Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



Form 10-Q

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2010ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                                  to


Commission file number 0-19654



VITESSE SEMICONDUCTOR CORPORATION(Exact name of Registrant as specified in its charter)

Delaware(State or other jurisdiction of
incorporation or organization)

77-0138960(I.R.S. Employer Identification No.)741 Calle Plano
Camarillo, California 93012(Address of principal executive offices, including zip code)Registrant's telephone number, including area code:(805) 388-3700


---

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 ý    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o


Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes o    No ý

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of May 13, 2010 there were
459,009,339 shares of the registrant's $0.01 par value common stock outstanding.



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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2010

TABLE OF CONTENTS



PART I. FINANCIAL INFORMATIONItem 1.

Financial StatementsUnaudited Consolidated Balance Sheets as of March 31, 2010 and September 30,
2009


3Unaudited Consolidated Statements of Operations for the Three and Six Months Ended March 31,
2010 and 2009


4Unaudited Consolidated Statement of Shareholders' Deficit and Comprehensive Loss for the Six
Months Ended March 31, 2010


5Unaudited Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2010 and
2009


6Notes to Unaudited Consolidated Financial Statements


7Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations


19Item 3.

Quantitative and Qualitative Disclosures About Market Risk


30Item 4.

Controls and Procedures


30PART II. OTHER INFORMATIONItem 1.

Legal Proceedings


31Item 1A.

Risk Factors


31Item 2.

Unregistered Sales of Equity and Use of Proceeds


32Item 3.

Defaults Upon Senior Securities


32Item 4.

Reserved


32Item 5.

Other Information


32Item 6.

Exhibits and Reports on Form 8-K


33


2

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS



VITESSE SEMICONDUCTOR CORPORATION        UNAUDITED CONSOLIDATED BALANCE SHEETS

March 31,
2010

September 30,
2009(in thousands,
except share data)ASSETSCurrent assets:Cash and cash equivalents

$
37,190

$
57,544Accounts receivable, net


18,143


15,074Inventory


19,856


18,809Restricted cash


388


398Prepaid expenses and other current assets


4,637


4,956Total current assets


80,214


96,781Property, plant and equipment, net


7,797


7,874Other intangible assets, net


1,117


1,541Other assets


4,064


3,077$
93,192

$
109,273LIABILITIES AND SHAREHOLDERS' DEFICITCurrent liabilities:Accounts payable

$
11,333

$
11,191Accrued expenses and other current liabilities


21,106


14,182Derivative liability





12,209Deferred revenue


3,115


4,566Current portion of debt and capital leases


87


5,236Convertible subordinated debt





10,000Total current liabilities


35,641


57,384Other long-term liabilities


1,813


1,810Long-term debt, net of discount


25,314


24,652Derivative liability


65,459


Convertible subordinated debt


41,070


86,700Total liabilities


169,297


170,546Commitments and contingenciesShareholders' deficit:Preferred stockSeries B, $0.01 par value, 10,000,000 shares authorized; 760,786 shares outstanding at March 31, 2010


8


Common stock, $0.01 par value, 5,000,000,000 shares authorized; 404,841,802 and 230,905,580 shares outstanding at March 31, 2010 and September 30,
 2009, respectively


4,053


2,314Additional paid-in-capital


1,805,943


1,754,598Accumulated deficit


(1,886,191
)

(1,818,271
)Noncontrolling interest


82


86Total shareholders' deficit


(76,105
)

(61,273
)$
93,192

$
109,273


See
accompanying notes to consolidated financial statements.

3

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VITESSE SEMICONDUCTOR CORPORATION        UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

Three months ended
March 31,

Six months ended
March 31,2010

2009

2010

2009(in thousands, except per share data)

(in thousands, except per share data)Product revenues

$
43,661

$
34,577

$
85,272

$
79,387Intellectual property revenues


250





290


5,000Revenues


43,911


34,577


85,562


84,387Costs and expenses:Cost of revenues


19,362


18,228


38,465


40,675Engineering, research and development


12,276


10,939


24,235


22,520Selling, general and administrative (net of a gain on the sale of building of $2.9 million for the six months ended March 31, 2009)


9,083


9,930


19,612


20,349Accounting remediation & reconstruction expense & litigation costs





1,515


73


3,464Goodwill impairment











191,418Amortization of intangible assets


182


386


431


705Costs and expenses


40,903


40,998


82,816


279,131Income (loss) from operations


3,008


(6,421
)

2,746


(194,744
)Other (expense) income:Interest expense, net (including $30.4 million and $38.6 million change in derivative valuation for the three and six months ended March 31,
2010, respectively)


(32,951
)

(1,170
)

(43,171
)

(2,300
)Loss on extinguishment of debt








(21,576
)

Other (expense) income, net


29


(48
)

105


96Other expense, net


(32,922
)

(1,218
)

(64,642
)

(2,204
)Loss before income tax expense (benefit) and noncontrolling interest in earnings of consolidated subsidiary


(29,914
)

(7,639
)

(61,896
)

(196,948
)Income tax expense (benefit)


4,147


(554
)

6,025


96Net loss


(34,061
)

(7,085
)

(67,921
)

(197,044
)Less: net loss attributable to noncontrolling interest


(1
)




(1
)

(1
)Fair value adjustment of Preferred StockSeries B








126


Net loss available to common stockholders

$
(34,060
)
$
(7,085
)
$
(68,046
)
$
(197,043
)Net loss per common sharebasic and dilutedNet loss per share

$
(0.08
)
$
(0.03
)
$
(0.18
)
$
(0.86
)Weighted average shares outstanding:Basic and diluted


403,897


230,227


375,363


228,194


See
accompanying notes to consolidated financial statements.

4

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VITESSE SEMICONDUCTOR CORPORATION        CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT AND COMPREHENSIVE LOSS

Preferred Stock

Common Stock







Total
Shareholders'
Equity
(Deficit)Additional
Paid-in-
Capital

Accumulated
Deficit

Noncontrolling
Interest(In thousands, except
share data)

Shares

Amount

Shares

AmountBalance at September 30, 2009




$



230,905,580

$
2,314

$
1,754,598

$
(1,818,271
)
$
86

$
(61,273
)Net loss

















(67,920
)

(1
)

(67,921
)Compensation expense related to stock options and awards














1,127








1,127Conversion of Series B Preferred Shares


(10,000
)




1,000,000


10


(10
)







Debt restructuring costs














(1,050
)







(1,050
)Tax expense on debt transaction














512








512Shares issued pursuant to debt restructuring


770,786


8


172,936,222


1,729


50,766








52,503Distribution to minority partners




















(3
)

(3
)Balance at March 31, 2010


760,786

$
8


404,841,802

$
4,053

$
1,805,943

$
(1,886,191
)
$
82

$
(76,105
)


See accompanying notes to consolidated financial statements.

5

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VITESSE SEMICONDUCTOR CORPORATION        UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

Six months ended
March 31,2010

2009(in thousands)Cash flows from operating activities:Net loss

$
(67,921
)
$
(197,043
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


1,730


2,204Share-based compensation


1,127


1,583Change in market value of embedded derivative liability


38,631


Allowance for sales return reserve





(36
)Loss on extinguishment of debt


20,765


Impairment of goodwill





191,418Capitalization of interest


614


Amortization of debt issuance costs


398


377Amortization of debt discount


831Gain on sale of Colorado building





(2,924
)Minority interest in earnings of consolidated subsidary


(1
)

Other


512


7Change in operating assets and liabilities:Accounts receivable


(3,069
)

(81
)Inventory


(1,047
)

9,288Restricted cash


10


201Prepaids and other current assets


299


(155
)Accounts payable


141


(4,678
)Accrued expenses and other liabilities


6,928


(3,338
)Deferred revenue


(1,451
)

3,018Net cash used in operating activities


(1,503
)

(159
)Cash flows from investing activities:Restricted cash





17Proceeds from sale of Colorado building





6,500Transaction costs for sale of Colorado building





(547
)Capital expenditures


(1,228
)

(1,170
)Distribution to minority partners


(3
)

1Purchase of intangible assets





(1,982
)Net cash (used in) provided by investing activities


(1,231
)

2,819Cash flows from financing activities:Payment of convertible debentures


(10,000
)

Payment of senior debt


(5,000
)

Debt issuance costs


(1,365
)

Equity issuance costs


(1,050
)Prepayment fee on senior debt


(50
)

Payment of capital lease obligations


(155
)

Net cash used in financing activities


(17,620
)

Net (decrease) increase in cash


(20,354
)

2,660Cash and cash equivalents at beginning of period


57,544


36,722Cash and cash equivalents at end of period

$
37,190

$
39,382Non-cash investing and financing activities:Issuance of 2014 convertible debentures

$
40,343

$
Common stock issued in exchange for 2024 debentures

$
36,317Preferred stockSeries B issued in exchange for 2024 debentures

$
16,187

$
Compound embedded derivative issued in exchange for 2024 debentures

$
27,925

$



See
accompanying notes to consolidated financial statements.

6

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VITESSE SEMICONDUCTOR CORPORATION        NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS        March 31, 2010

Note 1. The Company and its Significant Accounting Policies

Description of Business

Vitesse Semiconductor Corporation ("Vitesse" or the "Company") is a leading worldwide supplier of high-performance
integrated circuits ("ICs") that are utilized primarily by manufacturers of networking systems for carrier, enterprise and storage communications applications. Vitesse designs, develops and markets a
diverse portfolio of high-performance, cost-competitive semiconductor products. For more than 25 years, Vitesse has led the transition of new technologies in
communications networks.

Vitesse
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 stock trades on the OTCQB marketplace under the ticker symbol VTSS.

Basis of Presentation

The interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the instructions to Securities and Exchange Commission ("SEC") Form 10-Q and Article 10 of SEC
Regulation S-X. They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these
financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended September 30, 2009, included in our Annual Report on
Form 10-K filed with the SEC on December 14, 2009.

The
consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments that, in the opinion of management, are necessary
to present fairly our consolidated financial position at March 31, 2010 and September 30, 2009, the consolidated results of our operations for the three and six months ended
March 31, 2010 and 2009, our consolidated cash flows for the six months ended March 31, 2010 and 2009 and the changes in our shareholders' equity (deficit) for the six months ended
March 31, 2009. The results of operations for the three and six months ended March 31, 2010 are not necessarily indicative of the results to be expected for future quarters or the full
year.

The
Company's fiscal year is October 1 through September 30.

Reclassifications

Certain reclassifications have been made to prior year amounts and related footnotes to conform to current year presentation.

Correction of Error

During the first quarter of 2010, we identified an error in our financial statements as of September 30, 2009 and for the
quarter and year then ended. This error was the result of an operational change that was not appropriately reflected in our inventory costing and accounting processes. In accordance with Accounting
Standards Codification ("ASC") Topic 250, "Accounting Changes and Error Corrections," originally issued as SAB No. 99"Materiality"and SAB
No. 108"Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year

7

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 1. The Company and its Significant Accounting Policies (Continued)

Financial Statements,"management evaluated the materiality of the error from a qualitative and quantitative perspective and concluded that the error was not material to any
prior periods. Further, we evaluated the materiality of the error on the results of operations for the first quarter as well as the expected results of operations for the full year and concluded that
the error in the first quarter was quantitatively significant to the first quarter financial statements but was not anticipated to be material to the full year or the trend of financial results.
Accordingly, we corrected the error in the first quarter. The effects of the adjustment to correct the error on specific line items of the financial statements for the six months ended
March 31, 2010 were as follows:

Six Months Ended
March 31, 2010Decrease in cost of sales

$
934Increase in income from operations


934Decrease in net loss


934Net loss per sharebasic and diluted

$



The
adjustment to correct the error had no impact on the three months ended March 31, 2010.

Computation of Net Loss per Share

In accordance with ASC Topic 260 "Earnings Per Share" ("ASC 260") originally issued as SFAS 128,
"Earnings per Share," basic net income and loss per share is computed by dividing net income or loss available to common shareholders by the weighted
average number of common shares outstanding during the period.

For
periods in which we report income from continuing operations, the weighted average number of shares used to calculate diluted income per share is inclusive of common stock
equivalents from unexercised stock options, restricted stock units, warrants, convertible preferred stock and convertible debentures. Unexercised stock options, restricted stock units and warrants are
considered to be common stock equivalents if, using the treasury stock method, they are determined to be dilutive. The dilutive effect of the convertible preferred stock and convertible debentures is
determined using the if-converted method.

For
the three and six months ended March 31, 2010 and 2009, the Company recorded a loss from continuing operations and in accordance with ASC 260, all outstanding potential common
shares were excluded from the diluted loss per share computation. For periods in which the Company reports a loss from continuing operations, diluted loss per share is calculated using only the
weighted average number
of shares outstanding during each of the periods, as the inclusion of any common stock equivalents would be anti-dilutive.

Financial Instruments

ASC Topic 825, "Financial Instruments," defines fair value of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. Our financial instruments include cash equivalents, restricted cash, accounts receivable, accounts payable,

8

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VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 1. The Company and its Significant Accounting Policies (Continued)

accrued
expenses and various debt instruments. These financial instruments are stated at their carrying values, which are estimates of their fair values.

Restricted
cash consists of interest-bearing certificates of deposit ("CD") collateralizing letters of credit and other commitments. As of March 31, 2010 and September 30,
2009, the Company had approximately $1.8 million and $2.0 million, respectively, in CD.

Our
senior term loan is stated at carrying value of $25.0 million as of March 31, 2010 and $30.0 million as of September 30, 2009, which are estimates of its
fair value.

We
estimate the fair values of the 2014 Debentures and embedded derivatives using a convertible bond valuation model within a lattice framework. These valuations are determined using
Level 3 inputs. The valuation model combines expected cash outflows with market based assumptions regarding risk-adjusted yields, stock price volatility, recent price quotes and
trading information of the Company's common stock into which the 2014 Debentures are convertible. The fair value of the 2014 Debentures includes the face value of the debentures plus the discount,
which is amortized as interest expense over the life of the debentures. The fair value of the 2014 Debentures was $43.6 million as of March 31, 2010. On October 30, 2009, the date
of issuance, the fair value of the bifurcated compound derivative was $28.0 million. As of March 31, 2010, the fair value of the bifurcated compound derivative was $65.5 million,
with the change of $37.5 million reflected as interest expense in the Statement of Operations for the six month period ended March 31, 2010. On January 7, 2010 shareholders of the
Company authorized the issuance of a total of 5,000,000,000 shares of common stock, providing the Company with sufficient common shares to satisfy all potential conversion obligations. The Company
will continue to mark the bifurcated compound derivative to market due to the conversion price not being indexed to the Company's own stock. Specifically, the feature requiring the Company to redeem
foregone interest upon conversion by the holder feature causes the exercise price to not be indexed to the Company's own stock. The change in the fair value of the bifurcated compound derivative is
primarily related to the change in price of the underlying common stock. The
change in value of the bifurcated compound derivative is a non-cash item; further, the Company can elect to settle the embedded derivative in either cash or common shares. As of
March 31, 2010, the Company has enough common shares to settle all of its potential conversion obligations. The Company intends to settle this obligation in common shares should it be exercised
by its holders. As the Company intends to, and has the ability to, satisfy the obligations with equity securities, in accordance with ASC Topic 470 Debt ("ASC 470"), the Company
has reclassified the liability as a long-term liability on its Consolidated Balance Sheet as of March 31, 2010.

As
of September 30, 2009, the fair value of our 2024 Debentures was the face value of $96.7 million. The fair value of the related embedded derivative as of
September 30, 2009 was $12.2 million.

Recent Accounting Pronouncements

We do not believe that there are any recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force),
the American Institute of Certified Public Accountants or the SEC that would have a material impact on the Company's present or future consolidated financial statements.

9

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VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 2. Supplemental Financial Information

Inventory

The following table presents the principal components of the Company's inventory:

March 31,
2010

September 30,
2009(in thousands)Inventory:Raw materials

$
1,868

$
1,411Work-in-process


7,239


8,335Finished goods


10,749


9,063Total

$
19,856

$
18,809


Revenues by Product Markets

The following table presents revenues from the Company's product markets:

Three Months Ended
March 31,

Six Months Ended
March 31,2010

2009

2010

2009(in thousands)Carrier Networking Products

$
17,170

$
16,040

$
36,358

$
34,893Enterprise Networking Products


19,813


13,081


37,930


29,027Non-Core Products


6,678


5,456


10,984


15,467Net Product Revenues

$
43,661

$
34,577

$
85,272

$
79,387


Revenues from Intellectual Property

The following table presents revenues from intellectual property:

Three
Months
Ended
March 31,

Six Months
Ended
March 31,2010

2009

2010

2009(in thousands)Licensing Revenues

$
250

$


$
290

$
5,000


10

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VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 2. Supplemental Financial Information (Continued)

Revenues by Geographic Area

The following table presents revenues by geographic area:

Three Months Ended
March 31,

Six Months Ended
March 31,2010

2009

2010

2009(in thousands)North America(1)

$
17,304

$
14,102

$
35,053

$
38,924Asia Pacific


18,577


16,190


36,962


36,055Europe


8,030


4,285


13,547


9,408Total Net Revenues

$
43,911

$
34,577

$
85,562

$
84,387


(1)North
America includes the United States, Canada and Mexico


Computation of Net Loss per Share

The following table presents the computation of loss per share:

Three Months Ended
March 31,

Six Months Ended
March 31,2010

2009

2010

2009(in thousands, except per share data)Net loss

$
(34,061
)
$
(7,085
)
$
(67,921
)
$
(197,044
)Less: net loss attributable to noncontrolling interest


(1
)




(1
)

(1
)Fair value adjustment of Preferred StockSeries B








126


Net loss available to common shareholders

$
(34,060
)
$
(7,085
)
$
(68,046
)
$
(197,043
)Weighted average number of sharesbasic and diluted


403,897


230,227


375,363


228,194Loss per sharebasic and dilutedNet loss

$
(0.08
)
$
(0.03
)
$
(0.18
)
$
(0.86
)Less: net loss attributable to noncontrolling interest











Fair value adjustment of Preferred StockSeries B











Net loss available to common shareholders

$
(0.08
)
$
(0.03
)
$
(0.18
)
$
(0.86
)


For
each of the quarters and six month periods ended March 31, 2010 and 2009, the Company recorded a loss from continuing operations and in accordance with ASC 260, all
outstanding potential common shares were excluded from the diluted loss per share computation. For periods in which the

11

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 2. Supplemental Financial Information (Continued)

Company
reports a loss from continuing operations, diluted loss per share is calculated using only the weighted average number of shares outstanding during each of the periods, as the inclusion of any
common stock equivalents would be anti-dilutive.

The
weighted average potential common shares excluded from the diluted loss per share computation are as follows:

Three Months
Ended
March 31,

Six Months Ended
March 31,2010

2009

2010

2009(in thousands)Outstanding stock options


19,602


21,982


19,985


21,655Outstanding restricted stock units


1,685


3,429


983


2,890Outstanding warrants


150


150


150


150Convertible preferred stock


76,079





76,079


2014 Convertible debentures


222,191





222,191


2024 Convertible debentures





37,981





37,981Total potential common shares excluded from calculation


319,707


63,542


319,388


62,676


Note 3. Debt

As of September 30, 2009, we had outstanding a $30.0 million senior secured term loan with Whitebox VSC, Ltd. (the "Senior Term Loan") and $96.7 million in
aggregate principal amount of 1.5% Convertible Subordinated Debentures due 2024 (the "2024 Debentures). Effective October 16, 2009, the Company entered into an agreement to amend the Senior
Term Loan with Whitebox. Pursuant to the amendment to the Senior Term Loan, the Company repaid $5.0 million of the original $30.0 million and agreed to an interest rate increase on the
remaining $25.0 million outstanding. In accordance with ASC 470, this transaction was accounted for as a debt modification whereby fees of $0.5 million incurred pursuant to the
modification were expensed as incurred.

The
Company also entered into a Debt Conversion Agreement (the "Conversion Agreement") with the beneficial owners of more than 96.7% of the 2024 Debentures (the "Noteholders"). Pursuant
to the Conversion Agreement, the Noteholders agreed to exchange their 2024 Debentures for a combination of $6.4 million in cash, 172,936,222 shares of common stock, and $50.0 million in
newly issued 8.00%
Convertible Second Lien Debentures Due 2014 (the "2014 Debentures") convertible into 222,191,111 shares of common stock. 770,785 shares of Series B Preferred Stock were also issued to certain
Noteholders. The Conversion Agreement was consummated on October 30, 2009. The Company also paid $3.6 million in cash to 3.3% of the holders of the 2024 Debentures who declined to
participate in the Conversion Agreement.

In
accordance with ASC 470, this transaction was accounted for as a debt extinguishment, pursuant to which the Company recognized a $21.6 million loss. The loss on the
extinguishment of debt was calculated as the difference between the aggregate fair values of the new instruments, including the compound embedded derivative associated with the 2014 Debentures,
totaling $130.8 million, plus

12

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 3. Debt (Continued)

$0.8 million
in additional amounts and fees paid to the creditors, compared to the net carrying values of the 2024 Debentures and related premium put derivative of $96.7 million and
$13.3 million, respectively.

In
connection with the debt exchange and the debt modification, the Company incurred third-party costs of approximately $2.9 million that were allocated to the underlying
financial instruments issued based on the relative fair value of each instrument. Of the total fees incurred, $0.5 million was allocated to the modification of the Senior Term Loan and expensed
as incurred, $1.0 million was allocated to the issuance of the common and preferred shares and charged against additional paid-in capital, and $1.4 million was allocated to
the issuance of the 2014 Debentures and was capitalized in other assets as debt issuance costs, to be amortized as interest expense over the term of the loan. Unamortized debt issuance costs as of
March 31, 2010 were $1.3 million.

Note 4. Fair Value Measurements

Assets and liabilities measured at fair value on a recurring basis include the following at March 31, 2010 and September 30, 2009 (in thousands):

Fair Value
Measurements UsingLevel 1

Level 2

Level 3

TotalQuarter ended March 31, 2010Derivative liabilitypremium put

$


$


$


$
Derivative liabilitycompound embedded derivative








65,459


65,459Year ended September 30, 2009Derivative liabilitypremium put

$


$


$
12,209

$
12,209Derivative liabilitycompound embedded derivative














The
following table provides a reconciliation of the beginning and ending balances for the derivative liabilitypremium put and derivative liabilityembedded
compound derivative liability measured at fair value using significant unobservable inputs (Level 3) (in thousands):

Derivative
liability
premium put
related to
2024 Debentures

Compund
Embedded
Derivative
related to
2014 DebenturesBalance at September 30, 2009

$
12,209

$
Transfers in and/or out of Level 3





27,925Total losses included in earnings


1,096


37,534Settlement


(13,305
)

Balance at March 31, 2010

$


$
65,459


13

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 4. Fair Value Measurements (Continued)

The
compound embedded derivative liability, which is included in long term liabilities, represents the value associated with the right of the holders of the 2014 Debentures associated
with the equity conversion feature and a "make-whole" feature of the 2014 Debentures.

There
is no current observable market for this type of derivative and, as such, we determined the value of the embedded derivative using a lattice-based convertible bond valuation model
that combined expected cash outflows with market-based assumptions. The fair value of the 2014 Debentures without the embedded compound derivative feature was also estimated using a convertible bond
valuation model within a lattice framework. The convertible bond valuation model combined expected cash outflows with market-based assumptions regarding risk-adjusted yields, stock price
volatility and recent price quotes and trading information regarding shares of our common stock into which the 2014 Debentures are convertible. On January 7, 2010 shareholders of the Company
authorized the issuance of a total of 5,000,000,000 shares of common stock, providing the Company with sufficient common shares to satisfy potential conversion obligations. The Company will continue
to mark the embedded derivative to market due to the conversion price not being indexed to the Company's own stock. The change in the fair value of the bifurcated compound embedded derivative is
primarily related to the change in price of the underlying common stock. At the Company's option it can settle the embedded derivative in either cash or common shares. As of March 31, 2010, the
Company has enough common shares to settle the entire obligation in shares. The Company intends to settle this obligation in common shares should it be exercised by its holders. As the Company intends
to, and has the ability to, satisfy the obligations with equity securities, in accordance with ASC 470, the Company has reclassified the liability as a long-term liability on its Consolidated
Balance Sheet as of March 31, 2010. The change in fair value of the compound embedded derivative liability is recorded in interest expense.

The
valuation methodologies used by the Company as described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair
values. Furthermore, although management believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine
the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

Note 5. Income Taxes

The provision for income taxes as a percentage of income from continuing operations before income taxes was (9.73%) for the six months ended March 31, 2010 compared to (1.74%) for
the comparable period in the prior year. For the year ending September 30, 2010, the Company's estimated effective tax rate is (9.73%). The Company's effective tax rate is primarily impacted by
continuing operating losses.

At
October 1, 2009, the Company had net deferred tax assets of $422.1 million before considering the effect of the valuation allowance. These deferred tax assets are
primarily composed of net operating loss ("NOL") carryforwards, research and development credits, tangible and intangible assets recovery, and other accruals and reserves. Due to
uncertainties surrounding the Company's ability to generate future taxable income to utilize the deferred tax assets, management had recorded a full valuation allowance against the deferred tax
assets.

14

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 5. Income Taxes (Continued)

Effective
October 16, 2009, the Company entered into a Debt Conversion Agreement (the "Conversion Agreement") with the beneficial owners of more than 96.7% of the 2024 Debentures
(the "Noteholders") whereby the Noteholders agreed to exchange their 2024 Debentures for a combination of cash, shares of common stock, the New Notes and, in some cases, shares of Series B
Preferred Stock. The Conversion Agreement was consummated on October 30, 2009 (the "Closing Date"). (See Note 3Debt).

The
Federal Tax Reform Act of 1986, and similar state laws, contains provisions that may limit the net operating loss and tax credits carry forwards to be used in any given year upon the
occurrence of certain events, including a significant change in ownership interests. Under IRC Section 382 and 383 rules, a change in ownership can occur whenever there is a shift in ownership
by more than fifty
percentage points by one or more five-percent shareholders within a three-year period. When a change of ownership is triggered, the NOLs and credits may be impaired.

We
performed a study to evaluate the status of net operating losses. Based on that study, we believe that, as a result of the Conversion Agreement discussed above, the Company
experienced an "ownership change" as defined for U.S. federal income tax purposes as of October 30, 2009 that will trigger an impairment of the use of our NOLs and credits as of the fiscal year
ended September 30, 2010. As a result of the ownership change, the Company only has approximately $55.7 million of NOLs that can be used in future tax years and is subject to an annual
limitation of $3.1 million in utilizing its NOLs. The NOLs will expire in fiscal year 2030. Also, due to the ownership change, the research and development credits have been limited as to usage
such that the Company does not anticipate being able to use any of its research and development credits existing as of the ownership change in future tax years.

ASC
Topic 740 Income Taxes ("ASC 740"), originally issued as FIN 48,"Accounting for Uncertainty in Income TaxesAn Interpretation of
FASB Statement No. 109", prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. Due to significant net operating losses, the cumulative effect of applying this interpretation upon adoption on October 1, 2009, had no impact on retained
earnings.

The
total amount of gross unrecognized tax benefits increased by $340,000 for potential federal and state tax liabilities. These amounts, if recognized, would impact the effective tax
rate.

The
Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. As of March 31, 2010, no material interest or penalties were
accrued due to significant net operating losses.

The
Company is subject to taxation in the US and various state and foreign jurisdictions. The Company recently completed an examination by the Internal Revenue Service for the tax years
ended September 30, 2004 through September 30, 2006. The audit resulted in an adjustment that reduced the Company's federal NOL carryforwards. Effectively, all the Company's tax years in
which a tax net operating loss is carried forward to the present are subject to examination by the federal, state, and foreign tax authorities. Therefore, the Company cannot estimate the range of
unrecognized tax benefits that may significantly change within the next twelve months.

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 6. Shareholders' Equity

Preferred Stock

The Company is authorized to issue up to 10,000,000 shares of non-voting convertible preferred stock, par value of $0.01
per share. As of March 31, 2010, 760,786 preferred shares that are convertible into common stock on a 100:1 basis were outstanding. No preferred shares were outstanding as of
September 30, 2009.

The
Company did not have sufficient authorized common shares for the conversion of all 770,786 preferred shares outstanding as of December 31, 2009. In accordance with ASC Topic
480 "Distinguishing Liabilities from Equity" ("ASC 480"), we classified 44,533 Series B preferred shares as temporary equity in the mezzanine section of the balance sheet as of
December 31, 2009. These shares were measured at $0.25 per share, the fair value of the common stock they would have been converted into on that date. Upon our shareholders' approval of an
increase in authorized shares to a total of 5,000,000,000 shares of common stock on January 7, 2010, we had sufficient authorized common shares for the conversion of all preferred shares
outstanding, and thus, all such shares are classified as permanent equity.

During
the quarter ended March 31, 2010, 10,000 preferred shares were converted to 1,000,000 shares of common stock.

Common Stock

As of March 31, 2010 and September 30, 2009 the Company was authorized to issue up to 5,000,000,000 and 500,000,000
shares of common stock, par value of $0.01 per share, respectively. On October 30, 2009, in connection with our debt restructuring, we issued 172,936,222 shares of common stock. As of
March 31, 2010 and September 30, 2009, 404,841,802 shares and 230,905,580 shares of common stock were outstanding, respectively.

Stock Option Plans

The Company has several share-based plans that have expired, but under which stock options are still outstanding. In February 2010, our
board of directors approved a new plan, the 2010 Vitesse Semiconductor Corporation Incentive Plan (the "2010 Incentive Plan"). On May 11, 2010, the shareholders approved the 2010 Incentive
Plan. The 2010 Incentive Plan permits the grant of stock options, stock appreciation rights, stock awards, restricted stock and stock units, and other stock or cash-based awards. It will
replace the Vitesse Semiconductor Corporation 2001 Stock Incentive Plan.

Under
all stock option plans, a total of 80,097,525 shares of common stock have been reserved for issuance and 33,037,954 shares remained available for future grant as of
March 31, 2010. The following

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 6. Shareholders' Equity (Continued)

table
summarizes compensation costs related to the Company's share-based compensation plans (in thousands):

Three Months
Ended
March 31,

Six Months Ended
March 31,2010

2009

2010

2009(in thousands)Cost of revenues

$
79

$
153

$
225

$
359Engineering, research and development


158


207


405


435Selling, general and administrative


206


352


497


789Total share-based compensation expense

$
443

$
712

$
1,127

$
1,583


Stock Options

Activity under all stock option plans for the six months ended March 31, 2010 was as follows:

Shares

Weighted
average
exercise
price

Weighted
average
remaining
contractual
life (in years)

Aggregate
intrinsic
valueOptions outstanding, September 30, 2009


21,249,683

$
5.47Granted


10,839,750

$
0.26Cancelled or expired


(2,050,434
)
$
16.53Options outstanding, March 31, 2010


30,038,999

$
2.83


6.52

$
1,793,317Options exercisable, March 31, 2010


16,552,595

$
4.80


4.14

$
80,848


Restricted Stock Units

A summary of restricted stock unit activity for the six months ended March 31, 2010 is as follows:

Shares

Weighted
Average
Grant-Date
Fair Value
per ShareRestricted stock outstanding, September 30, 2009


3,443,253

$
0.35Awarded


10,457,750


0.26Forfeited


(138,959
)

0.35Restricted stock outstanding, March 31, 2010


13,762,044

$
0.28


17

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Table of Contents

VITESSE SEMICONDUCTOR CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2010

Note 7. Legal Proceedings

We are involved in legal proceedings in the ordinary course of business, including actions against us which assert or may assert claims or seek to impose fines and penalties in
substantial amounts, such as the matter described below.

The DOJ Subpoena and SEC Investigation

In May 2006, we received a grand jury subpoena from the office of the United States Attorney for the Southern District of New York
requesting documents from 1999 through the present. The Division of Enforcement of the SEC also conducted an investigation of Vitesse. The Division of Enforcement requested documents from
January 1, 1995 through the present. Vitesse has cooperated with both government agencies in their investigations. While the investigation by the United States Attorney is still ongoing, the
staff of the SEC's Division of Enforcement has agreed to recommend to the SEC a proposed settlement that would conclude for the Company all matters arising from the SEC investigation into historical
stock option practices and certain other accounting irregularities. Under the proposed settlement, the Company would pay a $3.0 million civil penalty and consent to the entry of a final
judgment by a federal court permanently enjoining the Company from violations of the antifraud and other provisions of the federal securities laws. In connection with the Company's settlement with the
staff of the Division of Enforcement, we recorded a $3.0 million expense related to the civil penalty payable to the SEC. The proposed settlement is contingent on the review and approval of
final documentation by the Company and the staff of the SEC's Division of Enforcement of the SEC, and is subject to final approval by the SEC.

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Table of Contents

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement

You should read the following discussion and analysis in conjunction with our Unaudited Consolidated Financial
Statements and the related Notes thereto contained in Part I, Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete
description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report, as well as
in our Annual Report on Form 10-K for the year ended September 30, 2009 and our Quarterly
Report on Form 10-Q for the period ended December 31, 2009 filed with the SEC, which discuss our business in greater detail.

This Quarterly Report contains forward-looking statements that involve risks and uncertainties. We use words such as "anticipates," "believes," "plans,"
"expects," "future," "intends," "may," "should," "estimates," "predicts," "potential," "continue," "becoming," "transitioning" and similar expressions to identify such forward-looking statements. Our
forward-looking statements include statements as to our business outlook, revenues, margins, expenses, tax provision, capital resources sufficiency, capital expenditures, interest income, cash
commitments and expenses. Forward-looking statements are not guarantees of future performance and the Company's actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such differences include, but are not limited to, those referenced in the subsection entitled "Risk Factors" in Part II, Item 1A of
this Report, and similar discussions in our other SEC filings. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC,
before deciding to purchase, hold or sell our common stock. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by
law.

Overview

We design, develop and market a diverse portfolio of high-performance, cost-competitive semiconductor solutions
for telecommunications carrier and enterprise networks worldwide. We believe that engineering excellence and dedicated customer service distinguish Vitesse as an industry leader in
high-performance Ethernet LAN, WAN, and RAN, Ethernet-over-SONET/SDH, optical transport (OTN), and best-in-class signal integrity and
physical layer products for Ethernet, Fibre Channel, Serial Attached SCSI, InfiniBand(r), video, and PCI Express applications.

We
are a leading supplier of high-performance integrated circuits ("ICs") principally targeted at systems manufacturers in the communications and storage industries. Within
the communications industry, our products address telecommunications carrier and enterprise networking, where they enable data to be transmitted at high-speeds and processed and switched
under a variety of protocols.

We
focus our product development and marketing efforts on products that leverage the convergence of carrier and enterprise networking onto IP-based networks. These evolving
networks must deliver more bandwidth and provide increasing data-based capabilities to provide "quadruple play" services that integrate voice, data and video traffic over both wired and
wireless networks. Increasingly, these networks will be delivered based on Ethernet technology to provide these services at lower cost. We believe that products in this emerging technology area
represent the best opportunity for us to provide differentiation in the market.

Debt Restructuring

In October 2009, Vitesse completed a debt restructuring transaction. The debt restructuring resulted in the conversion of 96.7% of the
Company's 2024 Debentures into a combination of cash, common stock, Series B Preferred Stock and 2014 Debentures. With respect to the remaining 3.3% of

19

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Table of Contents

the
2024 Debentures, Vitesse settled its obligations in cash. Additionally, Vitesse repaid approximately $5.0 million of its $30.0 million Senior Term Loan, the terms of which were
amended as part of the debt restructuring transactions.

Under
the terms of the debt restructuring transactions, Vitesse:



Critical Accounting Policies

Our critical accounting policies are described in the Annual Report on Form 10-K for the year ended
September 30, 2009. There have been no significant changes to these policies during the six months ended March 31, 2010. These policies continue to be those that we believe are most
important to a reader's ability to understand our financial results.

Valuation of Compound Embedded Derivative related to Subordinated Debentures

In accordance with ASC Topic 815 Derivatives and Hedging ("ASC 815"), originally issued as SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," embedded derivatives must be bifurcated from the underlying debt instrument and valued
as a separate financial instrument. Management evaluated the terms and features of the 8.00% Convertible Second Lien Debentures Due 2014 (the "2014 Debentures") and identified an embedded derivative
(the "compound embedded derivative" or "derivative liability") requiring bifurcation and accounting at fair value because the economic and contractual characteristics of the compound derivative meet
the criteria for bifurcation and accounting for separately as set forth in ASC 815 due to the conversion price not being indexed to the Company's own stock. Any gain or loss on the fair value of the
compound derivative will be reflected in current earnings. The embedded compound derivative is comprised of the conversion option and a make whole payment for foregone interest if the holder converts
the debenture early. We estimated the approximate fair value of the compound derivative as the difference between the estimated value of the 2014 Debentures with and without the compound derivative
features. The fair value of the 2014 Debentures was estimated using a convertible bond valuation model within a lattice framework. These valuations were determined using Level 3 inputs. The
convertible bond valuation model combined expected cash outflows with market-based assumptions regarding risk-adjusted yields, stock price volatility and recent price quotes and trading
information regarding shares of our common stock into which the 2014 Debentures are convertible. Our analysis was premised on the assumption that the holder would act in a manner that maximizes the
potential return, or "payoff", at any given

20

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Table of Contents

point
in time. Included in this premise was the assumption that the holder would compare the potential return associated with each available alternative, including, as specified in the terms of the
contract, holding the debt instrument, exercising an equity conversion option, or exercising a put option.

On
October 30, 2009, the date of issuance, the fair value of the bifurcated compound derivative was $28.0 million. As of March 31, 2010, the fair value of the
bifurcated compound derivative was $65.5 million, with the change of $37.5 million reflected as interest expense in the Statement of Operations for the six month period ended
March 31, 2010. The change in the fair value of the bifurcated compound derivative is a non-cash item resulting from the increase in the market price of the underlying common stock.
Should the bifurcated compound derivative be exercised by the holders, settlement is in shares of the Company's common stock. The Company intends to settle this obligation in common shares should it
be exercised by its holders. As the Company intends to, and has the ability to, satisfy the obligations with equity securities, in accordance with ASC 470, the Company has reclassified the
liability as a long-term liability on its Consolidated Balance Sheet as of March 31, 2010.

Results of Operations for the Three and Six Months Ended March 31, 2010 compared to the Three and Six Months Ended March 31, 2009

The following table sets forth certain consolidated statement of operations data expressed as a percentage of net revenue for the
periods indicated:

Three Months
Ended
March 31,

Six Months Ended
March 31,2010

2009

2010

2009Revenues


100.0
%

100.0
%

100.0
%

100.0
%Cost and expenses:Cost of revenues


44.1
%

52.7
%

45.0
%

48.2
%Engineering, research and development


28.0
%

31.6
%

28.3
%

26.7
%Selling, general and administrative


20.7
%

28.7
%

22.9
%

24.1
%Accounting remediation & reconstruction expense & litigation costs


0.0
%

4.4
%

0.1
%

4.1
%Goodwill impairment


0.0
%

0.0
%

0.0
%

226.8
%Amortization of intangible assets


0.4
%

1.1
%

0.5
%

0.8
%Costs and expenses


93.2
%

118.5
%

96.8
%

330.7
%Income (loss) income from operations


6.8
%

(18.5
)%

3.2
%

(230.7
)%Other (expense) income:Interest expense, net


(75.0
)%

(3.4
)%

(50.5
)%

(2.7
)%Loss on extinguishment of debt


0.0
%

0.0
%

(25.2
)%

0.0
%Other (expense) income, net


0.1
%

(0.1
)%

0.1
%

0.1
%Other expense, net


(74.9
)%

(3.5
)%

(75.6
)%

(2.6
)%Loss before income tax expense and noncontrolling interest in earnings of consolidated subsidiary


(68.1
)%

(22.0
)%

(72.4
)%

(233.3
)%Income tax expense (benefit) expense


9.4
%

(1.6
)%

7.0
%

0.1
%Net loss


(77.5
)%

(20.4
)%

(79.4
)%

(233.4
)%Less: net loss attributable to noncontrolling interest


(0.0
)%

0.0
%

(0.0
)%

(0.0
)%Fair value adjustment of Preferred StockSeries B


0.0
%

0.0
%

0.1
%

0.0
%Net loss available to common stockholders


(77.5
)%

(20.4
)%

(79.5
)%

(233.4
)%


21

---



Table of Contents

Product Revenues

We classify our IC products into three categories: (i) Carrier Networking Products; (ii) Enterprise Networking Products;
and (iii) Non-Core Products. The Carrier Networking Products line services core, metro, and access networks. The Enterprise Networking Products line services the market for Ethernet
switching and transmission within local area networks in small-medium-business and enterprise (SMB/SME) markets. Our Non-Core Products are product lines have not received additional
investment over the prior three years and as a result have generally been in decline. The following tables summarize our net product mix by product line.

Three Months Ended
March 31, 2010

Three Months Ended
March 31, 2009Amount

% of Net
Revenues

Amount

% of Net
Revenues

Change

%
Change(in thousands, except percentages)Carrier Networking Products

$
17,170


39.3
%
$
16,040


46.4
%
$
1,130


7.0
%Enterprise Networking Products


19,813


45.4
%

13,081


37.8
%

6,732


51.5
%Non-Core Products


6,678


15.3
%

5,456


15.8
%

1,222


22.4
%Net Product Revenues

$
43,661


100.0
%
$
34,577


100.0
%
$
9,084


26.3
%




Six Months Ended
March 31, 2010

Six Months Ended
March 31, 2009Amount

% of Net
Revenues

Amount

% of Net
Revenues

Change

%
Change(in thousands, except percentages)Carrier Networking Products

$
36,358


42.6
%
$
34,893


44.0
%
$
1,465


4.2
%Enterprise Networking Products


37,930


44.5
%

29,027


36.6
%

8,903


30.7
%Non-Core Products


10,984


12.9
%

15,467


19.5
%

(4,483
)

(29.0
)%Net Product Revenues

$
85,272


100.0
%
$
79,387


100.0
%
$
5,885


7.4
%


Net
product revenues for the second quarter of 2010 were $43.7 million compared to $34.6 million for the same period in 2009. This increase of $9.1 million or 26.3%
was driven primarily by overall strengthening customer demand for our core products. Carrier Networking increased by $1.1 million or 7.0%. Enterprise Networking increased $6.7 million or
51.5% due to an increase in physical layer, PMD and signal integrity product segments as well as growth in both Ethernet and fabric switch products. Sales of Non-Core Products were up
$1.2 million or 22.4% due to strength in our NPU products selling into Carrier-Ethernet applications. Our Non-Core Products are product lines that have had minimal
on-going investment over the prior three years and as a result have generally been in decline.

Intellectual Property Revenues

Three Months Ended
March 31, 2010

Three Months Ended
March 31, 2009Amount

% of
Licensing
Revenues

Amount

% of
Licensing
Revenues

Change

%
Change(in thousands, except percentages)Licensing Revenues

$
250


100.0
%
$



100.0
%
$
250


100.0
%


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Table of Contents

Six Months Ended
March 31, 2010

Six Months Ended
March 31, 2009Amount

% of
Licensing
Revenues

Amount

% of
Licensing
Revenues

Change

%
Change(in thousands, except percentages)Licensing Revenues

$
290


100.0
%
$
5,000


100.0
%
$
(4,710
)

(94.2
)%


In
2008, we began to leverage our substantial intellectual property portfolio into licensing opportunities with third-parties. Intellectual property revenues were $0.3 million in
the second quarter of 2010; no revenues were recognized in the second quarter of 2009. We recognized $0.3 million and $5.0 million in the first six months of year 2010 and 2009,
respectively. No royalties were received or recognized in the second quarter of 2010.

Cost of Revenues

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Cost of revenues

$
19,362

$
18,228

$
1,134


6.2
%Percent of net revenues


44.1
%

52.7
%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Cost of revenues

$
38,465

$
40,675

$
(2,210
)

(5.4
)%Percent of net revenues


45.0
%

48.2
%


As
a fabless semiconductor company, our cost of revenues consists predominantly of: (i) purchased finished wafers; (ii) assembly services; and (iii) labor and
overhead costs associated with product procurement and testing.

Our
cost of revenues increased from $18.2 million for the three months ended March 31, 2009 to $19.4 million for the same period in 2010, primarily due to increased
product shipments. As a percentage of net revenues, our cost of revenues was 44.1% in the second quarter of 2010 compared with 52.7% in the second quarter of 2009, respectively. The decrease in our
cost of revenues as a percentage of net revenues is due to higher revenues, effective cost controls and favorable mix of products. The increase in revenues allowed us to better leverage fixed
manufacturing labor and overhead costs. We made progress in transitioning our test manufacturing activities from our California facility to an outsource model in an offshore facility, resulting in
reduced costs of test. In addition, we had a favorable mix of products with higher shipments of legacy fibre channel physical layer components and NPUs that have generally lower cost of revenue.
Through March 31, 2010, our cost of revenues decreased to $38.5 million from $40.7 million in the same period of 2009. As a percentage of net revenues, our cost of revenues was
45.0% for the six months ended March 31, 2010 compared to
48.2% in the same period of 2009. The decrease was due to reduced cost in our physical layer and ethernet switch product lines as a result of on-going cost control efforts including yield
enhancement efforts and reduced testing costs.

There
was no cost of revenues associated with intellectual property licensing revenues of $0.3 million in the quarter ended March 31, 2010 and $5.0 million for the
six months ended 2009. As a percentage of sales, excluding IP revenue, cost of revenues were 45.1% in the six months ended March 31, 2010 compared to 51.2% for the same period last year.

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Table of Contents

Engineering, Research and Development

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Engineering, research and development

$
12,276

$
10,939

$
1,337


12.2
%Percent of net revenues


28.0
%

31.6
%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Engineering, research and development

$
24,235

$
22,520

$
1,715


7.6
%Percent of net revenues


28.3
%

26.7
%


We
believe that continued investment in the design and development of future products is vital to maintaining a competitive edge. Engineering, research and development expenses consist
primarily of salaries and related costs, including share-based compensation expense of employees engaged in research, design, and development activities. Engineering, research and development also
includes costs of mask sets, electronic design automation tools, software licensing contracts, subcontracting and fabrication costs, depreciation and amortization, and facilities expenses. We will
continue to concentrate our spending in this area to meet our customer requirements and respond to market conditions.

Engineering,
research and development expenses increased $1.3 million and $1.7 million for the three and six months ended March 31, 2010, respectively, compared to
the same periods of 2009. The increase is attributable to increased labor costs due to increased headcount and contract labor and due to elimination of temporary salary reductions that were in place
in prior periods. For the three month period, there was also a $0.6 million increase in engineering tools.

Selling, General and Administrative

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Selling, general and administrative

$
9,083

$
9,930

$
(847
)

(8.5
)%Percent of net revenues


20.7
%

28.7
%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Selling, general and administrative

$
19,612

$
20,349

$
(737
)

(3.6
)%Percent of net revenues


22.9
%

24.1
%


Selling,
general and administrative expense consists primarily of personnel-related expenses, including share-based compensation expense, legal and other professional fees, facilities
expenses, outside labor and communications expenses.

In
the second quarter of 2010, selling, general and administrative expense decreased by $0.9 million from the second quarter of 2009. As a percentage of net revenues, selling,
general and

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administrative
expense decreased from 28.7% to 20.7%. During the quarter, professional fees decreased by $0.7 million compared to the same quarter of the prior year due to the transitioning of
accounting and finance functions from contract employees to full-time staff. The remainder of the decrease is the continuing benefit of our cost reduction efforts in the prior year.

For
the six months ended March 31, 2010, selling, general and administrative expense decreased by $0.7 million from the same period of 2009. As a percentage of net
revenues, selling, general and administrative expense decreased from 24.1% to 22.9%. During the six month period ended March 31, 2009, we recognized a gain on the sale of our Colorado building,
which offset selling, general and administrative expense for that period by $2.9 million. We did not have any similar transactions in 2010. In the six month period ended March 31, 2010,
professional fees decreased by $2.0 million compared to the same period of the prior year due to the transitioning of accounting and finance functions from contract employees to
full-time staff. During the period, we succeeded in reducing facilities, travel and supplies expenses by a total of $1.4 million due to our extensive cost reduction efforts.
Compensation related costs for the six months ended March 31, 2010 decreased by $0.8 million compared to the same period in 2009 as a result of headcount reductions in 2009. During the
six month period ended March 31, 2010, we incurred $1.0 million in non-capitalizable costs related to negotiating the restructuring of our debt, which was successfully
completed on October 30, 2009. The remainder of the decrease is the continuing benefit of our cost reduction efforts in the prior year.

Accounting Remediation & Reconstruction Expense & Litigation Costs

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Accounting remediation & reconstruction expense

$


$
1,515

$
(1,515
)

(100.0
)%Percent of net revenues


0.0
%

4.4
%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Accounting remediation & reconstruction expense

$
73

$
3,464

$
(3,391
)

(97.9
)%Percent of net revenues


0.1
%

4.1
%


Accounting
remediation and reconstruction expense and litigation costs consisted of fees incurred to resolve certain legal issues, remediate control deficiencies, and transition
accounting and reporting responsibilities to full-time staff, in addition to the completion or settlement of audits, investigations and lawsuits related to prior accounting periods. We did
not recognize any charges in the second quarter of 2010. Year-to-date, these costs totaled $73,000 and $3.5 million in 2010 and 2009, respectively. These costs consist
primarily of legal fees related to accounting remediation work. These costs have decreased significantly since we have resolved certain legal issues, completed and filed all outstanding financial
reports and transitioned accounting and reporting responsibilities to full-time staff.

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Goodwill Impairment

Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Goodwill Impairment

$


$
191,418

$
(191,418
)

100.0
%Percent of net revenues


0.0
%

226.8
%


During
the quarter ended December 31, 2008, we performed an analysis of our goodwill and determined that the carrying amount of goodwill exceeded the implied fair value of that
goodwill. As a result of the analysis, we recorded an impairment charge to fully write off our goodwill balance of $191.4 million during the quarter ended December 31, 2008.

Amortization of Intangible Assets

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Amortization of intangible assets

$
182

$
386

$
(204
)

(52.8
)%Percent of net revenues


0.4
%

1.1
%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Amortization of intangible assets

$
431

$
705

$
(274
)

(38.9
)%Percent of net revenues


0.5
%

0.8
%


The
decrease in amortization expense is primarily due to intangible assets related to our prior acquisitions of Adaptec and Infinera becoming fully amortized during 2009.

Interest Expense, net

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Interest expense, net

$
32,951

$
1,170

$
31,781


2716.3
%Percent of net revenues


75
%

3.4
%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Interest expense, net

$
43,171

$
2,300

$
40,871


1777.0
%Percent of net revenues


50.5
%

2.7
%


For
the three and six month periods ended March 31, 2010, interest expense, net of interest income, increased by $31.8 million and $40.9 million, respectively,
compared to the same periods in 2009. For both periods, the increase relates primarily to the change in the fair value of the embedded

26

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Table of Contents

derivatives
on the 2014 Debentures of $30.4 million and $38.6 million for the three and six month periods, respectively. Interest expense on the debentures and our Senior Secured Debt
increased from 2009 to 2010 by $1.4 million and $2.3 million for the three and six month periods ended March 31, 2010, respectively. For the six months ended March 31,
2010, we also incurred $1.1 million of interest expense related to the extinguishment of the derivative liability-premium put associated with the 2024 Debentures.

Loss on Extinguishment of Debt

Six Months Ended
December 31,

Change2010

2009

$

%(in thousands,
except percentages)Loss on extinguishment of debt

$
(21,576
)
$


$
(21,576
)

100.0
%Percent of net revenues


(25.2
)%

0.0
%


Effective
October 30, 2009, the Company finalized negotiations with the Noteholders of the 2024 Debentures to settle the obligations under the debentures, including all amounts
owed under the derivative liability for the premium put option, with a combination of cash, shares of the Company's common stock, shares of the Company's Series B Preferred stock and a new
issuance of $50.0 million of convertible bonds (see Note 3Debt in the accompanying consolidated financial statements). The Company recorded the new instruments issued in the
extinguishment of the 2024 Debentures at fair value and recognized $21.6 million loss for the difference between the fair values of the new instruments and approximately $0.8 million of
fees paid to the creditors compared to the net carrying value of the 2024 Debentures. For the purposes of calculating this loss on extinguishment, the net carrying amount of the 2024 Debentures
included the $96.7 million principal amount of the 2024 Debentures and $13.3 million of the premium put derivative, recorded at fair value.

Other Income (Expense), net

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Other income (expense), net

$
29

$
(48
)
$
77


(160.4
)%Percent of net revenues


0.1
%

(0.1
)%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Other income, net

$
105

$
96

$
9


9.4
%Percent of net revenues


0.1
%

0.1
%


The
change in other income primarily relates to foreign exchange transactions.

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Table of Contents

Income Tax Expense (Benefit)

Three Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Income tax expense (benefit) expense

$
4,147

$
(554
)
$
4,701


848.6
%Percent of net revenues


9.4
%

(1.6
)%




Six Months Ended
March 31,

Change2010

2009

$

%(in thousands,
except percentages)Income tax expense

$
6,025

$
96

$
5,929


6176.0
%Percent of net revenues


7.0
%

0.1
%


Income
tax expense was $4.1 million for the second quarter of fiscal 2010 compared to income tax benefit of $0.6 million for the second quarter of fiscal 2009, an increase
of $4.7 million. The increase in expense is primarily the result of limitations on the Company's NOL carryforwards as a result of an "ownership change" experienced for tax purposes on
October 30, 2009. For the three months ended March 31, 2009, income tax benefit represents the impact of taxable losses for the three months ended March 31, 2009.

Income
tax expense was $6.0 million for the six months ended March 31, 2010 compared to income tax expense of $0.1 million for the six months ended March 31,
2009, an increase of $5.9 million. The increase in expense is primarily the result of limitations on the Company's NOL carryforwards as a result of an "ownership change" experienced for tax
purposes on October 30, 2009. Net income tax expense for the six month ended March 31, 2010 represents minimum federal, state, and foreign income tax on income not eligible for offset by
loss carryforwards.

Liquidity and Capital Resources

Cash and cash equivalents decreased to $37.2 million at March 31, 2010, from $57.5 million at September 30,
2009, primarily as a result of the pay-down of the Senior Term Loan of $5.0 million, repayment of a portion of the 2024 Debentures of $10.0 million and approximately
$6.0 million in legal and other fees to complete the debt restructuring transaction.

Six Months Ended
March 31,2010

2009(in thousands)Net cash used in operating activities

$
(1,503
)
$
(159
)Net cash (used in) provided by investing activities


(1,231
)

2,819Net cash used in financing activities


(17,620
)

Net (decrease) increase in cash and cash equivalents

$
(20,354
)
$
2,660Cash and cash equivalents at beginning of period


57,544


36,722Cash and cash equivalents at end of period

$
37,190

$
39,382


In
the six months ended March 31, 2010, our operating activities used $1.5 million in cash. Our net loss of $67.9 million for the six months ended March 31,
2010 included non-cash charges of $20.8 million for the loss on extinguishment of debt, $38.6 million in the change in the market value of the embedded derivative liability,
$1.7 million of depreciation and $1.1 million of stock-based compensation. In the six months ended March 31, 2009, our operating activities used $0.2 million in

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cash.
Our net loss of $197.0 million for the six months ended March 31, 2009 included $2.2 million of depreciation, $1.6 million of stock-based compensation, and
$191.4 million of goodwill impairment offset by the gain on sale of the Colorado building of $2.9 million.

Accounts
receivable, net of allowance for sales return, increased $3.0 million from $15.1 million at September 30, 2009 to $18.1 million at March 31,
2010. The increase was primarily due to the timing of sales to our end users via our distributor network. Inventories increased $1.0 million, from $18.8 million at September 30,
2009 to $19.9 million at March 31, 2010, as our channel partners and distributors took action to increase their inventory in response to stronger demand. We were able to respond quickly
to the change in demand, increasing orders to our suppliers.

Investing
activities used cash of $1.2 million in the six months ended March 31, 2010 for capital expenditures. Investing activities provided cash of $2.8 million in
the six months ended March 31, 2009, which was primarily the result of the proceeds from the sale of the Colorado building for $6.0 million, net of commissions and transactions costs,
partially offset by capital expenditures of approximately $1.2 million and additions to intangibles of $2.0 million.

In
the six months ended March 31, 2010, our financing activities used $17.6 million primarily due to a cash payment of $10.0 million to the holders of 2024
Debentures, $5.0 million to pay down the principal amount of the Senior Term Loan, equity issuance costs of $1.1 million and debt issuance costs of $1.4 million. (See
Note 3Debt in the accompanying consolidated financial statements).

On
October 30, 2009, we closed the debt restructuring transaction with our major creditors pursuant to which we issued approximately $50.0 million of 2014 Debentures (See
Note 3Debt in the accompanying consolidated financial statements). Annual interest payments on the 2014 Debentures will be $4.0 million annually, an increase of
$2.5 million over the annual interest payments on the 2024 Debentures. The first interest payment on the 2014 Debentures is due April 1, 2010.

Concurrent
with the issue of the 2014 Debentures, the Company amended the terms of the Senior Term Loan Agreement. The amendment of the Senior Term Loan included a $5.0 million
repayment of principal, a fee of 1.0% of the amount of repayments; and a change to the interest terms. The amended interest terms on the Senior Term Loan will not materially impact the amount of
quarterly interest payments over the remaining life of the associated note, but additional interest expense accrued under a payment-in-kind interest ("PIK") provision will
increase the final payment due on the Senior Term Loan at maturity in the fiscal year ending September 30, 2012 by approximately $2.6 million over the face value of the note.

We
believe that our available cash will be adequate to finance our operating needs and meet our obligations for the next 12 months.

Special Meeting of Stockholders

At the special meeting of our stockholders on January 7, 2010, the stockholders approved an increase in the number of authorized
shares of common stock from 500,000,000 to 5,000,000,000. This increase permits the conversion of the 2014 Debentures into shares of common stock and provides additional available shares for other
general corporate purposes. In addition, the Company's shareholders also authorized the board of directors to affect a reverse stock-split when it is deemed appropriate. As of May 14, 2010, the
reverse stock-split has not been executed.

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Table of Contents

Contractual Obligations

Payment Obligations by Year<1 Year

1 - 3 Years

3 - 5 Years

>5 Years

TotalConvertible subordinated debt

$


$


$
50,000

$


$
50,000Long term debt





25,000








25,000Operating leases


3,076


5,814


2,711


199


11,800Inventory and related purchase obligations


3,976











3,976Software Licenses


7,059


9,425


3,200





19,684Total

$
14,111

$
40,239

$
55,911

$
199

$
110,460


As
of March 31, 2010, the 2014 Debentures, with a face value of $50.0 million, are outstanding. Additionally, we have $25.0 million in long-term debt
under the Senior Term Loan. Payments with respect to the Senior Term Loan are interest only until the maturity date of October 29, 2011. Effective October 16, 2009, the Company entered
into an amendment of the Senior Term Loan to include 2.0% payment-in-kind interest ("PIK"), plus an additional 0.3% PIK interest for every $1.0 million above
$15.0 million of the senior term loan that is not paid down by the Company for the period from October 17, 2009 until maturity or full payment of the note. As part of the debt
restructuring transactions, the Company paid $5.0 million of the original $30.0 million principal balance of the Senior Term Loan. Subsequent to the $5.0 million prepayment of the
Senior Term Loan, the Company has the ability to reduce the rate of interest by 0.3% for every $1.0 million of additional principal prepayment. (See Note 3Debt in the
accompanying consolidated financial statements).

We
lease facilities under non-cancellable operating leases that expire through 2015. Approximate minimum rental commitments under all non-cancellable operating
leases as of March 31, 2010, are included in the table above.

Inventory
and related purchase obligations represent non-cancellable purchase commitments for wafers and substrate parts. Software license commitments represent
non-cancellable licenses of intellectual property from third-parties used in the development of the Company's products.

For
purposes of the table above, obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding and that specify all significant
terms. Our purchase orders are based on our current manufacturing needs and are typically fulfilled by our vendors within a relatively short time.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and
rates. Our market risk exposure is primarily a result of fluctuations in foreign exchange rates and interest rates and is not material to our financial position. We do not hold or issue financial
instruments for trading purposes.

ITEM 4.    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We evaluated the design and operating effectiveness of our disclosure controls and procedures as of March 31, 2010, under the
supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, pursuant to Rule 13a-15(b) of the Exchange Act. Based on
this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2010, our disclosure controls and procedures were not effective because of the following
material weaknesses in our internal control over financial reporting:



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Due
to the identified material weaknesses, management has also concluded that the Company's internal control over financial reporting was not effective as of March 31, 2010.

Changes in Internal Control over Financial Reporting and Remediation of the Material Weaknesses

Management, in coordination with the input, oversight and support of our Audit Committee, continues its ongoing efforts to strengthen
our internal control over financial reporting and to address the material weaknesses described above. We are investing in ongoing efforts to continuously improve the control environment and have
committed considerable resources to the continuous improvement of the design, implementation, documentation, testing, and monitoring of our internal controls. In addition to improving the
effectiveness and compliance with key controls, our remediation efforts involve ongoing business and accounting process improvements and the implementation of key system enhancements. The process and
system enhancements are generally designed to simplify and standardize business practices and to improve timeliness and access to associated accounting data through increased systems automation
appropriate limitations around IT access as well as timely testing of controls throughout the year. While we expect remedial actions to be essentially implemented in 2010, some actions may not be in
place for a sufficient period of time to help us certify that material weaknesses have been fully remediated as of the end of 2010. We will continue to develop our remediation plans and implement
additional measures during 2010 and possibly into 2011.

For
the period ended March 31, 2010, we have increased controls to limit access to key applications and data.

Inherent Limitation on the Effectiveness of Internal Controls

The effectiveness of any system of internal control over financial reporting is subject to inherent limitations, including the exercise
of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over
financial reporting can only provide reasonable, not absolute, assurances. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls
as necessary or appropriate for our business, but cannot assure you that such improvements will be sufficient to provide us with effective internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

The information set forth under Note 8 of Notes to Unaudited Consolidated Financial Statements, included in Part I,
Item 1 of this Report, is incorporated herein by reference.

ITEM 1A.    RISK FACTORS

There have been no material changes to the risk factors disclosed in Part II, Item 1A of our Quarterly Report on
Form 10-Q for the period ended December 31, 2009, which updated the risk factors disclosed in our Annual Report on Form 10-K for the year ended
September 30, 2009.

ITEM 2.    UNREGISTERED SALES OF EQUITY AND USE OF PROCEEDS

None.

31

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Table of Contents

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.    RESERVED

ITEM 5.    OTHER INFORMATION

None.

32

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Table of Contents

ITEM 6.    EXHIBITS

3.1*

Certificate of Incorporation.10.1*

Resignation and Separation Agreement and General Release of Claims between the Company and Michael Green dated February 5, 2010.10.2*

Employment Agreement between the Company and Christopher Gardner dated February 12, 2010.31.1*

Rule13a-14(a)/302 SOX Certification of Chief Executive Officer.31.2*

Rule13a-14(a)/302 SOX Certification of Chief Financial Officer.32.1*

Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer.


*Filed
herewith.Executive
Compensation Plan or Agreement


33

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Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

May 17, 2010

VITESSE SEMICONDUCTOR CORPORATIONBy:

/s/ CHRISTOPHER R. GARDNER Christopher R. Gardner Chief Executive OfficerMay 17, 2010

VITESSE SEMICONDUCTOR CORPORATIONBy:

/s/ RICHARD C. YONKER Richard C. Yonker Chief Financial Officer
(Principal Financial and Accounting Officer)


34

---