the sale and licensing of our intellectual property, maintenance and support fees and royalty revenues following the sale by our licensees of products incorporating the licensed technology. We recognize revenues from the sale and licensing of our intellectual property 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 maintenance and 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 revenues are recognized ratably over the period during which the obligation exists, typically 12�months or less.
We recognize royalty revenues 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 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, as well as 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
We use different valuation methodologies that use Level 3 inputs to value our Term A Loan, Term B Loan, 2014 Debentures and related compound embedded derivative. The valuation methodologies we use and our assessment of the significance of a particular input to the fair value measurement may produce a fair value that may not be indicative of net realizable value or future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

35


Stock Based Compensation
We account for stock based compensation under ASC Topic 718, Compensation-Stock Compensation, which requires us to record related compensation costs. Calculating the fair value of stock-based compensation awards requires the input of highly subjective assumptions, including the expected life of the awards and expected volatility of our stock price. Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. Our estimates of expected volatilities are based on weighted historical implied volatility. The expected forfeiture rate applied in calculating stock-based compensation cost is estimated using historical data and is updated annually.
The assumptions used in calculating the fair value of stock-based awards involve estimates that require management judgment. If factors change and we use different assumptions, our stock-based compensation expense could change significantly in the future. In addition, if our actual forfeiture rate is different from our estimate, our stock-based compensation expense could change significantly in the future.
Income Taxes
We account for income taxes in accordance with ASC Topic 740, Income Taxes, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, we must make estimates and judgments in determining the provision for taxes for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions. Significant changes in these estimates may result in an increase or decrease to our tax provision in a subsequent period. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
We must assess the likelihood that we will be able to recover our deferred tax assets. Our valuation allowance against the deferred tax assets is based on our assessments of historical losses and projected operating results in future periods on a more likely than not basis. If and when we generate future taxable income in our tax jurisdictions against which these tax assets may be applied, some portion or all of the valuation allowance would be reversed and an increase in net income would consequently be reported in future years.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will more likely than not be sustained on audit, the second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as we have to determine the probability of various possible outcomes. We re-evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors such as changes in facts or circumstances, changes in tax law, new audit activity, and effectively settled issues. Determining whether an uncertain tax position is effectively settled requires judgment. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period in which a change in judgment occurs.
Litigation
We are party to various claims and lawsuits arising in the normal course of business. We closely monitor these claims and lawsuits and frequently consult with our legal counsel to determine whether they may, when resolved have a material adverse effect on our financial position or results or operations and accrue and/or disclose loss contingencies as appropriate.
Impact of Recent Accounting Pronouncements
For information with respect to recent accounting pronouncements and the impact of these pronouncements see The Company and Its Significant Accounting Policies footnote in the accompanying notes to the audited consolidated financial statements.

36


Results of Operations
The following table sets forth certain consolidated statements of operations data for the periods indicated. The percentages in the table are based on net revenues.
September 30,
2014
2013
2012
$
%
$
%
$
%
(in�thousands,�except�for�percentages)
Net revenues:
Product revenues
$
102,751

94.7
�%
$
101,334

97.6
�%
$
109,920

92.0
�%
Intellectual property revenues
5,746

5.3
�%
2,439

2.4
�%
9,563

8.0
�%
Net revenues
108,497

100.0
�%
103,773

100.0
�%
119,483

100.0
�%
Costs and expenses:

Cost of product revenues
44,480

41.0
�%
46,763

45.1
�%
46,407

38.8
�%
Engineering, research and development
42,450

39.1
�%
41,927

40.4
�%
42,713

35.7
�%
Selling, general and administrative
30,981

28.6
�%
30,210

29.1
�%
29,822

25.0
�%
Restructuring and impairment



�%



�%
(1,424
)
(1.2
)%
Amortization of intangible assets
360

0.3
�%
347

0.3
�%
330

0.3
�%
Costs and expenses
118,271

109.0
�%
119,247

114.9
�%
117,848

98.6
�%
(Loss) income from operations
(9,774
)
(9.0
)%
(15,474
)
(14.9
)%
1,635

1.4
�%
Other expense (income):
Interest expense, net
6,227

5.7
�%
7,916

7.7
�%
7,778

6.6
�%
Gain on compound embedded derivative



�%
(803
)
(0.8
)%
(4,897
)
(4.1
)%
Loss on extinguishment of debt
1,594

1.5
�%



�%



�%
Other expense, net
139

0.1
�%
39


�%
40


�%
Other expense, net
7,960

7.3
�%
7,152

6.9
�%
2,921

2.5
�%
Loss before income tax expense (benefit)
(17,734
)
(16.3
)%
(22,626
)
(21.8
)%
(1,286
)
(1.1
)%
Income tax expense (benefit)
341

0.3
�%
(548
)
(0.5
)%
(174
)
(0.1
)%
Net loss
$
(18,075
)
(16.6
)%
$
(22,078
)
(21.3
)%
$
(1,112
)
(1.0
)%

37


Fiscal Years Ended September 30, 2014 and 2013
Product Revenues
We sell our products into the following markets: (i)�Carrier networking; (ii)�Enterprise networking; (iii) Industrial-IoT networking; and (iv)�Non-core. The Carrier networking market includes core, metro, edge, and access equipment used for transport, switching, routing, mobile access, and backhaul in service provider networks. The Enterprise networking market covers Ethernet switching and routing equipment used within LANs in SME/SMB networks and Cloud Access services. The Industrial-IoT networking market includes industrial-class switching and routing equipment for networks within Industrial Process Control, Smart-Grid Energy Distribution, Transportation, and Factory Automation applications, as well as switching and connectivity for a broad variety of equipment such as security cameras, LCD signage, intelligent sensors, metering equipment, home and office automation and things of all kinds. The Non-core market is comprised of products that have not received additional investment over the last five fiscal years and, as a result, have generally been in decline.
In the normal course of business, we regularly assess our product portfolio. At such time, we may determine to phase-out products and put them through EOL. The EOL 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.
The demand for our products is affected by various factors, including our development and introduction of new products, availability and pricing of competing products, capacity constraints at our suppliers, EOL product decisions, and general economic conditions. Therefore, our revenues for the fiscal years ended 2014 and 2013 may not necessarily be indicative of future revenues.
Product revenues by market are as follows:
September 30,
2014
2013
Amount
%�of�Product
Revenues
Amount
%�of�Product
Revenues
Change
%
Change
(in�thousands,�except�percentages)
Carrier networking
$
47,369

46.1
%
$
55,373

54.6
%
$
(8,004
)
(14.5
)%
Enterprise networking
42,787

41.6
%
39,106

38.6
%
3,681

9.4
�%
Industrial-IoT networking
10,978

10.7
%
5,428

5.4
%
5,550

102.2
�%
Non-core
1,617

1.6
%
1,427

1.4
%
190

13.3
�%
Product revenues
$
102,751

100.0
%
$
101,334

100.0
%
$
1,417

1.4
�%
The lower Carrier networking revenues are largely attributable to a decrease in sales of older products for SONET/SDH applications, some of which went through EOL in prior periods. The decline is partially offset by increases in sales of our new products, primarily for Carrier Ethernet applications, which increased more than 70% from the prior year.

The higher Enterprise networking revenues are primarily due to increases in sales of our new products, both switches and 10G PHYs, as new customers ramp into production. The increases are partially offset by declines in sales of our crosspoint switches and older generation switches and PHYs.
The higher Industrial-IoT revenues are primarily due to increase sales of Ethernet Switches and Cu PHYs. Approximately half of the increase is due to the ramp of new products, with the remainder being mature Ethernet switch and PHY products used in new applications.
Revenues from our new products were $49.6 million in fiscal year 2014 as compared to $28.6 million in fiscal year 2013, and we expect revenues from our new products will continue to increase. In fiscal year 2012, a number of older products went through EOL. Revenues from these EOL products were $5.5 million in fiscal year 2014 as compared to $15.9 million in fiscal year 2013, and we expect revenues from these EOL products will continue to decline.
We also classify our product revenues based on our three product lines: (i) Ethernet switching; (ii) Connectivity; and (iii)�Transport processing.

38


Product revenues by product line is as follows:
September 30,
2014
2013
Amount
%�of�Product
Revenues
Amount
%�of�Product
Revenues
Change
%
Change
(in�thousands,�except�percentages)
Ethernet switching
$
50,914

49.6
%
$
38,675

38.2
%
$
12,239

31.6
�%
Connectivity
41,017

39.9
%
42,885

42.3
%
(1,868
)
(4.4
)%
Transport processing
10,820

10.5
%
19,774

19.5
%
(8,954
)
(45.3
)%
Product revenues
$
102,751

100.0
%
$
101,334

100.0
%
$
1,417

1.4
�%
The higher Ethernet switching revenues are largely attributable to an increase in sales of our new Enterprise switches and Carrier Ethernet switch engines and 1GE Cu PHYs into Carrier, Enterprise, and Industrial-IoT applications.
The lower Connectivity revenues are primarily attributable to the decrease in sales of some of our mature crosspoint switches and SONET PHYs, partially offset by a strong increase in sales of our new 10G PHYs, backplane PHYs and new crosspoint switches.
The lower Transport processing revenues are largely attributable to decreased sales of SONET/SDH framers that went through EOL in prior periods. The decrease is partially offset by an increase in sales of new OTN products.
Intellectual Property Revenues
September 30,
2014
2013
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)
Intellectual property revenues
$
5,746

5.3
%
$
2,439

2.4
%
$
3,307

135.6
%
Intellectual property revenues include licenses, royalties, and the sale of patents. Intellectual property revenues increased in fiscal year 2014 as compared to the prior fiscal year due to an increase in deliverables of intellectual property. The timing and amounts of intellectual property revenues can fluctuate from period to period. Expenses associated with intellectual property revenues are included in selling, general and administrative (SG&A) expenses.
Net revenues from customers that were equal to or greater than 10% of total net revenues is as follows:
September 30,
2014
2013
WPG Holdings**
23.8
%
17.7
%
____________________________________________
**
Distributor

39


Net revenues by geographic area is as follows:�
September 30,
2014
2013
Amount
%�of�Net Revenues
Amount
%�of�Net
Revenues
Change
%
Change
(in�thousands,�except�percentages)
United States
$
25,284

23.3
%
$
28,454

27.4
%
$
(3,170
)
(11.1
)%
China, including Hong Kong
31,653

29.2
%
32,545

31.3
%
(892
)
(2.7
)%
Taiwan
23,649

21.8
%
17,430

16.8
%
6,219

35.7
�%
Other Asia Pacific
14,258

13.1
%
11,479

11.1
%
2,779

24.2
�%
Europe, Middle East and Africa
13,653

12.6
%
13,865

13.4
%
(212
)
(1.5
)%
Total net revenues
$
108,497

100.0
%
$
103,773

100.0
%
$
4,724

4.6
�%
Revenues by geographic area is based upon the country of billing. The geographic location 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.
Cost of Product Revenues
September 30,
2014
2013
ti
Amount
%�of�Product Revenues
Amount
%�of�Product Revenues
Change
%
Change
(in�thousands,�except�percentages)

Cost of product revenues
$
44,480

43.3
%
$
46,763

46.1
%
$
(2,283
)
(4.9
)%
We use third-parties for wafer fabrication and assembly services. Cost of product revenues consists predominantly of: (i)�purchased finished wafers; (ii)�assembly services; (iii)�test services; and (iv)�labor and overhead costs associated with product procurement, planning and quality assurance.
Our cost of product revenues is affected by various factors, including product mix, volume, and provisions for excess and obsolete inventories, material costs, manufacturing efficiencies, and the position of our products within their life-cycles. Our cost of product revenues as a percent of net product revenues is affected by these factors, as well as customer mix, volume, pricing, and competitive pricing programs.
Cost of product revenues as a percentage of product revenues decreased for fiscal year 2014 primarily due to a mix shift toward switches and Cu PHYs, which have higher margins as compared to the prior fiscal year. The average selling price of our switch products is increasing as we sell more products into Carrier and Industrial-IoT markets, which generally carry higher margins. In addition, we have added a complete turnkey solution which incorporates software into our product portfolio, further increasing the average selling price. The margins of our Cu PHY products are increasing as we add more value-added features to these products, increasing their average selling prices.� Based on our increasing turnkey solutions mix, on-going cost reduction efforts, and higher estimated gross margins on our new product design wins, we anticipate that our product margins will continue to increase in fiscal year 2015.
Engineering, Research and Development
September 30,
2014
2013
Amount
%�of�Net
Revenues
Amount
%�of�Net
Revenues
Change
%
Change
(in�thousands,�except�percentages)


Engineering, research and development
$
42,450

39.1
%
$
41,927

40.4
%
$
523

1.2
%

R&D expenses consist primarily of compensation expenses for employees and contractors engaged in research, design and development activities. R&D also includes costs of mask tooling, which we fully expense in the period, and electronic design

40


automation tools, software licensing contracts, subcontracting and fabrication costs, depreciation and amortization, and overhead including facilities expenses.
The level of R&D expenses will vary from period-to-period, depending on timing of development projects and the purchase of masks aligned to those projects. The level of R&D expenses as a percentage of net revenues will vary, depending, in part, on the level of net revenues. Our R&D efforts are critical to maintaining a high level of new product introductions and are critical to our plans for future growth.
The increase in R&D spending for fiscal year 2014 compared to fiscal year 2013, is due primarily to higher employee compensation expenses of $2.6 million, including stock compensation, and higher new product evaluation board and test supplies expense of $0.4 million in the current period, as compared to the prior year period. These increases are partially offset by reduced mask tooling of $1.2 million and lower outside contractor expenses of $1.4 million in the current period, as compared to the prior year period.
Selling, General and Administrative
September 30,
2014
2013
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)


Selling, general and administrative
$
30,981

28.6
%
$
30,210

29.1
%
$
771

2.6
%
SG&A expenses consist primarily of compensation expenses, legal and other professional fees, facilities expenses, outside labor, and communication expenses, and are comparable to the prior fiscal year.
SG&A expenses in fiscal year 2014 increased $0.8 million, primarily due to higher employee compensation expenses of $2.3 million, including stock compensation, and relocation expenses of $0.5 million related to the move of our primary test operations from Singapore to Taiwan and our Camarillo facilities to an adjacent building. These increases are partially offset by lower expenses of $2.0 million for both asset retirement obligations and facilities expenses related to the move of our Camarillo headquarters.

Interest Expense, Net
September 30,
2014
2013
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)
Interest expense, net
$
6,227

5.7
%
$
7,916

7.7
%
$
(1,689
)
(21.3
)%
Net interest expense is comprised of cash interest expense, amortization of debt discount, premium, and debt issuance costs, net of interest income. Interest expense, net decreased primarily due to the repurchase in November 2013 of $13.7 million principal amount of our 2014 Debentures. In October 2014, we repaid the outstanding principal of $32.8 million of our 2014 Debentures. Accordingly, interest expense related to the 2014 Debentures will be $0.3 million in fiscal year 2015, compared to interest expense of $4.4 million in fiscal year 2014.
Gain on Compound Embedded Derivative
September 30,
2014
2013
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)


Gain on compound embedded derivative
$



%
$
(803
)
(0.8
)%
$
803

(100.0
)%


41


The fiscal year 2013 gain on our compound embedded derivative related to our 2014 Debentures was primarily generated by the decrease in the price of our underlying common stock during the relevant periods.
The compound embedded derivative included in our 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 common stock. The compound embedded derivative was 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 were indexed to our own common stock. A final valuation was completed on October 30, 2012, resulting in gain of $0.8 million due to the change in fair value.
Loss on Extinguishment of Debt
September 30,
2014
2013
Amount
%�of�Net
�Revenues
Amount
%�of�Net
Revenues
Change
%
Change
(in�thousands,�except�percentages)


Loss on extinguishment of debt
$
1,594

1.5
%
$



%
$
1,594

100.0
%
The loss on extinguishment of debt is due to the repurchase in November 2013 of $13.7 million principal amount of our 2014 Debentures at 107% of the principal amount thereof.
Income Tax Expense (Benefit)
September 30,
2014
2013
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)


Income tax expense (benefit)
$
341

0.3
%
$
(548
)
(0.5
)%
$
889

(162.2
)%
Our effective tax rate was (1.9)% for the fiscal year ended September�30, 2014 compared to 2.4% for the comparable period in the prior fiscal year. Our income tax expense (benefit) is primarily impacted by certain foreign taxes, certain nondeductible interest and share based expenses and the release of a portion of the valuation allowances related to certain foreign jurisdictions deferred tax assets as such balances were more likely than not realizable within the applicable carryforward period. The increase in income tax expense for fiscal year 2014 compared to fiscal year 2013 is largely attributable to the receipt of a $1.1 million refund of non-recurring withholding taxes on foreign income in fiscal year 2013.

42


Fiscal Years Ended September 30, 2013 and 2012
Product Revenues
Product revenues by market are as follows:
September 30,
2013
2012
Amount
%�of�Product
Revenues
Amount
%�of�Product
Revenues
Change
%
Change
(in�thousands,�except�percentages)
Carrier networking
$
55,373

54.6
%
$
49,828

45.4
%
$
5,545

11.1
�%
Enterprise networking
39,106

38.6
%
46,983

42.7
%
(7,877
)
(16.8
)%
Industrial-IoT networking
5,428

5.4
%
5,086

4.6
%
342

6.7
�%
Non-core
1,427

1.4
%
8,023

7.3
%
(6,596
)
(82.2
)%
Product revenues
$
101,334

100.0
%
$
109,920

100.0
%
$
(8,586
)
(7.8
)%
The increase in Carrier networking revenues is attributable to an increase in sales of our new Ethernet switch products, our new Connectivity products, and our SONET/SDH framers going through EOL. The increases were partially offset by declines in sales from other SONET/SDH products.
The decrease in Enterprise networking revenues is driven by a decrease in sales of our switch fabrics products that had gone through EOL in fiscal year 2012 and declines in our mature crosspoint switches, partially offset by a more than doubling in sales of our new switch products.
The increase in Industrial-IoT networking revenues is attributable to an increase in our Ethernet switch products as a result of primarily new, but also mature products, being adapted to new applications. The increase was partially offset by a decline in our crosspoint products compared to fiscal year 2012.
The decrease in Non-core revenues is largely attributable to a decrease of our legacy Fiber Channel PHYs and network processors, some of which had gone through EOL in fiscal year 2012.
Revenues from our new products were $28.6 million in fiscal year 2013 as compared to $15.7 million in fiscal year 2012. In fiscal year 2012, a number of older products went through EOL. Revenues from these EOL products were $15.9 million in fiscal year 2013 as compared to $24.9 million in fiscal year 2012.
We also classify our product revenues based on our three product lines: (i) Ethernet switching; (ii) Connectivity; and (iii)�Transport processing.
Product revenues by product line are as follows:
September 30,
2013
2012
Amount
%�of�Product
Revenues
Amount
%�of�Product
Revenues
Change
%
Change
(in�thousands,�except�percentages)
Ethernet switching
$
38,675

38.2
%
$
32,607

29.7
%
$
6,068

18.6
�%
Connectivity
42,885

42.3
%
52,933

48.1
%
(10,048
)
(19.0
)%
Transport processing
19,774

19.5
%
24,380

22.2
%
(4,606
)
(18.9
)%
Product revenues
$
101,334

100.0
%
$
109,920

100.0
%
$
(8,586
)
(7.8
)%
The increase in Ethernet switching revenues is largely attributable to a doubling in our new switches selling into both the Carrier and Enterprise networking markets. The increase was partially offset by declines in sales of our mature products.
Although revenues for our new Connectivity products increased, Connectivity revenues overall decreased due to the broad-based decline in the networking equipment market, which negatively impacted the demand for our mature SONET/SDH PHY products. In addition, there was a strong decline in our Non-core products, particularly Fibre Channel PHYs products.

43


The decrease in Transport processing revenues for fiscal year 2013 compared to fiscal year 2012 is largely attributable to lower sales of switch fabrics, network processors and OTN products that had gone through EOL in fiscal year 2012. These increases were offset by increased revenues for SONET/SDH framers, going through EOL in fiscal year 2013.
Intellectual Property Revenue
September 30,
2013
2012
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)
Intellectual property revenues
$
2,439

2.4
%
$
9,563

8.0
%
$
(7,124
)
(74.5
)%
For the fiscal year ended September 30, 2012, intellectual property revenues also included the settlement of all future royalties under an existing agreement. Intellectual property revenues decreased in fiscal year 2013 as compared to the prior fiscal year due to a decrease in deliverables of intellectual property.
Net revenues from customers that were equal to or greater than 10% of total net revenues are as follows:
September 30,
2013
2012
Nu Horizons Electronics**
*

13.5
%
WPG Holdings**
17.7
%
10.7
%
________________________________________________
* Less than 10% of total net revenues for period indicated.
** Distributors

Net revenues by geographic area are as follows:�
September 30,
2013
2012
Amount
%�of�Net
Revenues
Amount
%�of�Net
Revenues
Change
%
Change
(in�thousands,�except�percentages)
United States
$
28,454

27.4
%
$
41,559

34.7
%
$
(13,105
)
(31.5
)%
China, including Hong Kong
32,545

31.3
%
30,786

25.8
%
1,759

5.7
�%
Taiwan
17,430

16.8
%
15,871

13.3
%
1,559

9.8
�%
Other Asia Pacific
11,479

11.1
%
15,603

13.1
%
(4,124
)
(26.4
)%
Europe, Middle East and Africa
13,865

13.4
%
15,664

13.1
%
(1,799
)
(11.5
)%
Total net revenues
$
103,773

100.0
%
$
119,483

100.0
%
$
(15,710
)
(13.1
)%
Cost of Product Revenues
September 30,
2013
2012
Amount
%�of�Product Revenues
Amount
%�of�Product Revenues
Change
%
Change
(in�thousands,�except�percentages)

Cost of product revenues
$
46,763

46.1
%
$
46,407

42.2
%
$
356

0.8
%
Although the overall cost of product revenues did not change significantly, the cost as a percentage of revenues increased in fiscal year 2013 as compared to fiscal year 2012 due to a mix of products that had an overall higher cost.

44


Engineering, Research and Development
September 30,
2013
2012
Amount
%�of�Net
Revenues
Amount
%�of�Net
Revenues
Change
%
Change
(in�thousands,�except�percentages)


Engineering, research and development
$
41,927

40.4
%
$
42,713

35.7
%
$
(786
)
(1.8
)%
The decrease in R&D spending for fiscal year 2013 compared to fiscal year 2012 is largely attributable to lower overhead testing expenses of $1.5 million and other expenses of $0.7 million, partially offset by higher employee compensation and contractor expenses of $1.4 million for providing new product development and design services.
Selling, General and Administrative
September 30,
2013
2012
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)


Selling, general and administrative
$
30,210

29.1
%
$
29,822

25.0
%
$
388

1.3
%
In fiscal year 2013, our SG&A compensation expenses decreased by $1.6 million. Due to the relocation of our main Camarillo facility to an adjacent facility, we incurred $0.9 million in asset retirement expenses as well as increased rent of $0.7 million. In fiscal year 2012, we collected $1.9 million of accounts receivable that was written off as uncollectible in fiscal year 2011. Fiscal year 2012 also included a $1.3 million write-down of an intangible asset.
Restructuring and Impairment Charges
September 30,
2013
2012
Amount
%�of�Net
�Revenues
Amount
%�of�Net
Revenues
Change
%
Change
(in�thousands,�except�percentages)


Restructuring and impairment
$



%
$
(1,424
)
(1.2
)%
$
1,424

(100.0
)%
During fiscal year 2011 we consolidated design activities and consolidated our Camarillo operations into a single facility, exiting an adjacent leased facility. In the fourth quarter of fiscal year 2012, we determined that it was unlikely we would be able to sublease the exited property for the remaining lease term through December 2015. Therefore, we decided that we would reoccupy the exited facility upon expiration of our main Camarillo facility lease in January 2014, instead of locating to a new facility as originally planned. Accordingly, we reversed the remaining lease termination reserve of $1.4 million.

Interest Expense, Net
September 30,
2013
2012
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)
Interest expense, net
$
7,916

7.7
%
$
7,778

6.6
%
$
138

1.8
%
Net interest expense for the fiscal year 2013 is comparable to the prior fiscal year.


45


Gain on Compound Embedded Derivative
September 30,
2013
2012
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)


Gain on compound embedded derivative
$
(803
)
(0.8
)%
$
(4,897
)
(4.1
)%
$
4,094

(83.6
)%
The gain on our compound embedded derivative related to our 2014 Debentures is primarily generated by the decrease in the price of our underlying common stock during the relevant periods.

The compound embedded derivative included in our 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 common 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 were indexed to our own common stock. A final valuation was completed on October 30, 2012, resulting in gain of $0.8 million due to the change in fair value.
Income Tax Benefit
September 30,
2013
2012
Amount
%�of�Net
�Revenues
Amount
%�of�Net
�Revenues
Change
%
Change
(in�thousands,�except�percentages)


Income tax benefit
$
(548
)
(0.5
)%
$
(174
)
(0.1
)%
$
(374
)
214.9
%
Our effective tax rate was 2.4% for the fiscal year ended September�30, 2013 compared to 13.6% for the comparable period in the prior fiscal year. Our income tax benefit is primarily impacted by foreign taxes, a refund of withholding taxes on foreign income, and certain nondeductible interest and share based expenses. The income tax benefit is also impacted by the release of a portion of the valuation allowances related to certain foreign jurisdictions deferred tax assets as such balances were more likely than not realizable within the applicable carryforward period based on our analysis of the available positive and negative evidence.
Financial Condition and Liquidity
Cash Flow Analysis
Cash increased to $71.9 million at September�30, 2014, from $68.9 million at September�30, 2013 and from $23.9 million at September 30, 2012. Our cash flows from operating, investing and financing activities are summarized as follows:�
September 30,
2014
2013
2012
(in�thousands)
Net cash (used in) provided by operating activities
$
(6,946
)
$
(9,119
)
$
7,072

Net cash used in investing activities
(1,811
)
(1,492
)
(1,602
)
Net cash provided by financing activities
11,797

55,583

1,103

Net increase in cash
3,040

44,972

6,573

Cash at beginning of year
68,863

23,891

17,318

Cash at end of year
$
71,903

$
68,863

$
23,891


46


Net Cash (Used In) Provided By Operating Activities
During the fiscal year ended September�30, 2014, cash used in operating activities totaled $6.9 million. Excluding changes in working capital, we used $6.5 million to fund the cash portion of our net loss. Cash decreased $3.1 million from operating with higher accounts receivable and inventory levels. Lower accounts payable also used cash of $0.7 million. These uses were partially offset by lower prepaids and other assets of $0.6 million and higher deferred revenue of $2.7 million.
Inventories increased $2.1 million from $10.7 million at September�30, 2013 to $12.8 million at September�30, 2014 to meet anticipated increased demand. Deferred revenue increased $2.7 million from $2.2 million at September�30, 2013 to $4.9 million at September�30, 2014 due to more inventory held by and the timing of payments from distributors.
During the fiscal year ended September�30, 2013, cash used in operating activities totaled $9.1 million. Excluding changes in working capital, we used $13.5 million to fund the cash portion of our net loss. Cash increased $1.9 million from operating with lower inventory levels and prepaid and other assets, partially offset by $0.4 million from higher receivables. Cash also increased by $3.1 million due to increased accounts payable and deferred revenue due to higher purchases from distributors, which was offset by $0.2 million from lower accrued liabilities.
Inventories decreased $1.4 million from $12.1 million at September�30, 2012 to $10.7 million at September�30, 2013 due to ongoing efforts to ensure purchases align with production and efforts to manage excess inventory. Accounts payable, accrued liabilities and other liabilities increased by $1.6 million from $18.5 million at September�30, 2012 to $20.1 million at September�30, 2013 due to the timing of payments to our vendors and other service providers.
During the fiscal year ended September�30, 2012, cash provided by operating activities totaled $7.1 million. Excluding changes in working capital, cash generated by operations totaled $2.2 million. Cash increased $8.8 million from operating with lower inventory levels and $0.9 million from operating with lower accounts receivable, prepaid and other assets. These increases were partially offset by $1.9 million cash used to pay down accounts payable, accrued expenses and other liabilities, and $3.0 million related to a decrease in deferred revenue due to lower purchases from distributors.
Inventories decreased $8.8 million from $20.9 million at September�30, 2011 to $12.1 million at September�30, 2012 due to ongoing efforts to ensure purchases align with production and concerted efforts to manage excess inventory. Accounts payable, accrued liabilities and other liabilities decreased by $3.1 million from $21.6 million at September�30, 2011 to $18.5 million at September�30, 2012 due to the timing of payments to our vendors and other service providers and non-cash restructuring gain.
Net Cash Used In Investing Activities
Investing activities in fiscal year 2014 used $2.0 million for capital expenditures and payments under licensing agreements, partially offset by $0.2 million of proceeds from the sale of fixed assets. In fiscal years 2013 and 2012, investing activities used $1.6 million and $1.7 million, respectively, for capital expenditures and payments under licensing agreements.
Net Cash Provided By Financing Activities
Financing activities provided $11.8 million in cash in fiscal year 2014. Cash from the sale of common stock totaled $26.7 million, net of approximately $2.0 million in paid expenses. Proceeds from the exercise of stock options and issuances of shares under the employee stock purchase plan (ESPP) totaled $1.9 million. Cash used for the repurchase of our 2014 Debentures totaled $14.6 million. We also used cash to pay a consent fee of $0.3 million related to the November 2013 amendment of our credit agreement. Cash of $0.7 million was restricted for payment of the 2014 Debentures under the terms of the indenture following the sale of assets. Cash used for the repurchase of restricted stock units for payroll taxes on behalf of employees was $1.3 million.
Financing activities provided $55.6 million in cash in fiscal year 2013, primarily due to the sale of common stock. Proceeds from the sale of common stock totaled $54.5 million and were offset by $0.6 million in cash used for the repurchase of restricted stock units for payroll taxes paid on behalf of employees. In fiscal year 2012, financing activities provided $1.1 million in cash due to proceeds from the exercise of stock options and issuances of shares under the ESPP, offset by cash used for the repurchase and retirement of restricted stock units for payroll taxes.
Capital Resources, including Long-Term Debt, Contingent Liabilities and Operating Leases
Prospective Capital Needs
Our principal sources of liquidity are our existing cash, cash generated from product sales, and cash generated from the sales or licensing of our intellectual property. Our cash totaled $71.9 million at September�30, 2014. Our working capital at September�30, 2014 was $40.5 million.

47


In order to achieve sustained profitability and positive cash flows from operations, we may need to reduce operating expenses and/or increase revenues. We have completed a series of cost reduction actions that have improved our operating expense structure. We will continue to perform additional actions, as necessary. Our ability to maintain, or increase, current revenue levels to sustain profitability will depend, in part, on demand for our products.
At September 30, 2014, our current debt consisted of our 2014 Debentures, of which the total principal of $32.8 million was repaid on October 30, 2014 and our long-term debt consisted of our Term A and B Loans in the total principal amount of $17.2 million due on August 31, 2016. The credit agreement for our Term A and B Loans requires us to maintain an unrestricted cash balance of $8.0 million. We believe that our existing sources of liquidity, along with cash expected to be generated from revenues, will be sufficient to fund our operations for at least the next 12 months and to meet our minimum cash covenant. Our available liquidity could be adversely affected, however, if we incur operating losses and negative cash flows in the future, and we may need to reduce or postpone our operating costs or obtain alternate sources of financing, or both. We may need additional capital in the future and may not have access to additional sources of capital on favorable terms or at all. If we raise additional funds through the issuance of equity or debt securities, such securities may have rights, preferences or privileges senior to those of our common stock and our stockholders may experience dilution of their ownership interests. There can be no assurance, however, that our efforts will be successful.
We have a Form S-3 universal shelf registration statement on file with the SEC. The universal shelf registration statement on Form S-3 permits Vitesse to sell, in one or more public offerings, shares of our common stock, shares of preferred stock or debt securities, or any combination of such securities, for proceeds in an aggregate amount of up to $75.0 million. As of September�30, 2014, we raised a total of $28.7 million of gross proceeds from the sale of 8,582,076 shares of our common stock, leaving approximately $46.3 million of securities available for issuance pursuant to the Form S-3. The Form S-3 will expire in January 2017.
Contractual Obligations
Our significant contractual obligations as of September�30, 2014 are as follows:
Payment�Obligations�by�Fiscal�Year
2015
2016
2017
2018
2019
Thereafter
Total
(in�thousands)
Convertible subordinated debt (1)
$
32,843

$


$


$


$


$


$
32,843

Term A and B Loans (2)


17,199









17,199

Loan interest (3)
3,102

1,776









4,878

Operating leases (4)
2,002

651

169

60





2,882

Software licenses (5)
8,084

4,555

4,275

4,175





21,089

Inventory and other purchase obligations (6)
9,256

244

60







9,560

Total
$
55,287

$
24,425

$
4,504

$
4,235

$


$


$
88,451

________________________________________________
(1)
Represents amounts due for our 8.0% convertible debentures due October�2014.
(2)
Represents amounts due for our 9.0% fixed rate senior notes due August 31, 2016.
(3)
Interest payable for our 2014 Debentures through 2015 and Term A and B Loans through 2016.
(4)
We lease facilities under non-cancellable operating lease agreements that expire at various dates through 2018.
(5)
Software license commitments represent non-cancellable licenses of technology from third-parties used in the development of our products.�
(6)
Inventory and other purchase obligations represent non-cancellable purchase commitments. For purposes of the table above, inventory and other purchase obligations are defined as agreements that are enforceable and legally binding and that specify all significant terms. Our purchase orders are based on our current manufacturing needs and are typically fulfilled by our vendors within a relatively short time.Other purchase commitments may be for longer periods and are dictated by contractual terms.

48


Off-Balance Sheet Arrangements
At September�30, 2014, we had no material off-balance sheet arrangements, other than operating leases, certain software licenses and non-cancellable purchase commitments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from adverse changes in market rates and prices. Our market risk exposure is solely a result of fluctuations in foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.
Interest Rate Risk
Our Term A and B Loans and 2014 Debentures bear fixed interest rates, and therefore, would not be subject to interest rate risk.
Foreign Currency Exchange Risk
We conduct business in certain foreign markets, primarily in the EU and Asia. Our primary exposure to foreign currency risk relates to investments in foreign subsidiaries that transact business in a functional currency other than the United States dollar, primarily the Euro, Danish Kroner, Taiwanese Dollar, Chinese Renminbi and Indian Rupee. We primarily incur R&D, sales and customer support, and administrative expenses in these foreign currencies. All of our sales are denominated in United States dollars, and we are therefore subject to limited foreign currency exchange rate risks as a result of commercial operations in Europe and Asia. Fluctuations in the United States dollar exchange rate for Euro, Danish Kroner, Taiwanese Dollar, Chinese Renminbi, and Indian Rupee could result in increased or decreased costs for commercial operations in Europe and Asia. Had exchange rates of these foreign currencies been 10% higher or lower relative to the United States dollar during 2014, total R&D and SG&A expenses would have been approximately $2.5�million higher or lower.
A relatively small amount of our monetary assets and liabilities are denominated in foreign currencies. The impact on these assets and liabilities from fluctuations in related foreign currencies relative to the United States dollar would not have had a material impact on our fiscal year 2014 results of operations.
We outsource our wafer manufacturing, assembly and testing, warehousing and shipping operations to third-parties in foreign jurisdictions pursuant to short-term contracts that allow for changes in the fees we are charged for these services. While the expenses related to these services are denominated in United States dollars, if the value of the United States dollar decreases relative to the currencies of the countries in which such contractors operate, the prices we are charged for their services may increase. Fluctuations in currency exchange rates could affect our business in the future.
Currently, we have not implemented any hedging strategies to mitigate risks related to the impact of fluctuations in currency exchange rates.

49


ITEM 8.� FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets at September 30, 2014 and 2013
Consolidated Statements of Operations for the Years Ended September 30, 2014, 2013 and 2012
Consolidated Statements of Stockholders Equity (Deficit) for the Years Ended September 30, 2014, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended September 30, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
Schedule II Valuation and Qualifying Accounts

50


Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders
Vitesse Semiconductor Corporation
Camarillo, California
We have audited the accompanying consolidated balance sheets of Vitesse Semiconductor Corporation (Company) as of September 30, 2014 and 2013 and the related consolidated statements of operations, stockholders equity (deficit), and cash flows for each of the three years in the period ended September 30, 2014. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. 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 at September 30, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2014, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the 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.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Vitesse Semiconductor Corporations internal control over financial reporting as of September 30, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated December�4, 2014 expressed an unqualified opinion thereon.


/s/ BDO USA,�LLP
Los Angeles, California
December�4, 2014

51


VITESSE SEMICONDUCTOR CORPORATION
CONSOLIDATED BALANCE SHEETS
September�30,
2014
September�30,
2013
(in�thousands, except par value)
ASSETS


Current assets:


Cash
$
71,903

$
68,863

Accounts receivable
10,850

9,807

Inventories
12,792

10,692

Restricted cash
794

101

Prepaid expenses and other current assets
1,047

1,796

Total current assets
97,386

91,259

Property, plant and equipment, net
2,858

3,107

Other intangible assets, net
1,476

1,170

Other assets
3,104

3,425

$
104,824

$
98,961

LIABILITIES AND STOCKHOLDERS EQUITY


Current liabilities:


Accounts payable
$
6,814

$
7,436

Accrued expenses and other current liabilities
12,472

12,245

Current portion of debt, net
32,727



Deferred revenue
4,902

2,215

Total current liabilities
56,915

21,896

Other long-term liabilities
234

407

Long-term debt, net
16,417

16,366

Convertible subordinated debt, net


44,384

Total liabilities
73,566

83,053

Commitments and contingencies, See notes 11 and 12




Stockholders equity:


Preferred stock, $0.01 par value: 10,000 shares authorized; no shares issued or outstanding




Common stock, $0.01 par value: 250,000 shares authorized; 67,703 and 57,545 shares outstanding at September 30, 2014 and 2013, respectively
677

575

Additional paid-in-capital
1,924,984

1,891,661

Accumulated deficit
(1,894,403
)
(1,876,328
)
Total stockholders equity
31,258

15,908

$
104,824

$
98,961

See accompanying notes to consolidated financial statements.


52


VITESSE SEMICONDUCTOR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended September 30,
2014
2013
2012
(in�thousands,�except�per�share�data)
Net revenues:


Product revenues
$
102,751

$
101,334

$
109,920

Intellectual property revenues
5,746

2,439

9,563

Net revenues
108,497

103,773

119,483

Costs and expenses:

Cost of product revenues
44,480

46,763

46,407

Engineering, research and development
42,450

41,927

42,713

Selling, general and administrative
30,981

30,210

29,822

Restructuring and impairment




(1,424
)
Amortization of intangible assets
360

347

330

Costs and expenses
118,271

119,247

117,848

(Loss) income from operations
(9,774
)
(15,474
)
1,635

Other expense (income):




Interest expense, net
6,227

7,916

7,778

Gain on compound embedded derivative


(803
)
(4,897
)
Loss on extinguishment of debt
1,594





Other expense, net
139

39

40

Other expense, net
7,960

7,152

2,921

Loss before income tax expense (benefit)
(17,734
)
(22,626
)
(1,286
)
Income tax expense (benefit)
341

(548
)
(174
)
Net loss
$
(18,075
)
$
(22,078
)
$
(1,112
)
Net loss per common share - basic and diluted
$
(0.30
)
$
(0.55
)
$
(0.04
)
Weighted average common shares outstanding - basic and diluted
60,887

40,311

25,121

See accompanying notes to consolidated financial statements.


53


VITESSE SEMICONDUCTOR CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
Preferred�Stock
Common�Stock
Additional
Paid-in-Capital
Accumulated Deficit
Total Vitesse Semiconductor Corporation Stockholders' Equity (Deficit)
(in�thousands)
Shares
Amount
Shares
Amount
Balance at September 30, 2011
135

$
1

24,471

$
245

$
1,824,433

$
(1,853,138
)
$
(28,459
)
Net loss










(1,112
)
(1,112
)
Compensation expense related to stock options, awards and employee stock purchase plan








4,442



4,442

Issuance of common stock upon exercise of stock options




6



16



16

Issuance of shares under employee stock purchase plan




821

8

1,729



1,737

Release of restricted stock units




721

7

(7
)




Repurchase and retirement of restricted stock units for payroll taxes




(207
)
(2
)
(637
)


(639
)
Balance at September 30, 2012
135

1

25,812

258

1,829,976

(1,854,250
)
(24,015
)
Net loss










(22,078
)
(22,078
)
Compensation expense related to stock options, awards and employee stock purchase plan








4,396



4,396

Issuance of common stock upon exercise of stock options




9



20



20

Issuance of shares under employee stock purchase plan




953

9

1,657



1,666

Issuance of common stock, net of offering costs




29,371

294

54,147



54,441

Conversion of Series B Preferred Shares
(135
)
(1
)
674

7

(6
)




Release of restricted stock units




1,045

10

(10
)




Repurchase and retirement of restricted stock units for payroll taxes




(319
)
(3
)
(615
)


(618
)
Reclassification of compound embedded derivative liability to additional paid-in-capital








2,096



2,096

Balance at September 30, 2013




57,545

575

1,891,661

(1,876,328
)
15,908

Net loss










(18,075
)
(18,075
)
Compensation expense related to stock options, awards and employee stock purchase plan







6,075



6,075

Issuance of common stock upon exercise of stock options




52

1

121



122

Issuance of shares under employee stock purchase plan




722

7

1,808



1,815

Issuance of common stock, net of offering costs




8,582

86

26,519



26,605

Release of restricted stock units




1,183

12

(12
)




Repurchase and retirement of restricted stock units for payroll taxes




(381
)
(4
)
(1,250
)


(1,254
)
Other








62



62

Balance at September 30, 2014


$


67,703

$
677

$
1,924,984

$
(1,894,403
)
$
31,258

See accompanying notes to consolidated financial statements.


54


VITESSE SEMICONDUCTOR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30,
2014
2013
2012
(in�thousands)
Cash flows (used in) provided by operating activities:


Net loss
$
(18,075
)
$
(22,078
)
$
(1,112
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:



Depreciation and amortization
2,041

2,375

2,963

Stock-based compensation
6,075

4,396

4,442

Change in fair value of compound embedded derivative liability


(803
)
(4,897
)
Deferred income taxes
(15
)
156

(1,537
)
Restructuring charges




(1,424
)
Loss on asset impairment




1,324

Gain on disposal of assets
(131
)
(153
)


Loss on extinguishment of debt, net
1,594





Amortization of debt issuance costs
190

272

272

Amortization of debt discounts
1,806

2,552

2,363

Accretion of debt premiums
(15
)
(171
)
(157
)
Change in operating assets and liabilities:


Accounts receivable
(1,043
)
(404
)
188

Inventories
(2,100
)
1,368

8,797

Prepaids and other assets
601

535

739

Accounts payable
(673
)
1,710

528

Accrued expenses and other current liabilities
112

(218
)
(2,410
)
Deferred revenue
2,687

1,344

(3,007
)
Net cash (used in) provided by operating activities
(6,946
)
(9,119
)
7,072

Cash flows used in investing activities:


Capital expenditures
(1,484
)
(1,306
)
(808
)
Payments under licensing agreements
(510
)
(342
)
(867
)
Proceeds from sale of fixed assets
183

156

73

Net cash used in investing activities
(1,811
)
(1,492
)
(1,602
)
Cash flows provided by financing activities:



Proceeds from the exercise of stock options and issuances of shares under the employee stock purchase plan
1,937

1,686

1,753

Net proceeds from the sale of common stock
26,656

54,520



Repurchase of convertible subordinated debentures
(14,606
)




Consent fee on amendment of credit agreement
(308
)




Cash restricted under credit agreement
(687
)




Prepayment fee on senior debt






Repurchase and retirement of restricted stock units for payroll taxes
(1,254
)
(618
)
(639
)
Other
59

(5
)
(11
)
Net cash provided by financing activities
11,797

55,583

1,103

Net increase in cash
3,040

44,972

6,573

Cash at beginning of year
68,863

23,891

17,318

Cash at end of year
$
71,903

$
68,863

$
23,891

Supplemental disclosure of non-cash transactions:
Cash paid (refunded) during the fiscal year for:




Interest
$
4,861

$
5,323

$
5,341

Income taxes
(20
)
(1,245
)
1,440

Non cash investing and financing activities:



Common stock issued in exchange for Series�B Preferred Shares


7



Equity offering costs incurred but not paid
51

79



Licensing agreement obligation incurred but not paid
156





Reclassification of compound embedded derivative liability to additional paid-in-capital


2,096




See accompanying notes to consolidated financial statements.

55



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Vitesse Semiconductor Corporation (Vitesse, the Company, us, we or our) is a leading supplier of high-performance integrated circuits (ICs), associated application and protocol software, and integrated turnkey systems solutions used primarily by manufacturers of networking systems for Carrier, Enterprise and Industrial Internet of Things (IoT) networking applications. With these solutions, we enable networking industries to transition from legacy networks to standards-based, ubiquitous Ethernet Everywhere networking, starting from Enterprise networks and Carrier networks, and now penetrating Industrial-IoT networks.
Vitesse was incorporated in the state of Delaware in 1987. Our headquarters are located at 4721 Calle Carga, Camarillo, California, and our phone number is (805)�388-3700. Our stock trades on the NASDAQ Global Market under the ticker symbol VTSS.
Fiscal Year
Our fiscal year is October�1 through September�30.
Basis of Presentation
The accompanying consolidated financial statements are prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and accounting principles generally accepted in the United States of America (GAAP). Our reporting currency is the United States dollar. Our consolidated financial statements include the accounts of Vitesse and our subsidiaries. All inter-company accounts and transactions were eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to prior fiscal year amounts and related footnotes to conform to current fiscal year presentation with no changes to stockholders equity (deficit) amounts or net loss for fiscal year 2013 or 2012.
Foreign Currency Translation
The functional currency of our foreign subsidiaries is the United States dollar; however, our foreign subsidiaries transact in local currencies. Consequently, assets and liabilities are translated into United States dollars at the exchange rate on the balance sheet date. Revenues and expenses are translated at the average exchange rate prevailing during the period. Foreign currency transaction and translation gains and losses are included in results of operations.�
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the consolidated financial statements. Management regularly evaluates estimates and assumptions related to revenue recognition, allowances for doubtful accounts, warranty reserves, inventory valuation reserves, stock-based compensation, compound embedded derivative valuation, purchased intangible asset valuations and useful lives, asset retirement obligations, and deferred income tax asset valuation allowances. These estimates and assumptions are based on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results we experience may differ materially and adversely from our original estimates. To the extent there are material differences between the estimates and the actual results, our future results of operations will be affected.

56


Revenue Recognition
Product Revenues
In accordance with Accounting Standards Codification (ASC) Topic 605, Revenue Recognition, we recognize product revenues 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 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 revenues 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 customers 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 and royalty revenues 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 605-25, 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 fixes and technical support. No other upgrades, products, or post-contract support are provided. These arrangements may be renewable annually by the customer. Support revenues are recognized ratably over the period during which the obligation exists, typically 12�months or less.
We recognize royalty revenues 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 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

57


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.
Shipping and Handling Fees and Costs
Amounts billed to customers for shipping and handling is presented in product revenues. Costs incurred for shipping and handling are included in cost of revenues.
Engineering, Research and Development Costs
Engineering, research and development (R&D) costs are expensed when incurred. R&D expenses consist primarily of compensation expenses for employees and contractors engaged in research, design and development activities. R&D expenses also include costs of mask tooling, which we fully expense in the period, electronic design automation tools, software licensing contracts, subcontracting and fabrication, depreciation and amortization, and overhead including facilities expenses.
Intellectual property purchased from third parties is capitalized and amortized over the useful life of the intellectual property.
Marketing Costs
All of the costs related to marketing and advertising our products are expensed as incurred or at the time the marketing takes place.
StockBased Compensation
ASC Topic 718, Compensation-Stock Compensation (ASC 718) requires that all stockbased payments to employees, including grants of employee stock options and employee stock purchase rights, to be recognized in the financial statements based on their respective grant date fair values. The benefits of tax deductions in excess of recognized compensation cost are required to be reported as a financing cash flow, rather than operating cash flow, as required under previous literature. It is also required to calculate the compensation cost of full-value awards such as restricted stock based on the market value of the underlying stock at the date of the grant. We estimate the expected life of a stock award as the period of time that the award is expected to be outstanding. Expected lives are estimated in accordance with SEC Staff Accounting Bulletin (SAB) No.�107, as amended by SAB No.�110, which provides supplemental application guidance based on the views of the SEC. We are further required to estimate the fair value of stockbased payment awards on the date of grant using an optionpricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service periods. We estimate the fair value of each award as of the date of grant using the BlackScholes option pricing model, which was developed for use in estimating the value of traded options that have no vesting restrictions and that are freely transferable. The BlackScholes model considers, among other factors, the expected life of the award and the expected volatility of our stock price. Although the BlackScholes model meets the accounting guidance requirements, the fair values generated by the model may not be indicative of the actual fair values of our awards, as it does not consider other factors important to those stock-based payment awards, such as continued employment, periodic vesting requirements, and limited transferability.
We have elected to recognize compensation expense for all stockbased awards on a straight-line basis over the requisite service period for the entire award. The amount of compensation expense recognized through the end of each reporting period is equal to the portion of the grant-date value of the awards that have vested, or for partially vested awards, the value of the portion of the award that is ultimately expected to vest for which the requisite services have been provided.
Other Income, Net�
Other income, net, consists of interest income, foreign exchange gains and losses and other non-operating gains and losses.

58


Income Taxes
We account for income taxes pursuant to the provisions of ASC Topic 740, Income Taxes (ASC 740). Under the asset and liability method of ASC 740, 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 basis and operating loss and tax credit carryforwards. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we establish a valuation allowance. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, we include an expense or benefit within the tax provision in the statement of operations. ASC Topic 740-10 prescribes a more likely than not recognition threshold and measurement analysis for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We recognize potential accrued interest and penalties related to unrecognized tax benefits within the consolidated statements of operations as income tax expense.
Net Loss per Share
Basic and diluted net income and loss per share is computed by dividing net income or loss by the weighted average number of common shares outstanding during the period.
For periods in which we report net income, the weighted average number of shares used to calculate diluted income per share is inclusive of common stock equivalents from unexercised stock options, restricted stock units, shares to be issued under our Employee Stock Purchase Plan (ESPP), convertible preferred stock, convertible subordinated debentures (2014 Debentures) and senior term B loan. Unexercised stock options, restricted stock units, and unvested shares to be issued under our ESPP, are considered to be common stock equivalents if, using the treasury stock method, they are determined to be dilutive.
Under the two-class method of determining earnings for each class of stock, we consider the dividend rights and participating rights in undistributed earnings for each class of stock. The allocation of undistributed earnings to preferred shares is equal to the amount of earnings per common share that would be distributed on an as-converted basis.
Risks and Uncertainties
Our future results of operations involve a number of risks and uncertainties. Factors that could affect our business or future results and cause actual results to vary materially from historical results include, but are not limited to, the highly cyclical nature of the semiconductor industry; our high fixed costs; declines in average selling prices; decisions by our IC manufacturer customers to curtail outsourcing; our substantial indebtedness; our ability to fund liquidity needs; our failure to maintain an effective system of internal controls; product return and liability risks; the absence of significant backlog in our business; our dependence on international operations and sales; proposed changes to United States tax laws; that our management information systems may prove inadequate; our ability to attract and retain qualified employees; difficulties consolidating and evolving our operational capabilities; our dependence on materials and equipment suppliers; our loss of customers; adverse tax consequences; the development of new proprietary technology and the enforcement of intellectual property rights by or against us; the complexity of packaging and test processes in our industry; competition; our need to comply with existing and future environmental regulations; and fire, flood or other calamity affecting us or others with whom we do business.
Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of cash and accounts receivable. Cash consists of demand deposits maintained with several financial institutions, which often exceed Federal Deposit Insurance Corporation limits of $250,000. We have never experienced any losses related to these balances; however, our balances are significantly in excess of insured limits.
At September�30, 2014, there were two customers that accounted for 24.3% of accounts receivable. At September 30, 2013, there were two customers that accounted for 23.8% of accounts receivable. We believe that this concentration and the concentration of credit risk resulting from trade receivables owing from high-technology industry customers is substantially mitigated by our credit evaluation process, relatively short collection periods and maintaining an allowance for anticipated losses. We generally do not require collateral security for outstanding amounts.
We currently purchase wafers from a limited number of vendors. Additionally, since we do not maintain manufacturing facilities, we depend upon close relationships with contract manufacturers to assemble our products. We believe there are other vendors who can provide the same quality wafers at competitive prices and other contract manufacturers that can provide comparable services at competitive prices. We anticipate the continued use of a limited number of vendors and contract manufacturers in the near future. We are also dependent upon third parties for our probe testing. Under our fabless business model, our long-term revenue growth is dependent on our ability to obtain sufficient external manufacturing capacity, including

59


wafer production capacity. We believe that in addition to the vendors currently utilized by us, other vendors would be able to provide these services.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at the invoice amount and presented net of the allowance for doubtful accounts; they do not bear interest. We evaluate the collectability of accounts receivable at each balance sheet date using a combination of factors, such as historical experience, credit quality, age of the accounts receivable balances, and economic conditions that may affect a customers ability to pay. We include any accounts receivable balances that are determined to be uncollectible in the overall allowance for doubtful accounts using the specific identification method. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Our allowance for doubtful accounts was nil as of September�30, 2014 and 2013.
Inventories
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, testing 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 product revenues sold in the period the revision is made.
Property, Plant and Equipment
Property, plant and equipment are carried at cost less depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the assets remaining estimated useful lives, ranging from two to five years for machinery and equipment, including product tooling; and the shorter of lease terms or estimated useful lives for leasehold improvements. When property, plant and equipment is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts. Gains and losses from retirements and asset disposals are recorded in selling, general and administrative (SG&A) expenses.
We evaluate the recoverability of property, plant and equipment in accordance with ASC Topic 360, Property, Plant, and Equipment. We perform periodic reviews to determine whether facts and circumstances exist that would indicate that the carrying amounts of property, plant and equipment exceeds their fair values. If facts and circumstances indicate that the carrying amount of property, plant and equipment might not be fully recoverable, projected undiscounted net cash flows associated with the related asset or group of assets over their estimated remaining useful lives are compared against their respective carrying amounts. In the event that the projected undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets are written down to their estimated fair values. All long-lived assets to be disposed of are reported at the lower of carrying amount or fair market value, less expected selling costs.
Intangible Assets
Our intangible assets consist primarily of technology licensing agreements with third-parties and are carried at cost less amortization. We account for intangible assets in accordance with ASC Topic 350, Intangibles - Goodwill and Other. We evaluate our finite-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an intangible asset or asset group may not be recoverable. The carrying value of an intangible asset or asset group is not recoverable if the amounts of undiscounted future cash flows the assets are expected to generate (including any net proceeds expected from the disposal of the asset) are less than its carrying value. When we identify that impairment has occurred, we reduce the carrying value of the asset to its comparable market value (if available and appropriate) or to its estimated fair value based on a discounted cash flow approach. Currently, we do not have goodwill or indefinite-lived intangible assets.

60


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 entitys 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.
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 could obtain, for similar instruments, in the current market. Our debt instruments are included in current portion of debt, net, 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 our senior term A loan (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 our senior term B loan (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 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 was comprised of the conversion option and a make-whole payment for foregone interest if the holder converted 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 were indexed to our own common stock.
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 convertible bond valuation model within a binomial-lattice framework. These valuations were determined using Level�3 inputs. The valuation model combines 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 2014 Debentures are convertible. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement.

61


The compound embedded derivative was presented on the balance sheet at fair value and was marked-to-market, until the make-whole payment for foregone interest expired on October 30, 2012. The change in the fair value of the compound embedded derivative was a non-cash item primarily related to the change in price of the underlying common stock and is reflected in earnings.
The valuation methodologies we use as described above require considerable judgment and may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
Warranty
We establish reserves for future product warranty costs that are expected to be incurred pursuant to specific warranty provisions with our customers. We generally warrant our products against defects for one year from date of shipment, with certain exceptions in which the warranty period can extend to more than one year based on contractual agreements. A warranty reserve is recorded against revenues when products are shipped. At each reporting period, we adjust our reserve for warranty claims based on our actual warranty claims experience as a percentage of net revenues for the preceding 12�months and also consider the effect of known operational issues that may have an impact that differs from historical trends. Historically, our warranty returns have not been material.
Contingencies
We assess our exposure to loss contingencies, including environmental, legal and income tax matters, and provide an accrual for exposure if it is judged to be probable and reasonably estimable. If the actual loss from a loss contingency differs from managements estimates, results of operations could be adjusted upward or downward.
Recent Accounting Pronouncements
In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, A Similar Tax Loss, or a Tax Credit Carryforward Exists (A Consensus the FASB Emerging Issues Task Force). ASU 2013-11 provides guidance on financial statement presentation of unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The FASBs objective in issuing this ASU is to eliminate diversity in practice resulting from a lack of guidance on this topic in current GAAP. This ASU applies to all entities with unrecognized tax benefits that also have tax loss or tax credit carryforwards in the same tax jurisdiction as of the reporting date. This amendment is effective for public entities for fiscal years beginning after December 15, 2013, and interim periods within those years. We do not expect the adoption of this standard to have a material impact on our unaudited consolidated financial position and results of operations.
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in fiscal year 2018.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entitys Ability to Continue as a Going Concern. This standard sets forth managements responsibility to evaluate, each reporting period, whether there is substantial doubt about our ability to continue as a going concern, and if so, to provide related footnote disclosures. The standard is effective for annual reporting periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. We are currently evaluating this new standard and after adoption, we will incorporate this guidance in our assessment of going concern.

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NOTE 2COMPUTATION OF NET LOSS PER SHARE
For fiscal years 2014, 2013 and 2012, we recorded a net loss. As such, all outstanding potential common shares were excluded from the diluted earnings per share computation.
The following potentially dilutive common shares are excluded from the computation of net loss per share.
Outstanding as of September 30,
2014
2013
2012
(in�thousands)
Outstanding stock options
2,940

2,089

1,813

Outstanding restricted stock units
2,328

2,021

1,686

Employee Stock Purchase Plan shares
491

368

506

Convertible preferred stock




674

2014 Debentures
7,298

10,332

10,332

Term B Loan
1,887

1,887

1,887

Total potential common shares excluded from calculation
14,944

16,697

16,898


NOTE 3-DETAILS OF CERTAIN FINANCIAL STATEMENT COMPONENTS
The following tables provide details of selected balance sheet items:
September 30,
2014
2013
(in�thousands)
Inventories:


Raw materials
$
1,840


$
1,220

Work-in-process
4,503

3,652

Finished goods
6,449

5,820

$
12,792

$
10,692

September 30,
2014
2013
(in thousands)
Property, Plant and Equipment, Net:
Machinery and equipment
$
61,236

$
77,865

Furniture and fixtures
505

704

Computer equipment
7,356

8,736

Leasehold improvements
1,829

3,163

Construction in progress
44

305

70,970

90,773

Less: Accumulated depreciation
(68,112
)
(87,666
)

$
2,858

$
3,107

Depreciation expense totaled $1.7 million, $2.0 million, and $2.6 million for fiscal years 2014, 2013 and 2012, respectively. We retired or otherwise disposed of property, plant and equipment with cost and accumulated depreciation of $21.1 million and $21.0 million, respectively, for fiscal year 2014, and with cost and accumulated depreciation of $3.8 million and $3.7 million for fiscal year 2013.

63


September 30,
2014
2013
(in�thousands)
Other Intangible Assets, Net:
Intellectual property and technology license agreements
$
5,490

$
4,824

Less: Accumulated amortization
(4,014
)
(3,654
)

$
1,476

$
1,170

Intangible assets consisted primarily of technology licensing agreements with third-parties and acquired intellectual property. The weighted average period over which intangible assets acquired in fiscal years 2014 and 2013 are amortized is 6.48 years and 6.85 years, respectively.
The future amortization expense of amortizable intangible assets for the next five fiscal years is (in thousands): $372, $350, $245, $204, $168, and $137 in 2015, 2016, 2017, 2018, 2019 and thereafter, respectively.
September 30,
2014
2013
(in�thousands)
Other Assets:
Non-current portion of deferred tax asset, net
$
1,288

$
1,273

Restricted cash
1,500

1,500

Debt issue costs, net
8

287

Other
308

365


$
3,104

$
3,425

Restricted cash consists of interest bearing certificates of deposit with a domestic bank collateralizing letters of credit and other commitments.
September 30,
2014
2013
(in�thousands)
Accrued Expenses and Other Current Liabilities:
Accrued software license agreements
$
3,335

$
3,526

Accrued vacation
2,580

2,442

Accrued wages and benefits
2,730

1,729

Interest payable
1,645

2,196

Accrued income taxes
408

332

Accrued warranty liability
52

60

Accrued other
1,722

1,960


$
12,472

$
12,245


NOTE 4DEBT
September 30,
2014
2013
(in�thousands)
Term A Loan, bearing interest at 9.0% and 10.5% as of September 30, 2014 and 2013, respectively, due August�2016
$
7,791

$
7,919

Term B Loan, convertible until October 31, 2014, bearing interest at 9.0% and 8.0% as of September 30, 2014 and 2013, respectively, due August�2016
8,626

8,444

Other


3

Long-term debt, net
16,417

16,366

2014 Debentures, convertible, 8.0% fixed-rate notes, due October�2014
32,727

44,384

Total debt, net
$
49,144

$
60,750


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Additional information about our debt is as follows:
Term A Loan
Term B Loan
2014 Debentures
(in�thousands)
Principal
$
7,857

$
9,342

$
32,843

Unamortized debt discount
(66
)
(716
)
(116
)
Carrying value
$
7,791

$
8,626

$
32,727

Interest payable terms
Quarterly, in arrears

Quarterly, in arrears

Semi-annually, in arrears
Annual effective interest rate
9.5
%
13.5
%
12.2
%
Conversion price per common share
n/a

$
4.95

$
4.50

Our long-term debt is comprised of our Term A Loan and our Term B Loan, which we collectively refer to as our Term A and B Loans. On November 5, 2013 we amended the credit agreements for the Term A and B Loans (the Amendment). The Amendment extends the maturity dates of our Term A and B Loans to August 31, 2016, and also provides that the Term A and B Loans each bear interest in cash at 9.0% per annum payable quarterly in arrears. In addition, the Amendment provides us with greater flexibility to sell assets and use the resulting proceeds for purposes other than repaying the Term A and B Loans after repayment of our 2014 Debentures.
Upon the occurrence of certain change in control events, the holders of the Term A and B Loans may require us to redeem all or a portion of the loans at 100% of the principal amount plus accrued and unpaid interest.
We have the right to optionally prepay the Term A and B Loans in whole or in part, at any time and from time to time, subject to the payment of a prepayment fee. The prepayment fee is 3% for prepayments made on or after October 30, 2014 but prior to October 30, 2015, and 2% for prepayment made on or after October 30, 2015. We are required to maintain an unrestricted cash balance of $8.0 million and achieve minimum quarterly revenues of $10.0 million. The Term A and B Loans are collateralized by substantially all of our assets.
The credit agreement for the Term A and B Loans provided the lenders with the right to convert the Term B Loan into shares of our common stock at a conversion price of $4.95 per share through October 30, 2014. At September�30, 2014, conversion of the outstanding principal amount of the Term B Loan would have resulted in the issuance of 1.9 million shares of common stock. On October 31, 2014, the conversion right expired unexercised.
In connection with Amendment, we paid the lenders a consent fee of $0.3 million and we repurchased $13.7 million principal amount of our 2014 Debentures at 107% of the principal amount thereof plus accrued interest. We recorded a loss on extinguishment of debt of $1.6 million due to the repurchase. After this transaction, $32.8 million principal amount of 2014 Debentures remained outstanding.
As of September 30, 2014, our current debt consisted of our 2014 Debentures. During fiscal year 2014, cash of $0.7 million was restricted for payment of the 2014 Debentures under the terms of the indenture following the sale of assets. At September�30, 2014, conversion of the outstanding principal amount of the 2014 Debentures would have resulted in the issuance of 7.3 million shares of common stock. We repaid the outstanding principal of $32.8 million of our 2014 Debentures, plus accrued interest, on October 30, 2014, the maturity date of the debentures.
The compound embedded derivative related to the 2014 Debentures, which expired October 30, 2012, was comprised of the conversion option and a make-whole payment for foregone interest if the holder converted the debenture early. Upon expiration of the make-whole payment for forgone interest, the compound embedded derivative no longer met the criteria for bifurcation as all components of the conversion feature were 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, to equity.
The credit agreement for the Term A and B Loans provide for customary restrictions and limitations on our ability to incur indebtedness and liens on property, make restricted payments or investments, enter into mergers or consolidations, conduct asset sales, pay dividends or distributions and enter into specified transactions and activities, and also contain other customary default provisions. We were in compliance with all covenants as of September�30, 2014.

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Debt Maturities
Principal maturity of our total aggregated outstanding debt is as follows:
Fiscal year
(in�thousands)
2015
$
32,843

2016
17,199

Total
$
50,042

Except for required repurchases upon a change in control or in the event of certain asset sales, as described in the applicable credit agreements, we are not required to make any sinking fund or redemption payments with respect to this debt.
NOTE 5FAIR VALUE MEASUREMENTS
We measure the fair value of our Term A and B Loans and 2014 Debentures, which are carried at amortized cost, on a quarterly basis for disclosure purposes. We use a binomial-lattice model to estimate fair values of these financial instruments. The key unobservable input utilized in the model for our Term B Loan and 2014 Debentures includes a discount rate of 4.0% and 3.3%, respectively. The estimated fair value of our Term A Loan is determined using Level 3 inputs based primarily on the comparability of its terms to the terms we could obtain, for similar instruments, in the current market.
The estimated fair values of our financial instruments are as follows:
September 30,
2014
2013
Carrying value
Fair value
Carrying value
Fair value
(in�thousands)
Term A Loan
$
7,791

$
8,755

$
7,919

$
8,165

Term B Loan
8,626

10,245

8,444

9,781

2014 Debentures
32,727

33,040

44,384

49,282


NOTE 6-STOCKHOLDERS EQUITY
Authorized Capital Stock
We are authorized to issue up to 250 million shares of common stock, par value $0.01, per share, of which 9.2 million shares are reserved for future potential issuance upon conversion of debt, 8.4 million shares of common stock have been reserved for issuance under our stock compensation plans, and 3.0 million remaining shares of common stock are reserved for issuance under our ESPP.
We are authorized to issue up to 10 million shares of preferred stock, with a par value of $0.01 per share, none of which are outstanding.
In December 2012, we raised $17.1 million, net of offering costs of $1.6 million, from the registered public sale of 10,651,280 shares of common stock at $1.75 per share, which was a discount to the market price of our common stock.
In June 2013, we raised an additional $37.4 million, net of offering expenses of $2.8 million, from the registered public sale of 18,720,000 shares of common stock at $2.15 per share, which was a discount to the market price of our common stock.
In June 2014, we raised $26.6 million, net of offering expenses of $2.1 million, from the registered public sale of 8,582,076 shares of common stock at $3.35 per share.
NOTE 7STOCK BASED COMPENSATION
Stock Options
We have in effect one stock incentive plan, the 2013 Incentive Plan (the Plan) under which non-qualified stock options and restricted stock units have been granted to employees and non-employee directors. Options generally expire 10 years from the date of grant.

66


The Compensation Committee of the Board of Directors determines the stock-based compensation grants. The exercise price of options is the closing price on the date the options are granted. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model.
Under the Plan, we have 1.9 million�shares available for future grant as of September�30, 2014. The Plan permits the grant of stock options, stock appreciation rights, stock awards, performance awards, restricted stock and stock units, and other stock and cash-based awards. The Plan uses a fungible share concept, pursuant to which shares that are subject to appreciation awards (such as stock options and stock appreciation rights) are counted against the Plan share limit on a 1-for-1 basis for every such share subject to appreciation awards, and shares that are subject to full value awards (such as awards of stock, restricted stock and restricted stock units) are counted against the Plan share limit at a ratio of 1.5 shares for every share subject to the full value award.
As of September�30, 2014, none of our stock-based awards are classified as liabilities. We did not capitalize any stock-based compensation cost.
Compensation cost related to our Plan and ESPP is as follows:
September 30,
2014
2013
2012
(in�thousands)
Cost of revenues
$
823

$
617

$
567

Engineering, research and development
2,248

1,616

1,530

Selling, general and administrative
3,004

2,163

2,345

Total stock-based compensation expense
$
6,075

$
4,396

$
4,442

As of September�30, 2014, there was $6.0 million of unrecognized stock-based compensation expense related to non-vested stock options, restricted stock units, and our ESPP. The weighted average period over which the unearned stock-based compensation for stock options and restricted stock units is expected to be recognized is approximately 1.2 years and 1.6 years, respectively. An estimated forfeiture rate of 4.2% has been applied to all unvested options and restricted stock outstanding as of September�30, 2014. On a quarterly basis, we assess changes to our estimate of expected equity award forfeitures based on our review of recent forfeiture activity and expected future employee attrition. We recognize the effect of adjustments made to the forfeiture rates, if any, in the period that we change the forfeiture estimate. The effect of forfeiture adjustments in fiscal years 2014, 2013, and 2012 was not significant. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional equity awards and our stock price increases.
Activity in stock option awards is as follows:
Shares (in thousands)
Weighted�average
exercise�price
Weighted�average
remaining
contractual�life �(in years)
Aggregate
intrinsic�value (in thousands)
Options outstanding, September�30, 2011
1,699

$
29.77

6.37
$


Granted
401

2.55

Exercised
(6
)
2.54

3

Cancelled or expired
(281
)
76.87

Options outstanding, September�30, 2012
1,813

16.57

6.61
2

Granted
464

2.12

Exercised
(9
)
2.24

6

Cancelled or expired
(179
)
16.52

Options outstanding, September 30, 2013
2,089

13.43

6.67
591

Granted
1,014

2.53

Exercised
(52
)
2.36

64

Cancelled or expired
(111
)
76.55

Options outstanding, September 30, 2014
2,940

$
7.46

7.00
$
2,059

Options exercisable, September 30, 2014
1,633

$
11.36

5.63
$
668

This intrinsic value represents the excess of the fair market value of our common stock on the date of exercise over the exercise price of such options. The aggregate intrinsic values in the preceding table for the options outstanding represent the total pretax intrinsic value, based on our closing stock price of $3.60, $3.04, and $2.44 as of September�30, 2014, 2013 and 2012,

67


respectively, which would have been received by the option holders had those option holders exercised their in-the-money options as of those dates. There were 0.6 million in-the-money stock options that were exercisable as of September�30, 2014.
The fair value of stockbased awards is estimated at the date of grant using the BlackScholes option valuation model; however, the value calculated using an option pricing model may not be indicative of the fair value observed in a willing buyer/willing seller market transaction, or actually realized by the employee upon exercise. Expected volatility used to estimate the fair value of options granted is based on the historical volatility of our common stock. The risk-free interest rate is based on the United States Treasury constant maturity rate for the expected life of the stock option. The expected life of a stock award is the period of time that the award is expected to be outstanding. Expected lives are estimated in accordance with SAB No.�107, as amended by SAB No.�110, which provides supplemental application guidance based on the views of the SEC.
The per share fair values of stock options granted in connection with stock incentive plans have been estimated using the following weighted average assumptions:
September 30,
2014
2013
2012
Expected life (in years)
5.79
5.66
6.61
Expected volatility:
Weighted-average
81.5%
82.0%
86.9%
Range
79.5% - 81.6%
79.8% - 82.1%
82.2% - 87.1%
Expected dividend



Risk-free interest rate
1.7% - 1.9%
0.9% - 1.7%
1.0% - 1.3%
The weighted average fair value at the date of grant of options granted in fiscal years 2014, 2013 and 2012 was $1.75, $1.44 and $1.80, respectively.
On December 10, 2013, we granted 500,000 market-based stock options at an exercise price of $2.53 to executive officers. The market-based options vest if either of the following conditions is met prior to December 10, 2018: (i) the closing price of our common stock equals or exceeds twice the exercise price of $2.53 for 30 consecutive trading days; or (ii) a change in control occurs where the Companys stockholders receive in consideration of their shares of common stock cash or other consideration with a value at least equal to twice the exercise price of $2.53. We evaluate stock awards with market conditions as to the probability that the market conditions will be met and estimate the date at which the market conditions will be met in order to properly recognize stock-based compensation expense over the requisite service period. We used the following assumptions to estimate the fair value of the options: expected life of 1.3 years, expected volatility of 80.0%, a zero dividend rate, and a risk-free rate of 2.79%. The market-based options had a grant date per share fair value of $1.86.
The following table provides additional information in regards to options outstanding as of September�30, 2014:
Options Outstanding
Options Exercisable
Range of Exercise Price
Number Outstanding (in thousands)
Weighted Average Remaining Contractual Life (Years)
Weighted Average Exercise Price
Number Exercisable (in thousands)
Weighted Average Exercise Price
$2.10 - $2.26
424

8.43
$
2.11

194

$
2.10

2.53
987

9.19
2.53

116

2.53

2.54 - 4.36
743

6.74
3.45

542

3.49

4.60 - 47.20
589

4.83
7.84

583

7.87

48.00 - 145.40
197

0.43
57.56

198

57.56

$2.10 - $145.40
2,940

7.00
$
7.46

1,633

$
11.36

Restricted Stock Units
We grant restricted stock units to certain employees and to our non-employee directors. Grants vest over varying terms, to a maximum of four years from the date of the grant. Awards to non-employee directors upon their initial appointment or election to the board vest in installments of 33.3% each over the first three anniversaries of the grant date, and annual awards to non-employee directors vest 100% on the first anniversary of the grant date. Unvested restricted shares are forfeited if the recipients employment or board term terminates for any reason other than death, disability, or special circumstances as determined by the Compensation Committee of the Board of Directors.

68


Activity for our restricted stock award units is as follows:
Restricted
Stock�Units (in thousands)
Weighted�Average
Grant-Date�Fair
Value�per�Share
Weighted�average
remaining
contractual�life �(in years)
Aggregate
intrinsic�value (in thousands)
Restricted stock units, September 30, 2011
1,296

$
4.66

1.38
$
3,823

Awarded
1,258

2.57

Released
(721
)
3.99



Forfeited
(147
)
3.48

Restricted stock units, September 30, 2012
1,686

3.49

1.09
4,113

Awarded
1,527

2.12

Released
(1,045
)
3.19



Forfeited
(147
)
2.88

Restricted stock units, September 30, 2013
2,021

2.65

1.13
6,143

Awarded
1,600

2.62

Released
(1,183
)
2.69


Forfeited
(110
)
2.60

Restricted stock units, September 30, 2014
2,328

$
2.61

0.96
$
8,380

The aggregate intrinsic values in the preceding table for the restricted stock units outstanding represent the total pretax intrinsic value, based on our closing stock price of $3.60, $3.04, and $2.44 as of September�30, 2014, 2013 and 2012, respectively. We issue restricted stock units as part of our equity incentive plans. For the years ended September�30, 2014, 2013, and 2012, the total grant date fair value of shares vested from restricted stock unit grants was $3.2 million, $3.3 million and $2.9 million, respectively. For the majority of restricted stock units granted, the number of shares issued on the date the restricted stock units vest is net of the minimum statutory withholding requirements that we pay in cash to the appropriate taxing authorities on behalf of our employees. The impact of such withholding totaled $1.3 million, $0.6 million and $0.6 million for each of the years ended September�30, 2014, 2013, and 2012, respectively, and was recorded as settlement on restricted stock tax withholding in the accompanying consolidated statements of stockholders equity (deficit). Although shares withheld are not issued, they are treated as common stock repurchases in our consolidated financial statements, as they reduce the number of shares that would have been issued upon vesting.
Employee Stock Purchase Plan
Pursuant to our ESPP, eligible employees may authorize payroll deductions of up to 15% of their regular base salary subject to certain limits to purchase shares at the lower of 85% of the fair market value of the common stock on the date of the commencement of the offering or on the last day of the 6-month offering period. During fiscal years 2014, 2013 and 2012, a total of 721,900, 952,516 and 821,470 shares, respectively, were purchased by and distributed to employees at a weighted average price of $2.50, $1.75 and $2.11 per share, respectively. At fiscal 2014 year-end, we had 3.0 million shares of our common stock reserved for future issuance under the plan. We recognized $0.6 million, $0.6 million and $0.6 million stock compensation expense under the ESPP during the fiscal years ended September 30, 2014, 2013 and 2012, respectively. We determine the fair value of the ESPP awards using the Black-Scholes pricing model. Underlying assumptions used were as follows:
September 30,
2014
2013
2012
Expected life (in years)
0.5
0.5
0.5
Expected volatility (range)
37.1% - 50.3%
47.6% - 49.8%
40.4% - 48.4%
Expected dividend



Risk-free interest rate
0.07% - .08%
0.11% - .14%
0.09% - .20%


69


NOTE 8INCOME TAXES
The components of loss before income tax expense (benefit) for the years ended September�30, 2014, 2013 and 2012 were as follows:
September 30,
2014
2013
2012
(in thousands)
(Loss) income before income taxes:
Domestic
$
(18,871
)
$
(23,646
)
$
(3,406
)
Foreign
1,137

1,020

2,120

$
(17,734
)
$
(22,626
)
$
(1,286
)
Income tax expense (benefit) consists of the following for the years ended September�30, 2014, 2013 and 2012:
September 30,
2014
2013
2012
(in thousands)
Income tax expense (benefit):
Current:
Federal
$
(27
)
$


$
(188
)
State
71

54

41

Foreign
312

(758
)
1,510

Total current
356

(704
)
1,363

Deferred:
Federal






State






Foreign
(15
)
156

(1,537
)
Total deferred
(15
)
156

(1,537
)
Total income tax expense (benefit):
$
341

$
(548
)
$
(174
)
A reconciliation of the income tax expense (benefit) by applying the statutory United States federal income tax rate to loss before income tax expense (benefit) is as follows:
September 30,
2014
2013
2012
$
%
$
%
$
%
(in thousands, except for percentages)
Federal income tax benefit at statutory rate
$
(6,030
)
34.0
�%
$
(7,693
)
34.0
�%
$
(437
)
34.0
�%
State tax benefit net of federal benefit
(242
)
1.4
�%
(536
)
2.4
�%
(13
)
1.0
�%
Foreign taxes
(68
)
0.4
�%
(1,156
)
5.1
�%
1,102

(85.7
)%
Tax credits



�%
(438
)
1.9
�%
(1,230
)
95.6
�%
Nondeductible expenses
650

(3.7
)%
771

(3.4
)%
1,015

(78.9
)%
Other



�%
87

(0.4
)%
(100
)
7.9
�%
Change in valuation allowance
6,131

(34.6
)%
7,164

(31.7
)%
(1,147
)
89.2
�%
Rate change/other adjustments on deferred taxes
(100
)
0.6
�%
1,253

(5.5
)%
636

(49.5
)%
Income tax expense (benefit)
$
341

(1.9
)%
$
(548
)
2.4
�%
$
(174
)
13.6
�%
Our effective tax rate was (1.9)% for the fiscal year ended September�30, 2014 compared to 2.4% and 13.6% for the comparable periods in the prior years. Our income tax expense (benefit) is primarily impacted by foreign taxes, certain nondeductible interest and share based expenses. The income tax expense (benefit) is also impacted by the release of a portion of the valuation allowances related to certain foreign jurisdictions deferred tax assets as such balances were more likely than not realizable within the applicable carryforward period based on our analysis of the available positive and negative evidence.

70


Deferred tax assets and liabilities are recognized for future tax consequences between the carrying amounts of assets and liabilities and their respective tax basis using enacted tax rates in effect for the fiscal year in which the differences are expected to reverse. Significant deferred tax assets and liabilities, consist of the following:
September 30,
2014
2013
(in thousands)
Deferred Tax Assets:
Net operating loss carryforward
$
31,418

$
27,110

Research and development tax credits
10,165

10,574

Deferred income
2,724

2,664

Stock based compensation(1)
3,354

12,313

Fixed assets and intangible property
7,293

7,955

Inventories
1,714

2,256

Allowances and reserves
9,436

9,277

Foreign tax credit/AMT credit
88

88

Other
3

11

Total deferred tax assets
66,195

72,248

Deferred Tax Liabilities:
Debt amortization
(11
)
(2,065
)
Total deferred tax liabilities
(11
)
(2,065
)
Net deferred income taxes
66,184

70,183

Valuation allowance(1)
(64,788
)
(68,802
)
Net deferred tax assets
$
1,396

$
1,381

(1)
The Company identified an overstatement of its previously disclosed deferred tax asset for stock based compensation and the related valuation allowance in the amount of $9.1 million as of September 30, 2013. The Company evaluated the impact of this error in accordance with SAB No. 99 and concluded that it was not material. Further, the Company maintains a full valuation allowance on all of its U.S. and state deferred tax assets, and there was no impact on the Company's financial position and results of operations. As of September 30, 2014 the Company recorded an adjustment of $9.1 million to decrease both the deferred tax asset for stock based compensation and the related valuation allowance. The previously reported amounts have not been revised.
At September�30, 2014, we had approximately $53.9 million, $27.3 million, and $119.2 million of federal, state, and foreign Net Operating Losses (NOLs) respectively, that can be used in future tax years. We also have available state research and development tax credit carryforwards of approximately $10.2 million. The federal NOLs and tax credits may be carried forward through 2034; state NOLs may be carried forward through 2034; state tax credits may be carried forward indefinitely; and foreign NOLs have various carryforward provisions in several jurisdictions.
In December 2012, we issued 10.7 million shares of common stock in a public offering which resulted in a Section 382 ownership change. In general, a Section 382 ownership change occurs if there is a cumulative change in our ownership by 5% shareholders (as defined in the Internal Revenue Code of 1986, as amended) that exceeds 50 percentage points over a rolling three-year period. An ownership change generally affects the rate at which NOLs and potentially other deferred tax assets are permitted to offset future taxable income. Of our federal NOL amount as of September�30, 2014, $25.4 million is subject to an annual Section 382 limitation of $1.4 million due to the December 2012 ownership change. Since we maintain a full valuation allowance on all of our U.S. and state deferred tax assets, the impact of the ownership change on the future realizability of our U.S. and state deferred tax assets did not result in an impact to our provision for income taxes for the year ended September�30, 2014, or on our net deferred tax asset as of September�30, 2014.
In June 2013, we issued an additional 18.7 million shares of common stock in a public offering. Based on a preliminary evaluation we do not believe this offering caused another Section 382 ownership change. As additional relevant information becomes available we will update our evaluation. If an additional ownership change did occur or does occur in the future, our ability to utilize our NOL carryforwards and other deferred tax assets to offset future taxable income may be further limited and the value and recoverability of our NOLs and other deferred tax assets could be further diminished.
We analyzed our need to maintain the valuation allowance against our otherwise recognizable deferred tax assets in the federal, state, and foreign jurisdictions and have recorded a total valuation allowance of $64.8 million of as September�30, 2014, which represents a decrease of $4.0 million from the prior fiscal year. Because we have historically experienced net tax losses, the benefits of which resulted in recognized deferred tax assets, we have placed a $55.0 million valuation allowance against all of our otherwise recognizable deferred tax assets in the federal and state jurisdictions. Furthermore, we have also placed a $9.8

71


million valuation allowance against most of our deferred tax assets in our foreign jurisdictions as we have concluded that it is more likely than not that the majority of our foreign deferred tax assets will not be realized.
Accounting guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The total amount of gross unrecognized tax benefits was approximately $10.3 million as of September�30, 2014 and approximately $10.6 million as of September�30, 2013. The total amount of gross unrecognized tax benefits decreased by $0.3 million, the majority of which related to state research and development tax credits that have not been utilized.
As of September�30, 2014, approximately $0.2 million of the $10.3 million unrecognized tax benefits related to our state tax liability is recorded in accrued expenses and other current liabilities on the consolidated balance sheets. The remaining $10.1 million, which relates to research and development tax credits that have not been utilized, is reflected as a reduction to the deferred tax asset arising from the research and development tax credits. As of September�30, 2013, approximately $0.2 million of the $10.6 million unrecognized tax benefits, related to our state tax liability, was recorded in accrued expenses and other current liabilities on the consolidated balance sheets. The remaining $10.4 million related to research and development tax credits that have not been utilized, was reflected as a reduction to the deferred tax asset arising from the research and development tax credits.
A reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows:
2014
2013
2012
(in thousands)
Beginning balance as of September 30:
$
(10,615
)
$
(10,822
)
$
(10,215
)
Gross decreases - tax positions in prior period
290

354



Gross increases - current-period tax positions


(147
)
(47
)
Gross increases - tax positions in prior period




(560
)
Ending balance as of September 30:
$
(10,325
)
$
(10,615
)
$
(10,822
)
We recognize accrued interest and penalties related to unrecognized tax benefits within the consolidated statements of operations as income tax expense. As of September�30, 2014, there were no material interest or penalties accrued due to significant net operating losses.
We are subject to taxation in the United States and various state and foreign jurisdictions. The 2010 through 2014 tax years generally remain subject to examination by their respective tax authorities. Effectively, all our tax years in which a tax NOL is carried forward to the present are subject to examination by federal, state and foreign tax authorities. Therefore, we cannot estimate the range of unrecognized tax benefits that may significantly change within the next 12 months.

72


NOTE 9SIGNIFICANT CUSTOMERS, CONCENTRATION OF CREDIT RISK AND GEOGRAPHIC INFORMATION
We manage and operate our business through one operating segment.
�Net revenues from customers equal to or greater than 10% of total net revenues is as follows:
September 30,
2014
2013
2012
Nu Horizons Electronics**
*

*

13.5
%
WPG Holdings**
23.8
%
17.7
%
10.7
%
�__________________________________________________
*Less than 10% of total net revenues for period indicated.
**Distributors
Net revenues by geographic area are as follows:
September 30,
2014
2013
2012
(in�thousands)
United States
$
25,284

$
28,454

$
41,559

China, including Hong Kong
31,653

32,545

30,786

Taiwan
23,649

17,430

15,871

Other Asia Pacific
14,258

11,479

15,603

Europe, Middle East and Africa
13,653

13,865

15,664

Total net revenues
$
108,497

$
103,773

$
119,483

Revenues by geographic area are based upon the country of billing. The geographic location 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 OEM and third-party manufacturing service providers in the Asia Pacific region are ultimately shipped to end-markets in the United States and Europe.
We also classify our product revenues based on our three product lines: (i) Ethernet switching, (ii) Connectivity and (iii) Transport processing. Product revenues by product lines are as follows:
September 30,
2014
2013
2012
(in�thousands)
Ethernet switching
$
50,914

$
38,675

$
32,607

Connectivity
41,017

42,885

52,933

Transport processing
10,820

19,774

24,380

Product revenues
$
102,751

$
101,334

$
109,920

Long-lived assets, which consist of property, plant and equipment, net of accumulated depreciation, are summarized as follows:
September 30,
2014
2013
(in�thousands)
Located within the United States
$
1,628

$
1,615

Located outside the United States
1,230

1,492

$
2,858

$
3,107


73


NOTE 10RETIREMENT SAVINGS PLAN
We have a qualified retirement plan under the provisions of Section�401(k) of the Internal Revenue Code covering substantially all U.S. employees. Participants in this plan may defer up to the maximum annual amount allowable under IRS regulations. Employee contributions are fully vested and non-forfeitable at all times. Beginning July 1, 2014, contributions by participants to the plan were matched by us and our matching contributions totaled $0.2 million for fiscal year 2014. Employees vest in matching contributions at 25% per year until they become 100% vested after four years of service. In compliance with governing regulations, we made contributions to the retirement savings plans of employees of our foreign subsidiaries in the amount of $0.9 million for fiscal year 2014, $0.8 million for fiscal year 2013, and $0.7 million for fiscal year 2012.
NOTE 11COMMITMENTS
Operating Leases and Software Licenses
We lease facilities under non-cancellable operating leases. The leases expire at various dates through fiscal year 2018 and frequently include renewal provisions for varying periods of time, provisions which require us to pay taxes, insurance, maintenance costs or provisions for minimum rent increases. Minimum lease payments, including scheduled rent increases, are recognized as rent expenses on a straight-line basis over the applicable lease term. Lease incentives received are recognized as a reduction of rental expense on a straight-line basis over the term of the lease. Rent expense, including common area maintenance expense, under operating leases totaled $3.0 million for fiscal year 2014, $3.5�million for fiscal year 2013, and $3.0�million for fiscal year 2012.
Software license commitments represent non-cancellable licenses of intellectual property from third-parties used in the development of our products.
Future minimum lease payments under non-cancellable operating leases that have remaining non-cancellable lease terms in excess of one year and software licenses are as follows:
2015
2016
2017
2018
2019
Thereafter
Total
(in�thousands)
Operating leases
$
2,002

$
651

$
169

$
60

$


$


$
2,882

Software licenses
8,084

4,555

4,275

4,175





21,089

Total
$
10,086

$
5,206

$
4,444

$
4,235

$


$


$
23,971

NOTE 12CONTINGENCIES
We are involved in legal proceedings in the ordinary course of business, including actions against us which assert or may assert claims or seek to impose fines and penalties in substantial amounts. Related legal defense costs are expensed as incurred.
Patents and Technology Licenses
We have entered into various licensing agreements requiring primarily fixed fee royalty payments. Certain of these agreements contain provisions for the payment of guaranteed or minimum royalty amounts. In the event that we fail to pay any minimum annual royalties, these licenses may automatically be terminated.
Warranties
We establish reserves for future product warranty costs that are expected to be incurred pursuant to specific warranty provisions with our customers. We generally warrant our products against defects for one year from date of shipment, with certain exceptions in which the warranty period can extend to more than one year based on contractual agreements. Our warranty reserves are established at the time of sale and updated throughout the warranty period based upon numerous factors including historical warranty return rates and expenses over various warranty periods. Historically, our warranty returns have not been material.

74


Intellectual Property Indemnities
We indemnify certain customers and our contract manufacturers against liability arising from third-party claims of intellectual property rights infringement related to our products. These indemnities appear in development and supply agreements with our customers as well as manufacturing service agreements with our contract manufacturers, are not limited in amount or duration and generally survive the expiration of the contract. Given that the amount of any potential liabilities related to such indemnities cannot be determined until an infringement claim has been made, we are unable to determine the maximum amount of losses that we could incur related to such indemnifications.
Director and Officer Indemnities and Contractual Guarantees
We have entered into indemnification agreements with our directors and executive officers, which require us to indemnify such individuals to the fullest extent permitted by Delaware law. Our indemnification obligations under such agreements are not limited in amount or duration. Certain costs incurred in connection with such indemnifications may be recovered under certain circumstances under various insurance policies. Given that the amount of any potential liabilities related to such indemnities cannot be determined until a lawsuit has been filed, we are unable to determine the maximum amount of losses that we could incur relating to such indemnities.
We have also entered into severance and change in control agreements with certain of our executives. These agreements provide for the payment of specific compensation benefits to such executives upon the termination of their employment with us.
Guarantees and Indemnities
In the normal course of business, we are occasionally required to undertake indemnification for which we may be required to make future payments under specific circumstances. We review our exposure under such obligations no less than annually, or more frequently as required. The amount of any potential liabilities related to such obligations cannot be accurately determined until a formal claim is filed. Historically, any such amounts that become payable have not had a material negative effect our business, financial condition or results of operations. We maintain general and product liability insurance which may provide a source of recovery to us in the event of an indemnification claim.
NOTE 13SUBSEQUENT EVENT
We repaid the outstanding principal of $32.8 million of our 2014 Debentures, plus accrued interest, on October 30, 2014, the maturity date of the debentures.

75


NOTE 14QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables set forth the consolidated statements of operations for each of our last eight quarters. This quarterly information is derived from unaudited interim financial statements and has been prepared on the same basis as the annual consolidated financial statements. The per-share computation for the fiscal year is a separate, annual calculation. Accordingly, the sum of the quarterly per-share amounts does not necessarily equal the annual per-share amount. In managements opinion, this quarterly information reflects all adjustments necessary for fair presentation of the information for the periods presented. The operating results for any quarter are not indicative of results for any future period.
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Total Year
(in thousands)
Fiscal Year 2014:
Net revenues:
Product revenues
$
24,863

$
24,869

$
26,012

$
27,007

$
102,751

Intellectual property revenues
2,220

723

1,139

1,664

5,746

Net revenues
27,083

25,592

27,151

28,671

108,497

Cost of product revenues
10,676

10,979

12,254

10,571

44,480

Loss from operations
(2,214
)
(4,379
)
(2,527
)
(654
)
(9,774
)
Net loss
(5,371
)
(5,831
)
(4,388
)
(2,485
)
(18,075
)
Net loss per share - basic and diluted
$
(0.09
)
$
(0.10
)
$
(0.07
)
$
(0.04
)
$
(0.30
)
Weighted average shares outstanding:
Basic and diluted
57,610

58,327

59,965

67,580

60,887

Fiscal Year 2013:
Net revenues:
Product revenues
$
23,905

$
24,689

$
26,285

$
26,455

$
101,334

Intellectual property revenues
1,822

64

133

420

2,439

Net revenues
25,727

24,753

26,418

26,875

103,773

Cost of product revenues
10,975

11,369

11,666

12,753

46,763

Loss from operations
(3,819
)
(3,872
)
(4,291
)
(3,492
)
(15,474
)
Net loss
(5,032
)
(4,847
)
(6,434
)
(5,765
)
(22,078
)

Net loss per share - basic and diluted
$
(0.18
)
$
(0.13
)
$
(0.17
)
$
(0.10
)
$
(0.55
)
Weighted average shares outstanding:
Basic and diluted
28,059

37,215

38,630

57,254

40,311

In the first quarter of fiscal year 2014, we recorded a loss on extinguishment of debt of $1.6 million due to the repurchase in November 2013 of $13.7 million principal amount of our 2014 Debentures at 107% of the principal amount thereof.
In the first quarter of fiscal year 2013, we recorded a gain on our compound embedded derivative of $0.8 million related to our 2014 Debentures.

76


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated as of September�30, 2014 the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules�13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September�30, 2014, our disclosure controls and procedures were effective.
Managements Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules�13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of September�30, 2014 based on the framework in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon that evaluation, our management concluded that our internal control over financial reporting was effective as of September�30, 2014.
Attestation Report of Registered Public Accounting Firm
BDO USA,�LLP, our independent registered public accounting firm that audited our financial statements included in this report, has issued an attestation report on our internal control over financial reporting. BDO USA,�LLPs attestation report appears in this Form�10-K.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September�30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitation on the Effectiveness of Controls
Our disclosure controls and procedures provide our Chief Executive Officer and Chief Financial Officer reasonable assurances that our disclosure controls and procedures will achieve their objectives. However, our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting can or will prevent all human error. A control system, no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Furthermore, the design of a control system must reflect the fact that there are internal resource constraints, and the benefit of controls must be weighed relative to their corresponding costs. Because of the limitations in all control systems, no evaluation of controls can provide complete assurance that all control issues and instances of error, if any, within the Company are detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur due to human error or mistake. Additionally, controls, no matter how well designed, could be circumvented by the individual acts of specific persons within the organization. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated objectives under all potential future conditions.

77


Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Vitesse Semiconductor Corporation
Camarillo, California
We have audited Vitesse Semiconductor Corporation's internal control over financial reporting as of September�30, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Vitesse Semiconductor Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Controls and Procedures-Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Vitesse Semiconductor Corporation maintained, in all material respects, effective internal control over financial reporting as of September�30, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Vitesse Semiconductor Corporation as of September 30, 2014 and 2013, and the related consolidated statements of operations, stockholders equity (deficit), and cash flows for each of the three years in the period ended September 30, 2014 and our report dated December�4, 2014 expressed an unqualified opinion thereon.

/s/ BDO USA,�LLP
Los Angeles, California
December�4, 2014

78


ITEM 9B. OTHER INFORMATION
None.
PART�III

Certain information required by Part III is omitted from this Annual Report on Form 10-K because we will file with the SEC no later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K a definitive proxy statement pursuant to Regulation 14A (the Proxy Statement) in connection with the solicitation of proxies for our 2015 Annual Meeting of Stockholders and certain information to be included therein is incorporated herein by reference.

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated by reference from our Proxy Statement under the headings Election of Directors, Executive Officers, Board Meetings and Committees, and Section�16(a) Beneficial Ownership Reporting Compliance.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from our Proxy Statement under the headings Executive Compensation, Director Compensation, Compensation Committee Interlocks and Insider Participation, and Compensation Committee Report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference from our Proxy Statement under the heading Security Ownership of Certain Beneficial Owners and Management and Equity Compensation Plan Information.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated by reference from our Proxy Statement under the heading Director Independence and Certain Relationships and Related Person Transactions.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference from our Proxy Statement under the heading Principal Accountant Fees and Services and Pre-Approval Policies and Procedures.

PART�IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1)
See the financial statements and financial statement schedules listed in Item�8. Financial Statements and Supplementary Data.
(a)(2)
See Schedule�II Valuation and Qualifying Accounts.
(a)(3)
See Exhibit Index following the signature page to this Annual Report on Form�10-K.

79


SCHEDULE II-Valuation and Qualifying Accounts
Balance at Beginning of Year
Charged to Costs and Expenses
Charged to Other Accounts
Deductions/Write-offs
Balance at End of Year
(in thousands)
Year ended September 30, 2014
Deducted from accounts receivable:
Allowance for doubtful accounts
$


$


$


$


$


Deducted from deferred tax asset
Valuation allowance
68,802

6,287



(10,335
)
64,754

Year ended September 30, 2013
Deducted from accounts receivable:
Allowance for doubtful accounts
258

(142
)


(116
)


Deducted from deferred tax asset
Valuation allowance(1)
102,408

(487
)


(33,119
)
68,802

Year ended September 30, 2012
Deducted from accounts receivable:
Allowance for doubtful accounts
2,212

(1,954
)




258

Deducted from deferred tax asset
Valuation allowance(1)
$
92,671

$
(1,147
)
$


$
10,884

$
102,408

(1)
As discussed in Note 8, the Company identified an overstatement of its previously disclosed deferred tax asset for stock based compensation and the related deferred tax asset valuation allowance in the amount of $9.1 million, $9.4 million, and $8.1 million as of September 30, 2013, 2012 and 2011, respectively. The Company evaluated the impact of these errors in accordance with SAB No. 99 and concluded that they were not material. Further, the Company maintains a full valuation allowance on all of its U.S. and state deferred tax assets, and there was no impact on the Companys financial position and results of operations. As of September 30, 2014 the Company recorded an adjustment of $9.1 million to decrease both the deferred tax asset for stock based compensation and the related valuation allowance. The previously reported amounts have not been revised.


80


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.�
December�4, 2014
VITESSE SEMICONDUCTOR CORPORATION
By:
/s/ CHRISTOPHER R. GARDNER
Christopher R. Gardner
Chief Executive Officer
December�4, 2014
VITESSE SEMICONDUCTOR CORPORATION
By:
/s/ MARTIN S. MCDERMUT
Martin S. McDermut
Chief Financial Officer
(Principal Financial and Accounting Officer)

81


POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christopher R. Gardner and Martin S. McDermut, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution for him, and in his name in any and all capacities, to sign any and all amendments to this Annual Report on Form�10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, and any of them or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange 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 date indicated.
December 4, 2014
/s/ Christopher R. Gardner

Christopher R. Gardner
Director, President and Chief Executive Officer
(Principal Executive Officer)
December 4, 2014
/s/ Martin S. McDermut

Martin S. McDermut
Chief Financial Officer
(Principal Financial and Accounting Officer)
December 4, 2014
/s/ Matthew Frey

Matthew Frey
Director
December 4, 2014
/s/ Steven P. Hanson

Steven P. Hanson
Director
December 4, 2014
/s/ James Hugar

James Hugar
Director
December 4, 2014
/s/ Scot B. Jarvis

Scot B. Jarvis
Director
December 4, 2014
/s/ William C. Martin

William C. Martin
Director
December 4, 2014
/s/ Edward Rogas, Jr.

Edward Rogas, Jr.
Director
December 4, 2014
/s/ Kenneth Traub

Kenneth Traub
Director


82


EXHIBIT INDEX
In reviewing the agreements included as exhibits to this Annual Report on Form�10-K, please note that they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about Vitesse or the other parties to the agreements. The agreements may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other party or parties to the applicable agreement and:
"
should not in all instances be treated as categorical statements of fact, but rather as a means of allocating the risk to one of the parties if those statements prove to be inaccurate;
"
may have been qualified by disclosures that were made to the other party or parties in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;
"
may apply standards of materiality in a manner that is different from what may be viewed as material to you or other investors; and
"
were made only as of the date of the applicable agreement or other date or dates that may be specified in the agreement and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about Vitesse may be found elsewhere in this Annual Report on Form�10-K and Vitesses other public filings, which are available without charge through the SECs website at www.sec.gov.
Incorporated�by�Reference
Exhibit Number
Exhibit�Description
Form
File�Number
Exhibit
Filing�Date
Filed or Furnished Herewith
3.1
Restated Certificate of Incorporation.
10-Q
001-31614
3.1
August�9, 2010
3.2
Amended and Restated Bylaws.
8-K
001-31614
3.2
December�2, 2004
3.3
Amendment No. 1 to Amended and Restated Bylaws
8-K
001-31614
3.2
May�14, 2014
4.1
Indenture between the Registrant and U.S. Bank National Association, as Trustee, dated as of October�30, 2009.
8-K
001-31614
4.1
October�30, 2009
4.2
Form of 8.0% Convertible Second Lien Debentures Due 2014 (included in Exhibit�4.1).
8-K
001-31614
4.1
October�30, 2009
4.3
Guaranty, dated October�30, 2009, executed by Vitesse Manufacturing�& Development Corporation and Vitesse Semiconductor Sales Corporation in favor of U.S. Bank National Association, as Trustee, under the Indenture dated October�30, 2009.
10-K/A
001-31614
4.6
January�28, 2010
10.1*
Employment Agreement between the Registrant and Christopher Gardner dated January 30, 2013.
10-Q
001-31614
10.1
August�6, 2013
10.2*
Employment Agreement, dated effective November 30, 2011, between the Registrant and Martin Nuss.
10-Q
001-31614
10.1
February�7, 2012
10.3*
Employment Agreement between the Registrant and Martin S. McDermut dated July�27, 2011.
10-K
001-31614
10.2
December�6, 2011
10.4*
Form of Indemnity Agreement between each of the directors and the Registrant.
8-K
001-31614
10.1
August�22, 2007
10.5*
Vitesse Semiconductor Corporation Fiscal Year 2014 Executive Bonus Plan, dated as of December 23, 2013
10-Q
001-31614
10.1
February�4, 2014
10.6*
Vitesse Semiconductor Corporation Amended and Restated 2001 Stock Incentive Plan as of September�4, 2009.
10-K/A
001-31614
10.1
January�28, 2010
10.7*
Form of Notice of Grant of Stock Options and Option Agreement under the Vitesse Semiconductor Corporation Amended and Restated 2001 Stock Incentive Plan.
10-K/A
001-31614
10.1
January�28, 2010
10.8*
Form of Notice of Grant of Restricted Stock Units and RSU Agreement under the Vitesse Semiconductor Corporation Amended and Restated 2001 Stock Incentive Plan.
10-K/A
001-31614
10.2
January�28, 2010
10.9*
Vitesse Semiconductor Corporation 2010 Incentive Plan.
14A
001-31614
App. A
March�31, 2010
10.10*
Form of Notice of Grant of Stock Options and Option Agreement under the Vitesse Semiconductor Corporation 2010 Incentive Plan.
10-K
001-31614
10.2
December�6, 2011
10.11*
Form of Notice of Grant of Restricted Stock Units and RSU Agreement under the Vitesse Semiconductor Corporation 2010 Incentive Plan.
10-K
001-31614
10.2
December�6, 2011
10.12*
Vitesse Semiconductor Corporation 2013 Incentive Plan.
8-K
001-31614
10.1
March�8, 2013
10.13*
Automatic Equity Grant Program for Eligible Directors under the Vitesse Semiconductor Corporation 2013 Incentive Plan.
10-K
001-31614
10.14
December�5, 2013

10.14*
Form of Notice of Grant of Stock Options and Option Agreement under the Vitesse Semiconductor Corporation 2013 Stock Incentive Plan.
10-K
001-31614
10.15
December�5, 2013

10.15*
Form of Notice of Grant of Restricted Stock Units and RSU Agreement under the Vitesse Semiconductor Corporation 2013 Stock Incentive Plan.
10-K
001-31614
10.16
December�5, 2013

10.16*
Vitesse Semiconductor Corporation Amended and Restated 2011 Employee Stock Purchase Plan.
8-K
001-31614
10.1
February�21, 2014
10.17
Loan Agreement, dated August�23, 2007 between the Registrant and Whitebox VSC,�Ltd.
8-K
001-31614
10.3
August�29, 2007
10.18
First Amendment to Loan Agreement, dated as of October�16, 2009, among the Registrant, the Lenders named therein and Whitebox VSC�Ltd., as agent.
8-K
001-31614
10.4
October�20, 2009
10.19
Second Amendment to Loan Agreement, dated as of February�4, 2011, among the Registrant, the Lenders named therein and Whitebox VSC�Ltd., as agent.
10-Q
000-19654
10.1
February�8, 2011
10.20
Third Amendment to Loan Agreement, dated as of November�5, 2013, among the Registrant, the Lenders named therein and Whitebox VSC�Ltd., as agent.
8-K
001-31614
10.1
November�7, 2013
10.21
Form�of Letter Agreement, dated as of November�5, 2013, between Registrant and certain holders of the Registrants 8.0% convertible second lien debentures due October�2014.
8-K
001-31614
10.2
November�7, 2013
21.0
List of Subsidiaries.
10-K
001-31614
21.0
December�5, 2013

23.1
Consent of BDO USA,�LLP.
X
24.1
Power of Attorney (included on signature page)
X
31.1
Certification of Principal Executive officer pursuant to Securities Exchange Act Rules�13a-14 and 15d-14 as adopted pursuant to Section�302 of the SarbanesOxley Act of 2002.
X
31.2
Certification of Principal Financial officer pursuant to Securities Exchange Act Rules�13a-14 and 15d-14 as adopted pursuant to Section�302 of the SarbanesOxley Act of 2002.
X
32.1
Certifications of Principal Executive Officer and Principal Financial Officer pursuant to Securities Exchange Act Rules�13a-14(b) of the Exchange Act and 18 U.S.C. Section�1350 as adopted pursuant to Section�906 of the SarbanesOxley Act of 2002.
X
101.INS
XBRL Instance Document**
X
101.SCH
XBRL Taxonomy Extension Schema Document**
X
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document**
X
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document**
X
101.LAB
XBRL Taxonomy Extension Label Linkbase Document**
X
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document**
X
_____________________________________________________
*
Each a management contract or compensatory plan or arrangement required to be filed as an exhibit to this annual report on Form�10-K.
Confidential treatment has been granted for certain portions omitted from this exhibit pursuant to an order granted by the Commission under Rule�24b-2 of the Securities Exchange Act of 1934, as amended. Confidential portions of this exhibit have been separately filed with the Securities and Exchange Commission.
**
XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections�11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section�18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.


83


EXHIBIT 23.1

Consent of Independent Registered Public Accounting Firm

Vitesse Semiconductor Corporation
Camarillo, California

We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-192697) and Form S-8 (Nos. 333-194239, 333-187148, 333-172694, 333-167604, 333-130002, 333-120696, 333-112247, 333-110139, 333-100665, 333-72816, 333-55466, 333-105156, 333-84460, and 333-33918) of Vitesse Semiconductor Corporation of our reports dated December�4, 2014, relating to the consolidated financial statements and financial statement schedule, and the effectiveness of Vitesse Semiconductor Corporations internal control over financial reporting, which appear in this Form�10-K.


/s/ BDO USA,�LLP
Los Angeles, California
December�4, 2014






EXHIBIT�31.1
Certification of Principal Executive Officer Pursuant to Securities
Exchange Act Rules�13a-14 and 15d-14 as Adopted Pursuant to
Section�302 of the Sarbanes-Oxley Act of 2002
I, Christopher R. Gardner, certify that:
1.
I have reviewed this annual report on Form�10-K of Vitesse Semiconductor Corporation;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules�13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules�13a-15(f) and 15d-15(f)) for the registrant and we have:
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the Registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the Registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the Registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrants internal control over financial reporting; and
5.
The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.

December�4, 2014
/s/ CHRISTOPHER R. GARDNER
Christopher R. Gardner
Chief Executive Officer




EXHIBIT�31.2
Certification of Principal Financial Officer Pursuant to Securities
Exchange Act Rules�13a-14 and 15d-14 as Adopted Pursuant to
Section�302 of the Sarbanes-Oxley Act of 2002
I, Martin S. McDermut, certify that:
1.
I have reviewed this annual report on Form�10-K of Vitesse Semiconductor Corporation;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules�13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules�13a-15(f) and 15d-15(f)) for the registrant and we have:
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the Registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the Registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the Registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrants internal control over financial reporting; and
5.
The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.

December�4, 2014
/s/ MARTIN S. MCDERMUT
Martin S. McDermut
Chief Financial Officer





Exhibit�32.1
Certification Pursuant to 18 U.S.C. Section�1350 as adopted
Pursuant to Section�906 of the SarbanesOxley Act of 2002
In connection with Annual Report of Vitesse Semiconductor Corporation (the Company) on Form�10-K for the fiscal year ended September�30, 2014 as filed with the Securities and Exchange Commission on the date hereof (the Report), each of the undersigned hereby certifies, pursuant to 18 U.S.C. Section�1350, as adopted pursuant to Section�906 of the Sarbanes-Oxley Act of 2002, that, to his knowledge:
1.
The Report fully complies with the requirements of Section�13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

December�4, 2014
/s/ CHRISTOPHER R. GARDNER
Christopher R. Gardner
Chief Executive Officer
December�4, 2014
/s/ MARTIN S. MCDERMUT
Martin S. McDermut
Chief Financial Officer





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