Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended September 30, 2003

or

For the transition period from                      to                     

Commission file number 000-19654

VITESSE SEMICONDUCTOR CORPORATION

(Exact name of registrant as specified in its charter)

741 Calle Plano, Camarillo, CA 93012

(Address of principal executive offices)

Registrant’s telephone number, including area code: (805) 388-3700

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common stock, $0.01 par value

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the common stock on September 30, 2003 as reported on the Nasdaq National Market, was approximately $1,364,498,181. Shares of common stock held by each officer and director and by each person who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of December 1, 2003, the registrant had outstanding 215,322,283 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Definitive Proxy Statement relating to the Company’s Annual Meeting of Stockholders to be held on January 26, 2004 (incorporated into Part III hereof).

Registration Statement on Form S-1 effective December 10, 1991 (incorporated into Part IV hereof).

Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

2003 ANNUAL REPORT ON FORM 10-K

INDEX

Table of Contents

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as “expects”, “anticipates”, “intends”, “plans” and similar expressions. Our actual results could differ materially from those discussed in these statements. Factors that could contribute to these differences include those discussed under “Risk Factors”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and elsewhere in this report. The cautionary statements made in this report should be read as being applicable to all forward-looking statements wherever they appear in this report.

PART I

Item 1.    Business

Vitesse Semiconductor Corporation (“Vitesse” or the “Company”) was incorporated in the State of Delaware in 1987. Our principal offices are located at 741 Calle Plano, Camarillo, California, and our phone number is (805) 388-3700. Our Internet address is www.vitesse.com. Our SEC filings are available through our website. Our common stock trades on the Nasdaq National Market under the symbol “VTSS”.

We are a leading supplier of high-performance integrated circuits (“ICs”) principally targeted at systems manufacturers in the communications and storage industries. Over the past few years, the proliferation of the Internet and the rapid growth in volume of data being sent over local and wide area networks placed a tremendous strain on the communications infrastructure. The resulting demand for increased bandwidth created a need for both faster as well as more expansive networks. There has also been a growing trend by systems companies towards the outsourcing of IC design and manufacture to suppliers such as Vitesse. Additionally, due to increasing needs for moving, managing and storing mission-critical data, the market for storage equipment has been growing significantly. Since the end of 2000, the communications industry has experienced a severe downturn due to the overbuilding of the communications infrastructure and excess inventories, among other reasons. In spite of these recent adverse conditions, we believe that the long-term prospects for the communications market remain strong. Our customers include leading communications and storage original equipment manufacturers (“OEMs”) such Alcatel, Cisco, EMC, Fujitsu, Hewlett Packard, Huawei, IBM, LSI Logic, Lucent, McData, Nortel, Siemens, Sun Microsystems, and Tellabs.

Background

Communications Market

Over the past decade there has been a dramatic growth in traffic on both public communications networks, such as those used by long-distance and local exchange carriers, and specialized networks, such as those used by Internet service providers. This has been driven by rapid growth of data-intensive applications such as Internet access, e-commerce, e-mail, video conferencing and the movement of large blocks of stored data across networks. These applications in turn spurred demand for high-speed interconnectivity between wide area networks (“WANs”), metropolitan area networks (“MANs”) and local area networks (“LANs”). Faced with this demand for bandwidth, communications service providers were forced to upgrade their infrastructure to provide high-speed data services to customers in addition to providing standard telephone services. At the same time, the abundance of capital available in the private and public markets in the late 1990s and 2000 and perceptions of exponential projected growth in network traffic accelerated the build-out of the communications infrastructure, leading to a significant increase in capital spending on networking equipment.

During this period of rapid expansion, our customers began increasing orders for semiconductor devices in anticipation of continued growth in demand for communications equipment. With device manufacturers such as

1

Table of Contents

Vitesse running at full capacity at that time, OEMs often ordered more devices than necessary in an effort to secure component deliveries. This resulted in a significant increase in inventory levels across the entire supply chain.

At the end of 2000, business conditions changed suddenly. As the supply of capital started to slow down and the overall economy began to weaken, many carriers and enterprises, faced with extreme financial hardship, either scaled back their expenditures or in some cases, ceased operations. Additionally, as it became evident that the infrastructure had been built out in excess of true end-user demand, capital spending on networking equipment across the industry dropped sharply. As a result of this widespread market downturn, we experienced a significant decline in sales of our products, which was further exacerbated by the high inventory levels at our customers. In response to the decreased demand for our products and the continuing disruption in our industry, we implemented a series of restructuring plans during fiscal 2001, 2002 and 2003. These restructuring plans, which included the sale of our optical module business, the closure of our Colorado Springs wafer fabrication facility (“fab”) and other facilities, the termination of employees, cancellation of certain development projects and the write-down of certain assets, have significantly lowered our operating costs going forward. For a detailed description of these restructuring plans see “Restructuring Costs” in the Management’s Discussion and Analysis section and Note 5 to the Consolidated Financial Statements of this report.

Despite the adverse conditions that have affected our business, we believe that the long-term prospects for the communications market and for Vitesse remain strong for several reasons.

First, the demand for additional bandwidth continues to grow, driven primarily by increased traffic on the Internet, as more households and enterprises increase their utilization of the Internet. The emergence of new data-intensive applications such as video-on-demand, next-generation wireless services, and virtual data centers is expected to drive additional traffic through the communications infrastructure. We further believe that the build-out of the infrastructure in developing countries will lead to increased demand for communications equipment.

Second, even as carriers and service providers are faced with capital spending constraints, in order to remain competitive they will need to upgrade their existing networks to not only offer additional services that their customers are demanding but to do so more efficiently and at a lower cost. We believe this trend will spur demand for systems that augment rather than replace existing equipment in the infrastructure, particularly in the metro/access environment.

Third, some MANs are experiencing traffic bottlenecks due to a lack of prior investment in equipment servicing the MAN as well as the interface between the MAN and the WAN. We believe this represents an opportunity for OEMs to supply equipment to carriers who wish to mitigate any bottlenecks.

Fourth, OEMs are focusing their efforts on providing superior software and services as a means of differentiating themselves from their competition. This, in conjunction with rising costs of maintaining component design teams and developing custom integrated circuits, has led to OEMs outsourcing their IC development efforts to companies such as Vitesse. The reductions in workforce that many OEMs have recently implemented have accelerated this trend. As a result of this outsourcing trend, even though capital expenditures for communications equipment have declined significantly since 2000 and are not expected to increase in the near term, we believe that the available market for our products has increased.

Finally, over the past five years, through a combination of acquisitions and internal development efforts, we have expanded our product line beyond our traditional products that served the market for long-haul optical transport. Specifically, we have enhanced our product offerings that serve the storage, enterprise and metro markets. We believe that these markets will recover faster from the current downturn than will the long-haul transport market.

Infrastructure improvements to networks have most prominently included a dramatic increase in the deployment of fiber optic technology to replace conventional copper wire. Optical fiber offers substantially

2

Table of Contents

greater capacity, is less error-prone and is easier to administer than copper wire. SONET (Synchronous Optical Network) in the United States and Japan and the equivalent SDH (Synchronous Digital Hierarchy) in the rest of the world are the primary standards for high-speed transmission of communications over optical fiber. By standardizing interoperability among different vendors’ equipment, the SONET/SDH standards facilitate high levels of data integrity, improved network reliability and reduced maintenance and other operations costs.

The demand for system bandwidth was initially addressed by a technique called wavelength division multiplexing (“WDM”). WDM is a technique that allows several optical signals, each of a different wavelength, to be transmitted simultaneously on a single optical fiber. The adoption of WDM has enabled system operators to significantly increase system bandwidth without the significant delay and expense of having to deploy additional fiber cables. While WDM increases the bandwidth carried by each optical fiber, it does not reduce the number of electronic components required. Instead, WDM has accelerated the growth of SONET/SDH deployment by eliminating fiber installation as a growth limiter. More recently, service providers are trying to address the demand for additional bandwidth by employing next-generation SONET systems that make more efficient use of the existing infrastructure.

Various protocols are being utilized today on top of the SONET optical base to ensure that routing and switching of information occurs accurately, including Asynchronous Transfer Mode (“ATM”) and Internet Protocol (“IP”). ATM is based on fixed-size packets called cells, and is designed to efficiently integrate voice, data and video and easily scale bandwidth. IP is a packet-based protocol that is generally accepted as the industry standard for LAN data transfer and is increasingly being used in MANs and WANs as well. Both ATM and IP packet switching network technologies are being deployed over optical networks based on the complementary SONET/SDH standards, known as ATM over SONET and Packet over SONET (“POS”). Fiber optic transmission systems that adhere to the SONET/SDH and ATM standards use data transmission rates of 155 Megabits per second (“Mb/s”), 622 Mb/s, 2.5 Gigabits per second (“Gb/s”) or 10 Gb/s today, with 40 Gb/s in development. Additionally, new protocols such as multi-protocol label switching (“MPLS”) have emerged that are better suited for data traffic while providing for the low latency and quality of service needs of voice and video traffic. We are also seeing the emergence of Ethernet being transported directly on SONET (Ethernet over SONET or “EoS”), which eliminates an additional layer of overhead from a SONET signal. We believe that EoS is replacing POS as the protocol in next-generation SONET equipment.

Most present-day LANs use the Ethernet transmission protocol, which operates at speeds of 10 Mb/s, 100 Mb/s (Fast Ethernet), 1 Gb/s (Gigabit Ethernet) or 10 Gb/s. Most desktop connections today support either 10 Mb/s or 100 Mb/s data rates, though Gigabit Ethernet is beginning to appear on the desktop. In order to support the migration of desktops to these higher data rates, LAN backbones and servers are increasingly employing the Gigabit Ethernet and 10 Gigabit Ethernet standard. We therefore expect to see a proliferation of higher performance switches in the LAN that will not only address higher bandwidth demands, but will also be capable of providing routing functionality handling different types of traffic.

Storage Market

The proliferation of the Internet and the resulting need to manage, move and store increasing amounts of mission-critical data has led to significant changes in the way that organizations are interconnecting storage systems. Previously, most storage devices were individually connected to servers in a topology termed Direct Attached Storage. However, as the volume of data that needs to be stored has increased, the server capacity and access speed limitations of Direct Attached Storage have become problematic. As a result, companies have moved toward the use of architectures such as Network Attached Storage (“NAS”) and Storage Area Networks (“SANs”). In a NAS system, individual storage devices can be connected to a network and thereby be made available to various servers on the network. In a SAN, multiple servers on a network are connected to a centralized pool of disk storage. This shift in topology has spawned the need to connect high-performance computers, peripheral equipment, storage devices and networks at very high speeds. While earlier storage networks used a standard interface protocol known as small computer systems interface, or SCSI, newer SANs,

3

Table of Contents

which require networking at high speeds over long distances, have increasingly used Fibre Channel, a practical, inexpensive, yet expandable standard that enables high-speed data transfer among workstations, mainframes, data storage devices and other peripherals. We have been a leading provider of Fibre Channel-based ICs since the inception of this standard over ten years ago.

Another protocol emerging in the storage market is Serial ATA, or SATA. SATA is the evolution of the ATA interface that is used in most computers and disk drives today from a parallel bus to a serial bus architecture. SATA is expected to enable the market for lower-cost storage networks that do not require the performance or robustness that a Fibre Channel network offers. We believe that this will result in an overall increase in the market for SANs as these systems become more affordable. Through our acquisition of APT Technologies, Inc. (“APT”) in January 2003, we have enhanced our efforts in developing products that address the SATA protocol.

Strategy

Our objective is to be the leading supplier of high-performance ICs for the global communications and storage markets. In order to attain this goal, our corporate strategy encompasses the following elements:

Target Growing Markets

We target emerging high-growth areas in the communications infrastructure such as products delivering services based on SONET/SDH, ATM, IP, MPLS, Fibre Channel and Gigabit Ethernet, which typically require ICs that are capable of high-bandwidth data transmission. We strive to provide solutions that adhere to the major networking protocols and perform common networking functions required by the most widely deployed communications equipment.

Leverage Technology into New Applications

We have had many years of experience designing and developing products for the high-performance communications market. Over this time frame we have acquired considerable analog, digital and mixed-signal design experience and have also developed significant amounts of core circuitry. Our strategy is to take these core skills and standard building blocks and leverage them into products that address new applications in new markets.

Provide Complete Solutions

To be a leader in our market segment, we must not only address the current needs of our customers, but also be aware of how these requirements are evolving. Over the past few years we recognized a trend among our customers to rely on standard products that they could purchase from component suppliers to meet a majority of their semiconductor needs. Accordingly, our objective is to evolve from being the supplier of solely the highest-speed physical layer ICs to being the supplier of all of the critical high-performance components in our customers’ systems. These components range from the analog electronics used in the conversion between optical and electrical signals to our legacy physical layer products to framers, processors and switches. We believe that this complete solution strategy results in better interoperability and provides our customers with cost-effective and faster time-to-market solutions. It also enables us to build defensible barriers against competitors who offer only a partial or single circuit solution. Additionally, we continually strive to integrate multiple functions on a single chip, thereby reducing device cost and improving performance.

Establish Close Relationships with Customers’ Engineering Management

One of the key elements of our strategy is to work closely with our customers’ systems design teams. We believe that these relationships enable us to better understand the customers’ needs and win designs for existing and new systems.

4

Table of Contents

Products

We have a wide variety of products that are primarily sold into four areas of the communications infrastructure: storage, enterprise, metro and long-haul. While many of our products are targeted at specific markets, some of them find applications in multiple types of communications equipment across all of our focus markets. Our products fall into the following broad categories:

Physical Media Devices

The physical media device (“PMD”) serves as the actual physical connection to the fiber optic cable and is responsible for converting the incoming optical signal into an electric signal. Similarly, for data flowing in the opposite direction, the PMD converts electric signals into optical signals. Some of the PMDs that we offer are laser drivers, transimpedance amplifiers and post amplifiers operating at speeds ranging from 1.25 Gb/s to 40 Gb/s.

Physical Layer Devices

The physical layer (“PHY”) devices perform various functions, such as converting high-speed analog signals from the PMD to digital signals, clock and data regeneration (“CDR”) and multiplexing/demultiplexing (“MUX/DMUX”). The CDR cleans and re-times the signal to synchronize it with the overall system clock, while the MUX/DMUX converts low-speed parallel data into higher speed serial data and vice versa. We offer a broad line of PHY products for the SONET, ATM, IP, Fibre Channel and Gigabit Ethernet markets at the 622 Mb/s, 1.0 Gb/s, 1.25 Gb/s, 2.5 Gb/s and 10 Gb/s data rates.

Framing, Mapping and Other Overhead Processing Functions

Framers are devices that take incoming data traffic from the PHY and process the framing information used for transporting data. Mappers convert data from one protocol to another. Some of the other critical functions in a communications system include forward error correction, performance monitoring and pointer processing. We offer a complete line of these products that operate at speeds up to 10 Gb/s, principally for next-generation SONET systems targeted at the metro market. One such product is the VSC9118, a 10 Gb/s multi-service mapper with a feature called virtual concatenation, which enables a system to more effectively and efficiently transmit LAN-based protocols such as Ethernet, Fibre Channel, Enterprise System Connection (“ESCON”) and digital video over the existing, well-established public network infrastructure.

Network Processors and Traffic Managers

A network processor is a software-programmable microprocessor that is optimized for networking and communications functions such as classification, filtering, policing, grooming, forwarding and routing. Traffic management ICs reside on a line card between the network processor and the switch fabric and perform the policing, queuing and buffering functions. We offer a family of network processors that is designed to deliver programmable high-performance deep-packet processing solutions at speeds up to 2.5 Gb/s. We also offer a traffic manager targeted at packet processing solutions within multi-service and ATM core switches, digital cross connects and high-speed routers.

Switches

The switch fabric is responsible for receiving data from a line card and routing it to its proper destination. As in the case of the network processor, this is a function that is primarily served by internally developed and manufactured application-specific IC solutions today. However, OEMs have increasingly begun to outsource the switch fabric to semiconductor suppliers such as ourselves. One of our current switch fabric solutions is GigaStream, which integrates advanced queuing and scheduling, a serial crossbar and multiple channels of high-speed serial link technology in a two-component fabric chip set. GigaStream’s flexible architecture allows systems designers to scale system bandwidth up to 80 Gb/s. This chip set is ideally suited for access, edge and

5

Table of Contents

metro area routers and multiservice switches at data rates up to 2.5 Gb/s. We are also sampling the TeraStream switch fabric, a two-component chipset that supports 2.5 Gb/s and 10 Gb/s port speeds with a maximum aggregate user bandwidth of 160 Gb/s.

We also supply a family of time slot interchange (“TSI”) and crosspoint switches for use in SONET and WDM equipment in the MAN. With the recent introduction by OEMs of next-generation SONET equipment, the demand for TSI switches has increased considerably. We have various TSI switches in our product portfolio that provide aggregate bandwidth up to 340 Gb/s. The crosspoint switches are available in a broad range of sizes from 2x2 to 144x144 matrices, with serial interface rates of up to 6.5 Gb/s.

Enterprise LAN products

Through our acquisition of Exbit Technology (“Exbit”) in fiscal 2001, we have expanded our product line to include switches and Media Access Controllers (“MACs”) that address Gigabit Ethernet applications in the LAN. We currently offer a family of triple speed (10/100/1000 Mb/s) Layer 2 and Layer 3 switches available in port counts ranging from 8 to 24. These switches are targeted at desktop, workgroup and LAN infrastructure boxes and enable these systems to migrate to Gigabit Ethernet speeds in a cost-effective manner.

Our MAC products are designed for use in modular Ethernet switch platforms in the LAN as well as in emerging Ethernet-over-SONET systems in the metro/access market when used in conjunction with our SONET mappers.

Storage and Serial Backplane Products

We supply a number of different products for the enterprise storage and serial backplane markets. Our products target various systems such as host bus adaptors, switches, servers, hubs, disk arrays and RAID (Redundant Array of Inexpensive Disks) subsystems using Fibre Channel, SCSI and Serial ATA interfaces. Our offerings consist of physical layer devices such as serialisers and deserialisers (“SerDes”), transceivers and port bypass circuits, as well as more integrated products such as switches and enclosure management controllers.

Our family of SerDes and transceiver products offers a wide range of performance and cost-effective solutions that are ideal for high-bandwidth interconnections between buses, backplanes, or other subsystems using standards such as Fibre Channel, Gigabit Ethernet and InfiniBand, a new high-performance data transfer specification. These products are available in single and quad channel configurations and provide data transfer rates from 1 Gb/s to 20 Gb/s.

Our port bypass circuit products are typically used in disk arrays and hubs, where high-speed serial signals need to be routinely steered around drives on a Fibre Channel loop in order to provide redundancy. Our products enable designers of disk arrays and RAID systems to integrate more ports and disk drives while maintaining consistently high signal quality using fewer components.

Enclosure management controllers are designed to monitor various physical characteristics of a storage system such as fan speed and temperature, and to dynamically perform diagnostics, disconnect disk drives or report status to the host without interrupting data flow to other resources within the enclosure. We offer a complete family of these products that support Fibre Channel and SCSI protocols and that interface seamlessly with our other storage products.

We also offer a variety of Fibre Channel, crosspoint and fabric switches that can be used in embedded applications such as disk arrays and RAID subsystems, as well as in standalone fabric and director class switches.

Additionally, we have products, both in production and in development, that address the emerging SATA market targeted at storage systems as well as servers.

6

Table of Contents

Manufacturing

Wafer Fabrication

The majority of our products make use of the state of the art CMOS technology with feature sizes down to 0.13 microns. Through fiscal 2003, we manufactured a portion of our IC products, including Gallium Arsenide (“GaAs”) and Indium Phosphide (“InP”) products, at our two fabs in Camarillo, California, and Colorado Springs, Colorado. In the third quarter of fiscal 2003, we decided to close our Colorado Springs fab and cease all future manufacturing of GaAs products. We expect this fab to be completely shut down in fiscal 2004. The Camarillo fab is expected to continue in a very limited capacity through at least fiscal 2004 but is not expected to generate any meaningful revenue or incur any material cost during this period.

Wafer fabrication for the great majority of our products is outsourced to third-party silicon foundries such as IBM, LSI Logic, Taiwan Semiconductor Manufacturing Corporation and United Microelectronics Corporation. Outsourcing our wafer manufacturing requirements enables us to eliminate the high costs of owning, operating and upgrading fabs and to focus our resources on design and test applications where we believe we have greater competitive advantages. The typical time required for our third-party foundries to produce wafers from a finished product specification is about 8-16 weeks. After fabrication, the wafers must be probed to separate usable and unusable die. We perform all of our wafer probing internally using advanced probers and testers.

Because wafer fabrication for a great majority of our products is outsourced, we depend on third-party foundries to allocate a portion of their manufacturing capacity sufficient to meet our needs and to produce products of acceptable quality in a timely manner. There are significant risks associated with our reliance on third-party foundries, including:

These and other risks associated with our reliance on third-party foundries could materially and adversely affect our business, financial condition and results of operations. For example, the third-party foundries that manufacture our wafers have from time to time experienced manufacturing defects and reductions in manufacturing yields. In addition, disruptions and shortages in foundry capacity may impair our ability to meet our customers’ needs and negatively impact our operating results. Our third-party 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 foundry capacity for the production of high-performance ICs such as ours. We do not have long-term agreements with any of our third-party foundries, but instead subcontract our manufacturing requirements on a purchase order basis. As a result, although we believe that we currently have access to adequate foundry capacity to support our sales levels, it is possible that the capacity we will need in the future may not be available to us on acceptable terms, if at all.

IC Assembly and Test

We outsource our IC packaging to multiple assembly subcontractors in the United States and Asia. Following assembly, the packaged parts are returned to us for final testing prior to shipment to customers. For final test we utilize advanced automated testers as well as high-performance bench test equipment.

Engineering, Research and Development

The market for our products is characterized by continually evolving industry standards, rapid changes in process technologies and increasing levels of functional integration. We believe that our future success will depend largely on our ability to continue to improve our products and our process technologies, to develop new technologies and to adopt emerging industry standards. Our product development efforts are focused on

7

Table of Contents

designing new products for the high-performance communications and storage markets based on understanding the evolving needs of our customers. We are expending considerable design efforts to increase the speed and complexity and to reduce the power dissipation of our products and to create new, value-added functionality. We have, and will continue to develop, cores and standard blocks that can be reused in multiple products, thereby reducing design cycle time and increasing first-time design correctness.

Our engineering, research and development expenses in fiscal 2003, 2002 and 2001, excluding the amortization of deferred stock-based compensation and purchased in-process research and development (“IPR&D”), were $84.3 million, $119.4 million and $133.0 million, respectively.

Competition

The markets for our products are intensely competitive and subject to rapid technological advancement in design technology, wafer manufacturing techniques and alternate networking technologies. We must identify and capture future market opportunities to offset the rapid price erosion that characterizes our industry. We may not be able to develop new products at competitive pricing and performance levels. Even if we are able to do so, we may not complete a new product and introduce it to market in a timely manner. Our customers may substitute use of our products in their next-generation equipment with those of current or future competitors. In the storage and enterprise markets, we principally compete against Agilent, Broadcom, Emulex, Marvell, PMC Sierra and Qlogic, while in the long-haul and metro markets, our competitors include Agere Systems, Applied Micro Circuits Corporation, Mindspeed and PMC Sierra. We also compete with the internal IC design units of systems companies such as Cisco. Over the next few years, we expect additional competitors, some of which may have greater financial and other resources, to enter the market with new products. In addition, we are aware of smaller privately-held companies that focus on specific portions of our range of products. These companies, individually and collectively, represent future competition for design wins and subsequent product sales.

We typically face competition at the design stage, where customers evaluate alternative design approaches that require integrated circuits. Our competitors have increasingly frequent opportunities to supplant our products in next generation systems because of shortened product life and design-in cycles in many of our customers’ products.

Competition is particularly strong in the market for communications ICs, in part due to the market’s growth rate, which attracts larger competitors, and in part due to the number of smaller companies focused on this area. 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 Vitesse might have otherwise won.

Sales and Customer Support

We sell our products principally through direct sales force to systems manufacturers. Because of the significant engineering support required in connection with the sale of high-performance ICs, we provide our customers with field engineering support as well as engineering support from our headquarters. Our sales cycle is typically lengthy and requires the continued participation of salespersons, field engineers, engineers based at our headquarters and senior management.

We augment this direct sales approach with domestic and foreign distributors that work under the direction of our sales force and service smaller accounts purchasing application specific standard products.

Our sales headquarters is located in Camarillo, California. We have six additional sales and field application support offices in the United States, one in Canada, two in China, five in Europe and one in Japan.

We generally warrant our products against defects in materials and workmanship for a period of one year.

8

Table of Contents

Intellectual Property

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. We have been awarded 47 U.S. patents and 3 European patents for various aspects of design and process innovations used in the design and manufacture of our products. We have 123 patent applications pending in the U.S. and 3 patent applications pending in Europe and are preparing to file several more patent applications. We believe that patents are of less significance in our industry than such factors as technical expertise, innovative skills and the abilities of our personnel.

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, none of these claims has resulted in the commencement of any litigation against us nor have we believed that it is 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 their merit or resolution, could be costly and divert the efforts and attention of our management and technical personnel. We cannot assure you that we would prevail in such disputes given the complex technical issues and inherent uncertainties in intellectual property litigation. If such litigation were to result in an adverse ruling, we could be required to:

Backlog

Vitesse’s sales are made primarily pursuant to standard purchase orders for delivery of products. Quantities of our products 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 representative of actual sales for any succeeding period, and we therefore do not believe that backlog is a good indicator of future revenue.

Environmental Matters

We are subject to a variety of federal, state and local environmental regulations relating to the use, storage, discharge and disposal of toxic, volatile and other hazardous chemicals used in our design and manufacturing processes. 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 and manufacturing processes. 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 or require us to incur significant compliance-related expenses.

Employees

As of September 30, 2003, we had 797 employees, including 486 in engineering, research and development, 118 in marketing and sales, 137 in operations and 56 in finance and administration. Our ability to attract and retain qualified personnel is essential to our continued success. None of our employees is represented by a collective bargaining agreement, nor have we ever experienced any work stoppage. We believe our employee relations are good.

9

Table of Contents

Risk Factors

We Have Experienced Continuing Losses From Operations Since March 31, 2001, and We Expect That Our Operating Results Will Fluctuate in The Future

We have experienced continuing losses from operations since our quarterly revenues peaked in the quarter ended December 31, 2000. While our revenues have improved slightly since the fourth quarter of fiscal 2002, they are still not sufficient to cover our operating expenses, and we anticipate future losses from operations as a result. Moreover, in fiscal 2001, 2002 and 2003 our operating results were materially and adversely affected by inventory write-downs, restructuring charges and impairment charges. We may be required to take additional similar charges in the future, which could have a material and adverse effect on our operating results. Due to general economic conditions and slowdowns in purchases of networking equipment, it has become increasingly difficult for us to predict the purchasing activities of our customers and we expect that our operating results will fluctuate substantially in the future. Future fluctuations in operating results may also be caused by a number of factors, many of which are outside our control. Additional factors that could affect our future operating results include the following:

For example, high levels of inventory at our customers contributed to a significant decline in sales of our products in fiscal 2001 and 2002. In addition, we recently decided to discontinue our line of optical module products and sell certain assets of that business, as a result of which our fiscal 2003 statements of operations and cash flows reflect losses from discontinued operations associated with that business.

We implemented significant restructuring programs and cost reductions in fiscal 2001, 2002 and 2003, and we cannot assure that we will not undertake further such actions in the future. In addition, in the past we have recorded significant new product development costs because our policy is to expense these costs at the time that they are incurred. We may incur these types of expenses in the future. These additional expenses may have a material and adverse effect on our results in future periods. The occurrence of any of the above-mentioned factors could have a material adverse effect on our business and on our financial results.

10

Table of Contents

The Market Price for Our Common Stock Has Been Volatile and Future Volatility Could Cause the Value of Your Investment in Our Company to Fluctuate

Our stock price has recently experienced significant volatility. In particular, our stock price declined significantly following announcements made by us and other semiconductor suppliers in fiscal 2001 and 2002 of reduced revenue expectations and of a general slowdown in the technology sector, particularly the optical networking equipment sector. While our revenues have improved slightly since the fourth quarter of fiscal 2002, we expect that uncertainty regarding demand for our products will cause our stock price to continue to be volatile. In addition, the value of your investment could decline due to the impact of any of the following factors, among others, upon the market price of our common stock:

In addition, many of the risks described elsewhere in this section could materially and adversely affect our stock price, as discussed in those risk factors. U.S. financial markets have recently experienced substantial price and volume volatility. Fluctuations such as these have affected and are likely to continue to affect the market price of our common stock.

In the past, securities class action litigation has often been instituted against companies following periods of volatility and decline in the market price of such companies’ securities. If instituted against us, regardless of the outcome, such litigation could result in substantial costs and diversion of our management’s attention and resources and have a material adverse effect on our business, financial condition and results of operations. We could be required to pay substantial damages, including punitive damages, if we were to lose such a lawsuit.

If We are Unable to Develop and Introduce New Products Successfully or to Achieve Market Acceptance of Our New Products, Our Operating Results Would be Adversely Affected

Our future success will depend on our ability to develop new high-performance integrated circuits for existing and new markets, introduce these products in a cost-effective and timely manner and convince leading equipment manufacturers to select these products for design into their own new products. Our quarterly results in the past have been, and are expected in the future to continue to be, dependent on the introduction of a relatively small number of new products and the timely completion and delivery of those products to customers. The development of new integrated circuits is highly complex, and from time to time we have experienced delays in completing the development and introduction of new products. Our ability to develop and deliver new products successfully will depend on various factors, including our ability to:

If we are not able to develop and introduce new products successfully, our business, financial condition and results of operations will be materially and adversely affected. Our success will also depend on the ability of our customers to successfully develop new products and enhance existing products for the communications and storage markets. The communications and storage 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 business, financial condition and results of operations will be materially and adversely affected.

11

Table of Contents

We are Dependent on a Small Number of Customers in a Few Industries

We intend to continue focusing our sales efforts on a small number of customers in the communications and storage markets that require high-performance integrated circuits. Some of these customers are also our competitors. For the year ended September 30, 2003, one customer, EMC Corporation, accounted for greater than 10% of total revenues. 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.

We Depend on Third-party Foundries and Other Suppliers to Manufacture Substantially All of Our Current Products

Wafer fabrication for the great majority of our products is outsourced to third-party silicon foundries such as IBM, LSI Logic, Taiwan Semiconductor Manufacturing Corporation and United Microelectronics Corporation. As a result, we depend on third-party foundries to allocate a portion of their manufacturing capacity sufficient to meet our needs and to produce products of acceptable quality in a timely manner. There are significant risks associated with our reliance on third-party foundries, including:

These and other risks associated with our reliance on third-party foundries could materially and adversely affect our business, financial condition and results of operations. For example, the third-party foundries that manufacture our wafers have from time to time experienced manufacturing defects and reductions in manufacturing yields. In addition, disruptions and shortages in foundry capacity may impair our ability to meet our customers’ needs and negatively impact our operating results. Our third-party 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 foundry capacity for the production of high-performance ICs such as ours. We do not have long-term agreements with any of our third-party foundries, but instead subcontract our manufacturing requirements on a purchase order basis. As a result, although we believe that we currently have access to adequate foundry capacity to support our sales levels, it is possible that the capacity we will need in the future may not be available to us on acceptable terms, if at all.

In addition to third-party foundries, we also depend on third-party subcontractors in the U.S. and Asia for the assembly and packaging of our products. As with our 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, business and financial results.

If We Do Not Achieve Satisfactory Manufacturing Yields or Quality, Our Business will be Harmed

The fabrication of integrated circuits 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 substantially all of our wafers from third-party foundries, we are responsible for low yields when these wafers are probed.

In the past, we have experienced difficulties in achieving acceptable yields on some of our products, particularly with new products, which frequently involve newer manufacturing processes and smaller geometry features than previous generations. Maintaining high numbers of shippable die per wafer is critical to our operating results, as decreased yields can result in higher per-unit costs, shipment delays and increased expenses associated with resolving yield problems. Because we also use estimated yields to value work-in-process

12

Table of Contents

inventory, yields below our estimates can require us to lower the value of inventory that is already reflected on our financial statements. 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. As a result, poor manufacturing yields, defects or other performance problems with our products could adversely affect our business and operating results.

Acquisitions May Be Difficult to Integrate, Disrupt Our Business, Dilute Stockholder Value or Divert the Attention of Our Management

Within the last several years we have made a series of acquisitions, including a number of significant acquisitions. Our management frequently evaluates available strategic opportunities, and as a result we may pursue additional acquisitions of complementary products, technologies or businesses in the future. If we fail to achieve the financial and strategic benefits of past and future acquisitions, however, including our recent acquisitions of Multilink Technology Corporation (“Multilink”) and APT, our business and operating results will be materially and adversely affected. In undertaking future acquisitions, we may:

For example, in connection with our acquisition of Versatile Optical Networks, Inc. (“Versatile”) in July 2001, we issued approximately 8.8 million shares of our common stock. In August 2003 we subsequently sold certain assets of this business at a loss, requiring us to recognize losses from discontinued operations on our fiscal 2003 statements of operations and cash flows. Acquisitions also involve numerous other risks after they are completed, including:

For example, in fiscal 2002 we recorded impairment charges of $398.9 million associated with goodwill and other intangible assets related to past acquisitions. As of September 30, 2003, and after accounting for these impairment charges, we had an aggregate of $194.8 million of goodwill and other intangible assets on our balance sheet. These assets may have to be further written down to the extent they are deemed to be impaired in the future and any such write-downs would adversely affect our results.

Our Industry is Highly Competitive

The markets for our products are intensely competitive and subject to rapid technological advancement in design technologies, wafer-manufacturing techniques, process tools and alternate networking technologies. We must identify and capture future market opportunities to offset the rapid price erosion that characterizes our

13

Table of Contents

industry. We may not be able to develop new products at competitive pricing and performance levels. Even if we are able to do so, we may not complete a new product and introduce it to market in a timely manner. Our customers may substitute use of our products in their next generation equipment with those of current or future competitors. In the storage and enterprise markets, we principally compete against Agilent, Broadcom, Emulex, Marvell, PMC Sierra and QLogic while in the long haul and metro markets, our competitors include Agere Systems, Applied Micro Circuits Corporation, Mindspeed and PMC Sierra. We also compete with internal IC design units of systems companies such as Cisco. Over the next few years, we expect additional competitors, some of which may have greater financial and other resources, to enter the market with new products. In addition, we are aware of venture-backed companies that focus on specific portions of our product line. These companies, individually and collectively, represent future competition for design wins and subsequent product sales.

We typically face competition at the design stage, where customers evaluate alternative design approaches that require integrated circuits. Our competitors have increasingly frequent opportunities to supplant our products in next generation systems because of shortened product life and design-in cycles in many of our customer’s products.

Competition is particularly strong in the market for communications ICs, in part due to the market’s growth rate, which attracts larger competitors, and in part due to the number of smaller companies focused on this area. These companies, individually and collectively, represent strong competition for many design wins and subsequent product sales. 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 Vitesse might have otherwise won.

Our International Sales and Operations Subject Us to Risks that Could Adversely Affect Our Revenue and Operating Results

Sales to customers located outside the U.S. have historically accounted for a significant percentage of our revenue and we anticipate that such sales will continue to be a significant percentage of our revenue. International sales constituted 30%, 24% and 23% of our total revenue in fiscal 2003, 2002 and 2001, respectively. International sales involve a variety of risks and uncertainties, including risks related to:

Failure to successfully address these risks and uncertainties could adversely affect our international sales, which could in turn have a material and adverse effect on our results of operations and financial condition.

We Must Keep Pace with Rapid Technological Change and Evolving Industry Standards

We sell products in markets that are characterized by rapid changes in both product and process technologies, including evolving industry standards, frequent new product introductions, short product life cycles

14

Table of Contents

and increasing demand for higher levels of integration and smaller process geometries. 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 in order to maintain our competitive position. Our failure to accomplish any of the above 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.

Our Business is Subject to Environmental Regulations

We are subject to a variety of federal, state and local environmental regulations relating to the use, storage, discharge and disposal of toxic, volatile and other hazardous chemicals used in our design and manufacturing processes. 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 and manufacturing processes. 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 or require us to incur significant compliance-related expenses.

Our Failure to Manage Changes to Our Operations Infrastructure May Adversely Affect Us

Prior to fiscal 2001 we experienced a period of rapid growth and expanded our operations infrastructure accordingly. More recently, we implemented a series of restructuring plans in fiscal 2001, 2002 and 2003 that reduced this infrastructure. Throughout this period we have also made a number of acquisitions. These changes have placed, and continue to place, a significant strain on our personnel, systems and other resources. Unless we manage these changes effectively, we may encounter challenges in executing our business, which could have a material adverse effect on our business and financial results. Our recent restructuring efforts, in particular, may disrupt our operations and adversely affect our ability to respond rapidly to any renewed growth opportunities.

We are Dependent on Key Personnel

Due to the specialized nature of our business, our success depends in part upon attracting and retaining the services of qualified managerial and technical personnel. The competition for qualified personnel is intense. The loss of any of our key employees or the failure to hire additional skilled technical personnel could have a material adverse effect on our business and financial results.

If We are Not Successful in Protecting Our Intellectual Property Rights, it May Harm Our Ability to Compete

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. We have been issued 47 U.S. patents and 3 European patents and have a number of pending patent applications. However, despite our efforts to protect our intellectual property, we cannot assure you that:

15

Table of Contents

A failure by us to meaningfully protect our intellectual property could have a material adverse effect on our business, financial condition, operating results and ability to compete. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited in certain countries.

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, none of these claims has resulted in the commencement of any litigation against us nor have we believed that it is 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 their merit or resolution, could be costly and divert the efforts and attention of our management and technical personnel. We cannot assure you that we would prevail in such disputes given the complex technical issues and inherent uncertainties in intellectual property litigation. If such litigation were to result in an adverse ruling we could be required to:

Our Ability to Repurchase Our Debentures, If Required, with Cash, upon a Change of Control May Be Limited

In certain circumstances involving a change of control or the termination of public trading of our common stock, holders of our 4% convertible subordinated debentures may require us to repurchase some or all of the debentures. We cannot assure that we will have sufficient financial resources at such time or will be able to arrange financing to pay the repurchase price of the debentures.

Our ability to repurchase the debentures in such event may be limited by law, by the indenture associated with the debentures, by the terms of other agreements relating to our senior debt and by such indebtedness and agreements as may be entered into, replaced, supplemented or amended from time to time. We may be required to refinance our debt in order to make such payments. We may not have the financial ability to repurchase the debentures if payment of our debt is accelerated.

Item 2.    Properties

Our executive offices and principal research and development and fabrication facility is located in Camarillo, California, and is being leased under a noncancellable operating lease that expires in 2009. The total space occupied in this building is approximately 111,000 square feet. Upon expiration of the lease in November 2002, we purchased our second wafer fabrication facility in Colorado Springs, Colorado. This facility includes a 10,000 square foot clean room for wafer fabrication and a product development center. We lease an additional 43,000 square feet in Camarillo for product development. In March 2001, we purchased an additional facility, located in Camarillo, for product development. This building is approximately 52,000 square feet. We also lease space for 13 other product development centers in California, Colorado, Denmark, Germany, Massachusetts, Minnesota, New Jersey, Oregon, and Texas and 15 sales and field application support offices (6 in the United States, 1 in Canada, 5 in Europe, 2 in China and 1 in Japan). As of September 30, 2003, we own space of approximately 156,000 square feet and lease space of approximately 440,000 square feet.

16

Table of Contents

Item 3.    Legal Proceedings

We are currently involved in several legal proceedings; however, we believe that resolution of these matters, if resolved against us, would not have a material and adverse effect on us.

Item 4.    Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

Executive Officers of the Registrant

The executive officers of the Company are as follows:

Louis Tomasetta, a co-founder of the Company, has been President, Chief Executive Officer and a Director since the Company’s inception in February 1987. From 1984 to 1987, he served as President of the integrated circuits division of Vitesse Electronics Corporation. Prior to that he was the director of the Advanced Technology Implementation department at Rockwell International Corporation. Dr. Tomasetta has over 30 years’ experience in the management and development of semiconductor-based businesses, products, and technology. Dr Tomasetta received his B.S., M.S., and Ph.D. degrees in electrical engineering from the Massachusetts Institute of Technology.

Ira Deyhimy, a co-founder of the Company, was Vice President of Product Development since the Company’s inception in February 1987 and became Vice President, Strategy Development in fiscal 2001. From 1984 to 1987, he was Vice President, Engineering at Vitesse Electronics Corporation. Prior to that, Mr. Deyhimy was manager of Integrated Circuit Engineering at Rockwell International Corporation. Mr. Deyhimy has over 30 years’ experience in semiconductor-based technology. Mr. Deyhimy holds a B.S. degree in physics from the University of California at Los Angeles and a M.S. degree in physics from the California State University at Northridge.

Christopher Gardner joined Vitesse in 1986, became Director of ASIC Products in 1992, Vice President and General Manager of ATE Products in 1996, and was appointed Vice President and General Manager of the Telecom Division in 1999. Mr. Gardner served as Vice President and Chief Operating Officer from November 2000 to June 2002. In June 2002, Mr. Gardner became Vice President and General Manager of the Transport Division. Prior to joining Vitesse, he was a member of the technical staff at AT&T Bell Laboratories, which later became part of Lucent Technologies. Mr. Gardner received his B.S.E.E. from Cornell University and his M.S.E.E. from the University of California at Berkeley.

Eugene Hovanec joined the Company as Vice President, Finance and Chief Financial Officer in December 1993. From 1989 to 1993, Mr. Hovanec served as Vice President, Finance & Administration, and Chief Financial Officer at Digital Sound Corporation. Prior to that, from 1984 to 1989, he served as Vice President and Controller at Micropolis Corporation. Mr. Hovanec holds a Bachelor of Business Administration degree from Pace University, New York. Mr. Hovanec also serves as a director of Interlink Electronics, Inc.

17

Table of Contents

Yatin Mody joined the Company in March 1992 as Manager of Budgeting and Cost Accounting, became Controller in August 1993, Vice President and Controller in November 1998, and Vice President, Finance in July 2002. Prior to that, Mr. Mody was at Deloitte and Touche, most recently as a manager. Mr. Mody holds a Bachelor of Technology degree in electrical engineering from the Indian Institute of Technology, Madras and an M.B.A degree from the University of California at Los Angeles.

Richard Riker joined Vitesse in June 2001 as Vice President, Sales and Marketing. He has over 21 years of experience in the semiconductor industry and related fields. From 2000 to 2001, Mr. Riker was Vice President, Sales and Business Development at Stargen. From 1994 to 2000, Mr. Riker was Director of Sales at Intel and Vice President Worldwide Sales, Digital Semiconductors, a business unit of Digital Equipment Corporation. Mr. Riker holds a B.S.E.E. from California State University at Long Beach and an M.B.A. from Pepperdine University.

18

Table of Contents

PART II

Item 5.    Market for Company’s Common Stock and Related Stockholder Matters

Our common stock is traded in the Nasdaq National Market System under the symbol VTSS. Our common stock has been trading on the Nasdaq National Market since December 11, 1991. The table below presents the quarterly high and low closing prices on the Nasdaq National Market during the past two fiscal years.

As of September 30, 2003, there were 2,169 shareholders of record. We have never paid cash dividends and presently intend to retain any future earnings for business development. Further, our bank line of credit agreement and certain of our lease agreements prohibit the payment of dividends without the consent of the bank and the lessors, respectively.

Information regarding our equity compensation plans is set forth under the caption “Equity Compensation Plan Information” in our Proxy Statement for the 2004 Annual Meeting of Shareholders.

Item 6.    Selected Financial Data

The selected financial data presented below was derived from the consolidated financial statements of the Company and should be read in conjunction with the audited consolidated financial statements, the notes thereto and the other financial data included therein.

With the adoption of SFAS No. 142, effective October 1, 2001, the Company ceased amortizing goodwill.

19

Table of Contents

Note 1: Diluted net income per share is computed using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. Diluted net loss per share is computed using the weighted-average number of common shares and excludes dilutive potential common shares, as their effect is antidilutive. The dilutive potential common shares that were antidilutive for fiscal 2003 totaled approximately 49.7 million shares.

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operations of Vitesse should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this report.

Overview

We are a leading supplier of high-performance integrated circuits, principally targeted at systems manufacturers in the communications and storage industries. Our customers include leading communications and storage OEMs such as Alcatel, Cisco, EMC, Fujitsu, Hewlett Packard, Huawei, IBM, LSI Logic, Lucent, McData, Nortel, Siemens, Sun Microsystems, and Tellabs. Over the past few years, the proliferation of the Internet and the rapid growth in volume of data being sent over local and wide area networks has placed a tremendous strain on the communications infrastructure. The resulting demand for increased bandwidth created a need for both faster as well as more expansive networks. There has also been a growing trend by systems companies towards the outsourcing of IC design and manufacture to suppliers such as Vitesse. Additionally, due to increasing needs for moving, managing and storing mission-critical data, the market for storage equipment has been growing significantly.

In the late 1990s and 2000, perceptions of exponential projected growth in network traffic accelerated the build-out of the communications infrastructure, leading to a significant increase in capital spending on communications and networking equipment. During this period, our customers began increasing orders for our products in anticipation of continued growth in demand for their products. At the end of fiscal 2000, however, business conditions changed suddenly. As credit tightened and the economy slipped into a recession, many carriers and service providers, faced with financial hardship, either scaled back their expenditures or in some cases, ceased operations. Additionally, as it became evident that the infrastructure had been built out in excess of true end-user demand, capital spending on networking equipment across the industry dropped sharply, and our customers began consuming a portion of the excess inventories of our components that they had accumulated in previous years rather than placing new orders with us. As part of this widespread market downturn, we experienced a significant decline in sales. In response to these arduous conditions, we implemented various restructuring plans during fiscal 2001, 2002 and 2003 as detailed below.

In spite of the difficult environment confronting the communications industry today, we believe that the long-term prospects for the global communications and storage markets in which we participate remain strong.

Significant Events During Our Last Three Fiscal Years

Since the end of 2000, our industry has experienced a widespread and severe downturn. As a result of this downturn, we experienced a significant decline in sales of our products, which was further exacerbated by the high inventory levels at our customers. In response to the decreased demand for our products and the continuing disruption in our industry, we implemented a series of restructuring programs and other significant changes to our business during fiscal 2001, 2002 and 2003. These changes included the closure of our Colorado Springs fab and other facilities, the termination of employees, the cancellation of certain development projects and the write-down of certain assets, and have significantly lowered our operating costs going forward. In addition to our restructuring programs, within the last the fiscal years we have made a number of acquisitions and have sold our optical module business.

20

Table of Contents

Restructuring Programs and Charges

Due to the prolonged downturn in our industry, we announced a number of restructuring programs in fiscal 2003, 2002 and 2001. A summary of each program is as follows:

A combined summary of these restructuring programs is as follows (in thousands):

21

Table of Contents

In connection with the acquisition of Multilink, we assumed accrued restructuring costs of $3.2 million related to excess facilities charges.

Workforce reduction includes the cost of severance and related benefits of employees affected by the restructuring plans. The excess facilities charges include lease termination payments, non-cancelable lease costs and write off of leasehold improvements and office equipment related to these leases. Contract settlements costs represent future purchase commitments related to unused licenses of non-cancelable software contracts, and the residual value guaranteed under certain equipment operating leases. The impairment of assets charge includes the write-down of the Colorado Springs facility manufacturing equipment and prepaid maintenance contracts associated with that equipment. The charge was determined based on the held and used classification under Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“SFAS 144”). Under this classification, when a decision has been made to abandon an asset group, all of the long-lived assets and certain identifiable intangibles in that asset group to be disposed of are tested for impairment. The charges for the Colorado Springs facility also includes impairment of the owned land and building based on the held and used classification under SFAS 144. The Colorado Springs manufacturing facility will cease production during fiscal 2004. Following the cessation of production, however, certain portions of the building could be used as office space. As such, we obtained fair value information for comparable commercial property in the Colorado Springs area. Based on an estimated fair value, we recorded an impairment charge to write down the land and building accordingly. The adjusted value of the long-lived assets will then be depreciated over the remaining estimated useful life.

Other Write-Offs and Special Charges

During the quarter ended June 30, 2003, we wrote off $6.8 million of GaAs inventory. As a result of our planned closure of the GaAs fabrication facility in Colorado Springs and the decision to exit the GaAs manufacturing process, we notified customers and requested final forecasts and purchase orders from these customers. Based on the customers’ responses, and required commitments to purchase the inventory in the near future, we determined that we had excess GaAs inventory on hand. As a result, we recorded a charge of $6.8 million, which is included in cost of revenues in fiscal 2003. During fiscal 2003 we also recorded a charge of $5.2 million to write down various equity investments held by the two Vitesse Venture Funds to the estimated fair market value, which is included in “Other Expenses” in the statement of operations for fiscal 2003.

In fiscal 2002, we also wrote off $30.5 million of excess and obsolete inventories. The continued industry downturn resulted in a decreased demand for our products and a significant reduction in sales forecasts established at the end of fiscal 2001 and the beginning of 2002. As a result, we recorded a charge of $30.5 million in accordance with our inventory reserve methodology, which was included in cost of revenues in fiscal 2002. Also, during the fourth quarter of fiscal 2002, we recorded a charge of $5.0 million to write down various equity investments held by the two Vitesse Venture Funds to the estimated fair market value, which is included in “Other Expenses” in the statement of operations for fiscal 2002.

Acquisitions and Discontinuations of Operations

We acquired Multilink in August 2003 in exchange for approximately 4.4 million shares of common stock valued at $23.3 million, the assumption of stock options and warrants to purchase approximately 2.0 million shares of common stock valued at $8.4 million, and acquisition-related expenditures of $0.5 million. In connection with the acquisition, we recorded an IPR&D charge of $2.0 million, goodwill of $13.0 million and other intangible assets of $7.0 million that will be amortized over 4 years. Through this transaction, we acquired an experienced team of system, mixed signal and digital design engineers that has successfully developed products for OC-192 transport, Forward Error Correction, 10 Gigabit Ethernet and high speed backplanes, as well as a family of products that is already in production.

In the third quarter of fiscal 2003, we also decided to discontinue our line of optical module products due to continued depressed levels of demand for these products. In August 2003, we entered into an agreement to sell

22

Table of Contents

certain assets of our optical module business to Avanex Corporation (“Avanex”) for shares of Avanex common stock valued at approximately $6.6 million. In accordance with generally accepted accounting principles (“GAAP”), our September 30, 2003 balance sheet reflects assets and liabilities held for sale and our fiscal 2003 statements of operations and cash flows reflect the results of the optical module business as discontinued operations for all periods presented.

In addition to the Multilink transaction we completed in August 2003, we have also made several other significant acquisitions since the beginning of fiscal 2001, including our acquisition of Versatile in July 2001 for approximately 8.8 million shares of our common stock and our acquisition of Exbit in June 2001 for approximately 2.7 million shares of our common stock and certain additional contingent consideration relating to the achievement of performance and retention goals. We also made a number of smaller acquisitions during this period, including our acquisition of APT in January 2003 for approximately $10.0 to $14.4 million, depending on the performance of the acquired business. While we frequently evaluate potential acquisition of business, products or technologies that we believe will contribute to our strategy, we do not currently have any binding commitments with respect to any additional material acquisitions.

Results of Operations

The following table sets forth statements of operations data expressed as a percentage of total revenues for the fiscal years indicated:

Year Ended September 30, 2003, as Compared to Year Ended September 30, 2002

Revenues

Revenues in fiscal 2003 were $156.4 million, an increase of 3.1% from the $151.7 million recorded in fiscal 2002. The relatively small increase in revenues was the result of market conditions and customer demand continuing to remain flat in the first half of fiscal 2003 compared to fiscal 2002, followed by modest growth in the second half of fiscal 2003.

23

Table of Contents

Revenues from storage and enterprise products were $82.9 million and $35.8 million in fiscal 2003, respectively, compared with $58.1 million and $30.0 million, respectively, in fiscal 2002. The increase in revenues in fiscal 2003 from these products is due to our continuing emphasis on these markets through the introduction of new products and enhanced marketing efforts.

Revenues from products targeting the metro market were $19.4 million in fiscal 2003 compared to $21.3 million in fiscal 2002. The relatively small decline in metro revenues was the result of a sequential quarterly decline in orders for older products targeting this market during fiscal 2002, offset by sequential quarterly growth in demand for new products during fiscal 2003.

Revenues from our legacy products, which include long-haul telecommunications products and ASICs for the Automatic Test Equipment (ATE) and military markets were $18.3 million in fiscal 2003 and $42.3 million fiscal 2002. The decrease in revenues generated from these products was primarily due to a significant reduction in orders from telecommunications customers as a result of the overbuilding of the long haul communications infrastructure which began in fiscal 2001 and has continued through fiscal 2003 as well as our reduced emphasis on markets outside communications and storage.

It is customary for product prices in the semiconductor industry to decline over time. Most of these price decreases are negotiated in advance and are usually based on increased volumes or the passage of time. In fiscal 2003 and 2002, we did not experience abnormal price decreases for the majority of our products.

Since fiscal 2001, many of our customers have restructured operations, cut product development efforts, reduced excess component inventories and divested parts of their operations as a result of their clients’ fluctuating capital expenditure levels. We believe that even though the business environment of the markets in which we participate has shown modest signs of improvement, the pattern of revenues for fiscal 2004 may be volatile as a result of fluctuating customer demand forecasts and inventory levels.

Cost of Revenues

Our cost of revenues was $73.2 million in fiscal 2003 compared to $110.2 million in fiscal 2002. As a percentage of total revenues, cost of revenues was 46.8% in fiscal 2003 and 72.6% in fiscal 2002. The decrease in cost of revenues as a percentage of total revenues in fiscal 2003 compared to fiscal 2002 was a result of inventory write-offs, increased revenues and our continued efforts to decrease fixed costs and improve manufacturing yields for mature semiconductor products. During the quarter ended June 30, 2003 we implemented a restructuring plan that included the closure of our 6-inch GaAs wafer fabrication facility in Colorado Springs and the exit of the GaAs manufacturing process in fiscal 2004. As a result we notified customers and requested final forecasts and purchase orders from these customers. Based on the customers’ responses and commitments to purchase the inventory in the near future, we determined that we had excess GaAs inventory on hand and recorded a charge of $6.8 million that is included in cost of revenues in fiscal 2003. In the year ended September 30, 2002, we wrote off $30.5 million of excess and obsolete inventories as a result of an industry-wide reduction in capital spending and the resulting decrease in demand for our products. Excluding the inventory write-offs, cost of revenues in fiscal 2003 and 2002 would have been $66.4 million, or 42.4% of revenues, and $79.6 million, or 52.5% of revenues, respectively. We anticipate that cost of revenues as a percentage of revenues will decline in the first quarter of fiscal 2004 as the complete impact of our cost reduction measures takes effect. Thereafter, cost of revenues as a percentage of revenues may fluctuate based primarily on the demand for our products and the relative mix of the products that we sell.

Engineering, Research and Development

Engineering, research and development expenses were $110.1 million in fiscal 2003 compared to $147.3 million in fiscal 2002. As a percentage of total revenues, engineering, research and development expenses were 70.4% in fiscal 2003 and 97.1% fiscal 2002. The decrease in both absolute dollars and as a percentage of

24

Table of Contents

revenues from fiscal 2002 was principally due to the inclusion of restructuring charges in the first and third quarters of fiscal 2002 and the resulting cost reductions from such restructurings plans in fiscal 2003. Our engineering, research and development costs are expensed as incurred.

Selling, General and Administrative

Selling, general and administrative expenses (“SG&A”) were $54.0 million in fiscal 2003, compared to $68.2 million in fiscal 2002. As a percentage of total revenues, SG&A expenses were 34.5% in fiscal 2003, compared to 44.9% in fiscal 2002. The decrease in both absolute dollars and as a percentage of revenues from the prior year was primarily due to our efforts to streamline our cost structure.

Restructuring Costs

Restructuring costs were $54.0 million in fiscal 2003, compared to $210.0 million in fiscal 2002. See further discussion in “Overview”.

In-Process Research and Development (“IPR&D”)

Purchased in-process research and development charges were $3.0 million in fiscal 2003. These charges related to the acquisition of APT and Multilink of $1.0 million and $2.0 million, respectively. There were no IPR&D charges in fiscal 2002 or 2001.

The related purchased IPR&D for each of the above mentioned transactions represents the present value of the estimated after-tax cash flows expected to be generated by the purchased technology that, at the acquisition dates, had not yet reached technological feasibility. The cash flow projections for revenues were based on estimated of relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of our new product introductions and that of our competitors, individual product sales cycles and the estimated life of each product’s underlying technology. Estimated operating expenses and income taxes were deducted from estimated revenue projections to arrive at estimated after-tax cash flows. Projected operating expenses include cost of goods sold, marketing and selling expenses, general and administrative expenses, and research and development, including estimated costs to maintain the products once they have been introduced into the market and are generating revenue.

Amortization of Goodwill and Intangible Assets

We elected to adopt Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), effective the beginning of fiscal 2002. In accordance with SFAS 142, we ceased amortizing goodwill as of October 1, 2001. There was no transitional impairment of goodwill upon adoption of SFAS 142.

Amortization of other intangible assets was $5.1 million in fiscal 2003, as compared to $5.2 million in fiscal 2002. The decrease in amortization expense is the result of the sale of our optical modules business, which enabled us to cease amortizing certain intangible assets. This was offset by an increase in other intangible assets acquired in our current year acquisitions.

Other Income, Net

Other income consists of interest income, interest expense, gain on extinguishment of debt and other expenses. Interest income was $4.6 million in fiscal 2003 compared to $16.7 million in fiscal 2002. The decrease in interest income of $12.1 million from fiscal 2002 was the result of lower cash balances and short-term and long-term investments held throughout the period as well as a significant decline in interest rates earned on our cash and investment balances. The decrease in cash and investment balances was primarily the result of the repurchase of our convertible subordinated debentures in the quarters ended December 31, 2001, September 30, 2002 and December 31, 2002, as well as a fixed operating cash outflow in a period of reduced revenues.

25

Table of Contents

Interest expense was $7.2 million in fiscal 2003 compared to $14.0 million in fiscal 2002. The decrease in interest expense of $6.8 million from fiscal 2002 was primarily the result of several interest rate swap agreements entered into during fiscal 2003 that significantly lowered interest expense relative to fiscal 2002, as well as the reduction in outstanding principal amount of our convertible subordinated debentures that resulted from our repurchases of those instruments.

During the first quarter of fiscal 2003, we purchased $68.6 million principal amount of our 4% convertible subordinated debentures due March 2005 at prevailing market prices, for an aggregate amount of approximately $51.1 million. As a result, for the year ended September 30, 2003, we recorded a gain on extinguishment of debt of approximately $16.6 million, net of a proportion of deferred debt issuance costs of $1.0 million.

In fiscal 2003, we recorded a charge of $5.2 million to write down certain equity investments held by the two Vitesse Venture Funds to the estimated fair market value. This was offset by the amortization of deferred gains of $2.8 million related to the termination of certain interest rate swap agreements. We will amortize the gains over the remaining life of the convertible subordinated debentures due March 2005. For additional information regarding our interest rate swap agreements, see Note 8 “Derivative Instruments and Hedging Activities” of the Notes to the Consolidated Financial Statements.

Income Tax Expense (Benefit)

For the year ended September 30, 2003, the total effective income tax rate was 0%. In fiscal 2003 and 2002, no deferred tax benefit was allocated to discontinued operations.

Loss from Discontinued Operations

Loss from discontinued operations was $36.0 million in the year ended September 30, 2003, which was comprised of revenues of $11.5 million, loss from operations of $17.9 million, and a loss on disposal of $18.1 million. Loss from discontinued operations was $33.8 million in the year ended September 30, 2002, which was comprised of revenues of $10.6 million, and a loss from operations of $33.6 million, which included a $6.6 million restructuring charge.

Year Ended September 30, 2002, as Compared to Year Ended September 30, 2001

Revenues

Revenues in fiscal 2002 were $151.7 million, a decline of 60% from the $383.9 million recorded in fiscal 2001. The decrease in revenues in 2002 was a result of continued adverse market conditions and the reduction in demand from our customers that began in fiscal 2001.

Revenues from storage and enterprise products were $58.1 million and $30.0 million in fiscal 2002, respectively, compared with $81.0 million and $52.0 million, respectively, in fiscal 2001. The decrease in revenues from these products in fiscal 2002 was primarily due to reduced capital spending on enterprise networking equipment as a result of weakening overall economic conditions in 2001 and 2002 and due to excess inventories of these products in our customers’ channels. Revenues from enterprise and storage products in 2002 were not as severely impacted as those from other areas of communications as enterprise and storage networks did not undergo the same level of over expansion as long haul networks did.

Revenues from products targeting the metro market were $21.3 million in fiscal 2002 compared to $40.0 million in fiscal 2001. The decline in metro revenues was the result of a significant reduction in orders from customers as a result of the overbuilding of the communications infrastructure, and due to the continued presence of excess inventories of these products in our customers’ channels.

26

Table of Contents

Revenues from our legacy products, which include long-haul telecommunications products and ASICs for the ATE and military markets were $42.3 million in fiscal 2002 and $210.9 million in fiscal 2001. The decrease in revenues generated from these products was primarily due to a significant reduction in orders from telecommunications customers as a result of the overbuilding of the long haul communications infrastructure which began in fiscal 2001 and has continued through fiscal 2002, the presence of excess inventories of these products in our customers’ channels as well as our reduced emphasis on markets outside communications and storage.

Cost of Revenues

Our cost of revenues was $110.2 million in fiscal 2002 compared to $201.6 million in fiscal 2001. As a percentage of total revenues, cost of revenues was 72.6% in fiscal 2002 compared to 52.5% in fiscal 2001. Continued industry-wide reductions in capital spending and the resulting decrease in demand for our products in fiscal years 2002 and 2001 resulted in significant downward adjustments to our sales forecasts. As a result, for fiscal 2002 and 2001 we recorded charges of $30.5 million and $50.6 million, respectively, for the write-off of excess and obsolete inventories in accordance with our inventory reserve methodology. Excluding the inventory write-offs, cost of revenues in fiscal 2002 and 2001 would have been $79.6 million, or 52.5% of revenues, and $150.9 million, or 39.3% of revenues, respectively. The increase in cost of revenues as a percentage of total revenues, exclusive of write-offs, from fiscal 2001 to fiscal 2002 was the result of significantly lower quarterly revenues on a base of relatively fixed manufacturing costs, as well as the introduction of new products that had lower yields when first released. This increase was partially offset by decreases in cost of revenues resulting from our transition from using our own fabrication facilities to relying on third-party foundries. There was also a slight improvement in our cost of revenues on a quarter-over-quarter basis during fiscal 2002 as a result of our efforts to decrease fixed costs and improve manufacturing yields for mature products.

Engineering, Research and Development

Engineering, research and development expenses were $147.3 million in fiscal 2002 compared to $150.7 million in fiscal 2001. As a percentage of total revenues, engineering, research and development expenses were 97.1% in fiscal 2002 and 39.3% fiscal 2001. The decrease in absolute dollars from the prior year was principally due to the reclassification of $23.0 million of our fiscal 2002 optical module division expenses to loss from discontinued operations compared to only $5.0 million in fiscal 2001. Including the abovementioned expenses, engineering, research and development expenses increased principally due to higher headcount from acquisitions completed in fiscal 2001 of approximately 240 employees, amortization of deferred stock compensation and higher costs to support our continuing efforts to develop new products. This increase was partially offset by the expense reductions associated with the restructuring plans announced in the first and third quarters of fiscal 2002.

Selling, General and Administrative

Selling, general and administrative expenses were $68.2 million in fiscal 2002, compared to $86.4 million in fiscal 2001. As a percentage of total revenues, SG&A expenses were 44.9 % in fiscal 2002, compared to 22.5% in fiscal 2001. Excluding charges of $3.0 million and $14.1 million recorded in fiscal 2002 and fiscal 2001, respectively, the decrease in absolute dollars from the prior year was primarily due to our efforts to streamline our cost structure. The $3.0 million charge recorded in fiscal 2002 was to increase the reserve for doubtful accounts.

Restructuring Costs

Restructuring costs were $210.0 million in fiscal 2002, compared to $3.7 million in fiscal 2001. See further discussion in “Overview”.

27

Table of Contents

Goodwill and Intangible Assets Impairment Charge

As a result of industry conditions, and our significant restructuring charge discussed above, we determined that there were indicators of impairment to the carrying value of our goodwill and purchased intangibles. During the third quarter of fiscal 2002, we performed a review of the value of our goodwill in accordance with SFAS 142. Based on our review, we recorded a charge of $398.9 million to write down the value of goodwill and other intangible assets during the quarter ended June 30, 2002.

Amortization of Goodwill and Intangible Assets

Amortization of other intangible assets was $5.2 million in fiscal 2002, compared to amortization of goodwill and other intangible assets of $86.5 million in fiscal 2001. The decrease in amortization was primarily due to the adoption of SFAS 142 as of October 1, 2001.

Other Income, Net

Other income consists of interest income, interest expense, gain on extinguishment of debt and other expenses. Interest income was $16.7 million in fiscal 2002 compared to $48.7 million in fiscal 2001. The decrease in interest income of $32.0 million from the prior year was the result of lower cash balances and short-term and long-term investments held throughout the year as well as a significant decline in interest rates earned on our cash balances. The decrease in cash balances was primarily the result of the repurchase of our convertible subordinated debentures in the quarters ended September 30, 2002 and December 31, 2001, as well as a fixed operating cash outflow in a period of reduced revenues.

Interest expense was $14.0 million in fiscal 2002 compared to $31.8 million in fiscal 2001. The decrease in interest expense of $17.8 million from the prior year was primarily the result of two interest rate swap agreements entered into during fiscal 2002 that significantly reduced interest expense relative to fiscal 2001, as well as the reduction in outstanding principal amount of our convertible subordinated debentures that resulted from our repurchases of those instruments.

In fiscal 2002, we purchased $273.4 million aggregate principal amount of our 4% convertible subordinated debentures due March 2005 at prevailing market prices, for an aggregate of approximately $203.1 million in cash. As a result, we recorded a gain on extinguishment of debt of approximately $66.3 million, net of a portion of debt issue costs of $4.0 million.

In fiscal 2002, we also recorded a charge of $5.0 million to write down an equity investment held by the two Vitesse Venture Funds to the estimated fair market value. Further, in the quarter ended September 30, 2002, we recorded a deferred gain of $9.3 million related to the termination of certain interest rate swap agreements. We will amortize the gain over the remaining life of the convertible subordinated debentures due March 2005. As a result, a gain of $0.4 million was recognized in the year ended September 30, 2002. For additional information regarding our interest rate swap agreements, see Note 8 “Derivative Instruments and Hedging Activities” of the Notes to the Consolidated Financial Statements.

Income Tax Expense (Benefit)

Our annual income tax expense for fiscal 2002 was $126.1 million compared to a tax benefit of $13.7 million in fiscal 2001. The increase in tax expense for fiscal 2002 was due principally to a net tax charge of $126.2 million recorded during the quarter ended June 30, 2002. This charge consisted of an increase to the valuation allowance of $145.8 million, partially offset by the reversal of income taxes payable of $19.6 million, resulting in an income tax receivable of $5.2 million at June 30, 2002. We conduct continuing evaluations of whether it is “more likely than not” that our deferred tax assets will be realized, including consideration of projections of future taxable income and the reversal of temporary differences. The increase to the valuation allowance in the quarter ended June 30, 2002 resulted from a determination at the time that it was not “more likely than not” that all of our deferred tax assets would be realized.

28

Table of Contents

Loss from Discontinued Operations

Loss from discontinued operations was $33.8 million in fiscal 2002, which was comprised of revenues of $10.6 million, and a loss from operations of $33.6 million, which included a $6.6 million restructuring charge. Loss from discontinued operations, net of tax benefit, was $3.9 million in fiscal 2001, which was comprised of revenues from discontinued operations of $0.2 million, loss from operations of $6.3 million and a tax benefit of $2.4 million.

Liquidity and Capital Resources

Off-Balance Sheet Arrangements

We have entered into several agreements to lease equipment. All of these leases have initial terms of three to five years and options to renew for an additional one to three years. We have the option to purchase the equipment at the end of each initial lease term, and at the end of each renewal period for the lessor’s original cost, which is not less than the fair market value at each option date. If we elect not to purchase the equipment at the end of each of the leases, we would guarantee a residual value to the lessors equal to 80% to 84% of the lessors’ cost of the equipment equal to $71.4 million. As of September 30, 2003, the lessors had advanced a total of $14.3 million under these leases, and held $57.1 million as cash collateral, which amount is included in restricted long-term deposits.

Operating Activities

We generated $0.5 million of cash in operating activities during fiscal 2003. Although we had a net loss from continuing operations of $131.2 million during this period, this amount reflected an aggregate of $129.0 million of non-cash items, including write-offs of property and equipment, prepaid maintenance and inventory, a write-down of assets held for sale, depreciation and amortization and amortization of deferred compensation expense, partially offset by gain on extinguishment of debt and amortization of gains on derivative instruments. In addition to the net impact of non-cash items, our operating activities for fiscal 2003 also reflect an increase in inventory and a decrease in accrued restructuring. These were offset in part by decreases in accounts receivable, prepaid expenses and other current assets and non-current assets as well as increases in accounts payable, accrued expenses and other current liabilities and income taxes payable.

We used $76.8 million in operating activities in fiscal 2002. Although we had a net loss from continuing operations of $849.7 million during this period, this amount included $801.1 million of non-cash items resulting primarily from impairment of goodwill and intangible assets of $398.9 million, property and equipment write-off of $135.2 million, and a change in deferred tax assets, net, of $139.1 million. It also included depreciation and amortization, inventory write-offs, prepaid maintenance write-offs, accrued restructuring and amortization of deferred compensation expense, partially offset by gain on extinguishment of debt. In addition to the net impact of non-cash items, our operating activities for fiscal 2002 also reflected an increase in inventory and prepaid expenses and other current assets and a decrease in accounts payable, accrued expenses and other current liabilities, accrued restructuring and incomes taxes payable. These were offset in part by decreases in accounts receivable and other assets.

We used $6.2 million in operating activities in fiscal 2001. Although we had a net loss from continuing operations of $108.0 million during this period, this amount included $186.4 million of non-cash items resulting primarily from depreciation and amortization of $136.8 million. It also included impairment of goodwill and intangible assets, inventory write-offs, an increase in equity associated with tax benefits from the exercise of stock options and amortization of deferred compensation expense, partially offset by gain on extinguishment of debt and a change in deferred tax assets. In addition to the net impact of non-cash items, our operating activities for fiscal 2001 also reflected an increase in inventory, prepaid expenses and other current assets and other assets and a decrease in accounts payable, accrued expenses and other current liabilities, accrued restructuring and incomes taxes payable. These were offset in part by a decrease in accounts receivable.

29

Table of Contents

Investing Activities

We generated $11.0 million and $315.0 million and used $33.9 million in investing activities during fiscal 2003, 2002 and 2001, respectively. The cash generated by investing activities during fiscal 2003 was principally due to the proceeds from the sale of $625.2 million in available-for-sale debt and equity securities and cash acquired in our current acquisitions, net of cash paid, of $16.1 million. This was offset by the purchases of $611.7 million in similar securities and $19.1 million in capital expenditures.

The cash generated by investing activities during fiscal 2002 was due to the maturity of investments of $1,199.6 million in held to maturity debt and equity securities, offset by purchases of $817.9 million in similar securities, $62.2 million for capital expenditures and $4.6 million for payments of collateral on an equipment lease recorded in restricted long-term deposits.

The cash used in investing activities during fiscal 2001 was primarily due to purchases of $2,158.8 million in held to maturity debt and equity securities, capital expenditures of $148.2 million, investments in restricted long term deposits of $12.2 million and payment for the purchase of companies, net of cash acquired, of $12.9 million, offset by the maturity of investments of $2,298.2 million in held to maturity debt and equity securities.

In addition, we had two non-cash transactions totaling $28.7 million in fiscal 2003. One transaction related to the lease for the land and building for our wafer fabrication facility in Colorado Springs, Colorado, which expired on October 30, 2002. We exercised our option to purchase the land and building for the lessor’s original cost, or $27.5 million. This lease was fully cash-collateralized and included in restricted long-term deposits as of September 30, 2002. The other transaction related to several equipment leases that expired on January 31, 2003. We exercised our option to purchase the equipment for the lessor’s original cost, or $6.3 million, of which $3.8 million had been previously written off in the restructuring plan implemented in the quarter ended June 30, 2002. These leases were 80% cash-collateralized and included in restricted long-term deposits as of September 30, 2002.

Financing Activities

In fiscal 2003 we used $40.3 million in financing activities, including the purchase of $68.6 million carrying value of our convertible subordinated debentures for $51.1 million and the repayment of debt obligations of $0.2 million. This was offset by proceeds of $7.6 million received from the issuance and sale of common stock pursuant to our stock option and stock purchase plans, proceeds of $3.3 million of deferred gain on derivative instrument and proceeds of $0.1 million received from the limited partners of the Vitesse Venture Funds. The limited partners are officers and employees of our company and represent an insignificant portion of the investments in the Vitesse Venture Funds.

In fiscal 2002 we used $186.8 million in financing activities, including the purchase of $273.4 million carrying value of our convertible subordinated debentures for $203.1 million and the repayment of $0.5 million to Vitesse Venture Fund partners for the sale of investments. This was offset by proceeds of $7.4 million received from the issuance and sale of common stock pursuant to our stock option and stock purchase plans, proceeds of $9.3 million of deferred gain on derivative instrument, and proceeds of $0.1 million received from the limited partners of the Vitesse Venture Funds.

In fiscal 2001, we used $123.8 million of cash from financing activities, including the purchase of $182.9 million carrying value of our convertible subordinated debentures for $148.7 million and the repayment of debt obligations of $11.3 million. This was offset by proceeds of $31.5 million received from the issuance and sale of common stock pursuant to our stock option and stock purchase plans and proceeds of $4.8 million received from the limited partners of the Vitesse Venture Funds.

We used $33.0 million, $33.7 million and $1.9 million in discontinued operations in fiscal 2003, 2002 and 2001, respectively.

30

Table of Contents

We believe that our cash and cash equivalents, short-term investments, cash flow from operations and revolving line of credit agreement are adequate to finance our planned growth and operating needs for the next 12 months. See discussion on the revolving line of credit in Note 7 of the Notes to Consolidated Financial Statements.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to our allowance for doubtful accounts and sales returns, inventory reserves, goodwill and purchased intangible asset valuations, asset impairments and income taxes. We base our estimates on historical experience and on various other assumptions 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. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies, among others, affect the significant judgments and estimates we use in the preparation of our consolidated financial statements:

Allowance for Doubtful Accounts, Sales Returns Reserve and Revenue Recognition

We evaluate the collectibility of our accounts receivable based on a combination of factors. At September 30, 2003, we maintained an allowance for doubtful accounts and sales returns reserve of approximately 7.2% of gross accounts receivable. In circumstances where we are aware of a specific customer’s inability to meet its financial obligations to us, we record a specific allowance to reduce the net receivable to the amount we reasonably believe will be collected. For all other customers, we record allowances for doubtful accounts based on the length of time the receivables are past due, the prevailing business environment and our historical experience. If the financial condition of our customers were to deteriorate or if economic conditions were to worsen, additional allowances may be required in the future.

We recognize product revenue when persuasive evidence of an arrangement exists, the sales price is fixed, products are shipped to customers, which is when title and risk of loss transfers to the customers, and collectibility is reasonably assured. Revenue from development contracts is recognized upon attainment of specific milestones established under the customer contracts. Revenue from products deliverable under development contracts, including design tools and prototype products, is recognized upon delivery. We record a provision for estimated sales returns in the same period as the related revenues are recorded. We base these estimates on historical sales returns and other known factors. Actual returns could be different from our estimates and current provisions for sales returns and allowances, resulting in future charges to earnings.

At September 30, 2003, our allowance for doubtful accounts and sales returns was $2.7 million or 7.2% of gross receivables, compared to $14.8 million or 28.5% of gross receivables as of September 30, 2002. The decrease in the reserve as a percentage of gross receivables from prior year is the result of writing off accounts against the allowance for doubtful accounts and sales returns reserve.

Inventory Valuation

At each balance sheet date, we evaluate our ending inventories for excess quantities and obsolescence. This evaluation includes analyses of sales levels by product and projections of future demand. If inventories on hand are in excess of forecasted demand, we provide appropriate reserves for such excess inventory. If we have previously recorded the value of such inventory determined to be in excess of projected demand, or if we determine that inventory is obsolete, we write off these inventories in the period the determination is made. Due

31

Table of Contents

to reduced capital spending by our customers and the resulting reduction in demand for our products, we wrote off $30.5 million of excess and obsolete inventory during fiscal 2002. Due to our planned exit from the GaAs manufacturing process in connection with the closure of our Colorado Springs, Colorado fab, we wrote off $6.8 million of excess and obsolete inventory in the quarter ended June 30, 2003. Remaining inventory balances are adjusted to approximate the lower of our standard manufacturing cost or market value. If future demand or market conditions are less favorable than our projections, additional inventory write-downs may be required, and would be reflected in cost of revenues in the period the revision is made.

Valuation of Goodwill, Purchased Intangible Assets and Long-Lived Assets

We perform goodwill impairment tests on an annual basis and on an interim basis if an event or circumstance indicates that it is more likely than not that impairment has occurred. We assess the impairment of other amortizable intangible assets and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include significant underperformance to historical or projected operating results, substantial changes in our business strategy and significant negative industry or economic trends. If such indicators are present, we evaluate the fair value of the goodwill of our one reporting unit to its carrying value. For other intangible assets and long-lived assets we determine whether the sum of the estimated undiscounted cash flows attributable to the assets in question is less than their carrying value. If less, we recognize an impairment loss based on the excess of the carrying amount of the assets over their respective fair values. Fair value of goodwill is determined by using a valuation model based on an income and market approach. Fair value of other intangible assets and long-lived assets is determined by discounted future cash flows, appraisals or other methods. If the long-lived asset determined to be impaired is to be held and used, we recognize an impairment charge to the extent the present value of anticipated net cash flows attributable to the asset are less than the asset’s carrying value. The fair value of the long-lived asset then becomes the asset’s new carrying value, which we depreciate over the remaining estimated useful life of the asset. See Note 3 “Goodwill and Other Intangible Assets”, Note 4 “Discontinued Operations” See Note 5 “Restructuring Costs and Other Special Charges” of the Notes to the Consolidated Financial Statements for additional information.

During the quarter ended June 30, 2003 we recorded a charge of $27.4 million for the write-down of certain manufacturing equipment used in our Colorado Springs fab and prepaid maintenance contracts associated with that equipment, as well as $23.7 million for the write-down of the Colorado Springs land and building. During the quarter ended June 30, 2002, we recorded goodwill and other intangible asset impairments of $396.0 million and $2.9 million, respectively, totaling $398.9 million. We also recorded a charge of $169.2 million during fiscal 2002 for the write-down of certain excess manufacturing equipment. To the extent we determine there are indicators of impairment in future periods, additional write-downs may be required.

Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then 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 likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. As of September 30, 2003 all tax benefits are subject to a 100% valuation allowance.

32

Table of Contents

Impact of Recent Accounting Pronouncements

In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS 149”). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The changes in this Statement require that contracts with comparable characteristics be accounted for similarly. In particular, this Statement (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and (4) amends certain other existing pronouncements. These changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS 149 did not have a material impact on our financial statements.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit and Disposal Activities (“SFAS 146”). SFAS 146 nullifies Emerging Issues Task Force (“EITF”) issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under EITF issue 94-3, a liability for an exit cost is recognized at the date of an entity’s commitment to an exit plan. Under SFAS 146, the liabilities associated with an exit or disposal activity will be measured at fair value and recognized when the liability is incurred and meets the definition of a liability in the FASB’s conceptual framework. This statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have a material impact on our financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”), which addresses the disclosure to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. The disclosure requirements are effective for interim and annual financial statements ending after December 15, 2002. The Company generally warrants its products against defects in materials and workmanship for a period of one year. The amount accrued for such warranty is insignificant.

FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees. FIN 45 requires the guarantor to recognize a liability for the non-contingent component of a guarantee, which is the obligation to stand ready to perform in the event that specified triggering events or conditions occur. The initial measurement of this liability is the fair value of the guarantee at inception. The recognition of the liability is required even if it is not probable that payments will be required under the guarantee or if the guarantee was issued with a premium payment or as part of a transaction with multiple elements. The initial recognition and measurement provisions are effective for all guarantees within the scope of FIN 45 issued or modified after December 31, 2002. The adoption of the recognition and initial measurement requirements of FIN 45 did not have a material impact on our financial position, cash flows or results of operations.

In February 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”), which addresses the consolidation by business enterprises of variable interest entities, which have one or both of the following characteristics: (1) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional financial support from other parties, or (2) the equity investors lack one or more of the following essential characteristics of a controlling financial interest: (a) the direct or indirect ability to make decisions about the entity’s activities through voting or similar rights, (b) the obligation to absorb the expected losses of the entity if they occur, or (c) the right to receive the expected residual returns of the entity if they occur. FIN 46 will have a significant effect on existing practice because it requires existing variable interest entities to be consolidated if those entities do not effectively disburse risks among parties involved.

33

Table of Contents

In addition, FIN 46 contains detailed disclosure requirements. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. This Interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. We believe FIN 46 will not have a material impact on our financial statements.

In November 2002, the FASB’s Emerging Issues Task Force (EITF) issued EITF 00-21 Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying EITF 00-21, separate contracts with the same entity or related parties that are entered into at or near the same time are presumed to have been negotiated as a package and should, therefore, be evaluated as a single arrangement in considering whether there are one or more units of accounting. That presumption may be overcome if there is sufficient evidence to the contrary. EITF 00-21 also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Alternatively, companies may elect to report the change in accounting as a cumulative-effect adjustment. Early application of this consensus is permitted. We believe that EITF 00-21 will not have a material impact on our financial statements.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risks

Cash Equivalents, Short-term and Long-term Investments

Cash equivalents and investments are principally composed of money market accounts, commercial paper rated A-1/P-1 and obligations of the U.S. government and its agencies. Our investments are made in accordance with an investment policy approved by the Board of Directors. Maturities of these instruments are less than 30 months with the majority being within one year. We classify these securities as held-to-maturity or available-for-sale depending on our investment intention. Held-to-maturity investments are recorded at amortized cost, while available-for-sale investments are recorded at fair value. We did not have any held-to-maturity investments at September 30, 2003.

Investments in fixed-rate, interest-earning instruments carry a degree of interest rate and credit rating risk. Fixed-rate securities may have their fair market value adversely impacted because of changes in interest rates and credit ratings. Due in part to these factors, our future investment income may fall short of expectations because of changes in interest rates or we may suffer losses in principal if we were to sell securities that have declined in market value because of changes in interest rates. Because of the nature of the issuers of the securities that we invest in, we do not believe that we have any cash flow exposure arising from changes in credit ratings.

Based on a sensitivity analysis performed on the financial instruments held as of September 30, 2003, an immediate 10% change in interest rates is not expected to have a material effect on our near-term financial condition or results of operations.

Debt

In the normal course of business, our operations are exposed to risks associated with fluctuations in interest rates. We address this risk through controlled risk management that includes the use of derivative financial instruments to economically hedge or reduce these exposures. We do not enter into financial instruments for trading or speculative purposes. The fair value of our debt is sensitive to fluctuations in the general level of the U.S. interest rates.

34

Table of Contents

We have from time to time managed our interest expense by entering into interest rate swap agreements under which we exchange an obligation to make fixed debt payments for an obligation to make floating rate payments that we anticipate will be lower. As U.S. interest rates change, the impact on the fair value of our debt is offset by the inverse change in fair value and cash flows on our interest rate swap hedges. To ensure the adequacy and effectiveness of our interest rate hedge positions, we continually monitor our interest rate swap positions, in conjunction with our underlying interest rate exposure, from an accounting and economic perspective.

However, given the uncertainty surrounding the economic correlation of changes in value due to changes in general U.S. interest rates on our debt and interest rate swap hedge positions, there can be no assurance that such programs will completely eliminate the adverse financial impact resulting from unfavorable movements in interest rates. In addition, the timing of the accounting for recognition of gains and losses related to the mark-to-market instruments for any given period may not coincide with the timing of the gains and losses related to the underlying economic exposures and, therefore, may adversely affect our consolidated operating results and financial position. The gains and losses realized from interest rate swaps are recorded in “Interest expense” in the accompanying consolidated statements of operations.

In the year ended September 30, 2003, we entered into several interest rate swap agreements to reduce the impact of interest rate changes on the fair value of our long-term debt. The swap agreements allowed us to swap long-term borrowings at fixed rates into variable rates that are anticipated to be lower than fixed rates available to us. As a result, the swaps effectively converted our fixed-rate debt to variable-rate debt and qualified for fair value hedge accounting treatment. Since these interest rate swap agreements qualified as a fair value hedge under SFAS No. 133, changes in the fair value of the swap agreement were recorded as interest expense and matched by changes in the designated, hedged fixed-rate debt to the extent that such changes were effective and as long as the hedge requirements were met. Periodic interest payments and receipts on both the debt and the swap agreement are recorded as components of interest expense in the accompanying consolidated statements of operations, as a result of which we report interest expense at the hedge-effected interest rate. Gains realized on termination of interest rate swap agreements are being recognized in operations over the remaining term of the respective long-term debt.

35

Table of Contents

Item 8.    Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

36

Table of Contents

INDEPENDENT AUDITORS’ REPORT

THE BOARD OF DIRECTORS AND SHAREHOLDERS

VITESSE SEMICONDUCTOR CORPORATION:

We have audited the accompanying consolidated financial statements of Vitesse Semiconductor Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vitesse Semiconductor Corporation and subsidiaries as of September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2003 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related 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.

KPMG LLP

Los Angeles, California

October 23, 2003

37

Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

CONSOLIDATED BALANCE SHEETS

September 30, 2003 and 2002

See accompanying notes to consolidated financial statements.

38

Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

39

Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE LOSS

Years ended September 30, 2003, 2002 and 2001