SemiLEDs Corp - Quarter Report: 2011 February (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended February 28, 2011

 

or

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                    

 

Commission File Number: 001-34992

 

SemiLEDs Corporation

(Exact name of registrant as specified in its charter)

 

 

+886-37-586788

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 27,253,777 shares of common stock, par value $0.0000056 per share, outstanding as of April 5, 2011.

 

 

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SEMILEDS CORPORATION

FORM 10-Q for the Quarter Ended February 28, 2011

INDEX

 

		Page No.
Part I. Financial Information
Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets as of February 28, 2011 and August 31, 2010 (unaudited)	3
	Condensed Consolidated Statements of Income (Loss) for the three and six months ended February 28, 2011 and 2010 (unaudited)	4
	Condensed Consolidated Statement of Stockholders’ Equity and Comprehensive Income (Loss) for the six months ended February 28, 2011 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the six months ended February 28, 2011 and 2010 (unaudited)	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.	Controls and Procedures	28
Part II. Other Information
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63
Item 3.	Defaults Upon Senior Securities	64
Item 4.	Reserved	64
Item 5.	Other Information	64
Item 6.	Exhibits	64
Signatures		65
Index to Exhibits		66

 

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PART I — FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

SEMILEDS CORPORATION

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except for per share amounts)

 

		February 28, 2011			August 31, 2010
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	102,637		$	13,520
Accounts receivable, net of allowance for doubtful accounts of $113 and $101		9,903			7,620
Accounts receivable from related parties		741			73
Inventory		15,182			11,362
Prepaid expenses and other current assets		1,694			2,269
Total current assets		130,157			34,844
Property, plant and equipment, net		43,242			31,929
Intangible assets, net		472			380
Investments in unconsolidated entities		15,435			15,961
Other assets		907			792
TOTAL ASSETS		$	190,213		$	83,906
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	4,594		$	2,814
Accrued liabilities		4,607			4,355
Long-term debt, current portion		3,541			1,752
Total current liabilities		12,742			8,921
Long-term debt, net of current portion		6,628			3,786
Total liabilities		19,370			12,707
Commitments and contingencies (Note 6)
STOCKHOLDERS’ EQUITY:
Common stock, $0.0000056 par value — 32,143 and 29,071 shares authorized; 27,254 and 7,428 shares issued and outstanding as of February 28, 2011 and August 31, 2010		—			—
Convertible preferred stock issuable in Series A to E, $0.0000056 par value — zero and 13,719 shares authorized; zero and 13,719 shares issued and outstanding as of February 28, 2011 and August 31, 2010		—			—
Additional paid-in capital		163,109			70,510
Accumulated other comprehensive income (loss)		3,952			(441		)
Retained earnings		3,782			1,130
Total stockholders’ equity		170,843			71,199
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	190,213		$	83,906

 

See notes to condensed consolidated financial statements.

 

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SEMILEDS CORPORATION

Condensed Consolidated Statements of Income (Loss)

(Unaudited)

(In thousands, except for per share amounts)

 

		Three Months Ended February 28,						Six Months Ended February 28,
		2011			2010			2011			2010
Revenues, net		$	9,957		$	7,684		$	22,973		$	14,389
Cost of revenues		7,628			4,515			14,004			9,384
Gross profit		2,329			3,169			8,969			5,005
Operating expenses:
Research and development		738			337			1,185			908
Selling, general and administrative		2,198			666			3,485			1,325
Total operating expenses		2,936			1,003			4,670			2,233
Income (loss) from operations		(607		)	2,166			4,299			2,772
Other income (expense):
Loss from unconsolidated entities		(675		)	(10		)	(897		)	(10		)
Interest income (expense), net		14			(6		)	2			(11		)
Other income, net		44			—			44			—
Foreign currency transaction loss, net		(163		)	(141		)	(739		)	(352		)
Total other expense, net		(780		)	(157		)	(1,590		)	(373		)
Income (loss) before income taxes		(1,387		)	2,009			2,709			2,399
Provision (benefit) for income taxes		(219		)	93			57			120
Net income (loss)		$	(1,168	)	$	1,916		$	2,652		$	2,279
Net income (loss) attributable to common stock:
Basic		$	(1,291	)	$	303		$	(418	)	$	30
Diluted		$	(1,291	)	$	325		$	(418	)	$	33
Net income (loss) per share attributable to common stock:
Basic		$	(0.05	)	$	0.04		$	(0.03	)	$	0.00
Diluted		$	(0.05	)	$	0.04		$	(0.03	)	$	0.00
Shares used in computing net income (loss) per share attributable to common stock (Note 8):
Basic		25,337			7,028			16,346			6,950
Diluted		25,337			8,009			16,346			8,012

 

See notes to condensed consolidated financial statements.

 

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SEMILEDS CORPORATION

Condensed Consolidated Statement of Stockholders’ Equity and Comprehensive Income (Loss)

(Unaudited)

(In thousands)

 

		Common Stock					Convertible Preferred Stock					Additional Paid-in			Accumulated Other Comprehensive			Retained			Total Stockholders’
		Shares		Amount			Shares		Amount			Capital			Income (Loss)			Earnings			Equity
BALANCE — August 31, 2010		7,428		$	—		13,719		$	—		$	70,510		$	(441	)	$	1,130		$	71,199
Issuance of common stock upon exercise of stock options		69		—			—		—			56			—			—			56
Issuance of common stock upon the completion of offering, net of issuance costs		6,038		—			—		—			92,003			—			—			92,003
Conversion into common stock		13,719		—			(13,719	)	—			—			—			—			—
Stock-based compensation		—		—			—		—			540			—			—			540
Comprehensive income:
Foreign currency translation adjustment		—		—			—		—			—			4,393			—			4,393
Net income		—		—			—		—			—			—			2,652			2,652
Total comprehensive income																					7,045
BALANCE — February 28, 2011		27,254		$	—		—		$	—		$	163,109		$	3,952		$	3,782		$	170,843

 

See notes to condensed consolidated financial statements.

 

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SEMILEDS CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

		Six Months Ended February 28,
		2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	2,652		$	2,279
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,038			2,151
Stock-based compensation expense		540			19
Loss from unconsolidated entities		897			10
Changes in operating assets and liabilities:
Accounts receivable, net		(2,254		)	(3,272		)
Inventory		(2,898		)	242
Prepaid expenses and other assets		(455		)	(56		)
Accounts payable		1,442			987
Accrued liabilities		317			1,237
Net cash provided by operating activities		3,279			3,597
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment		(11,624		)	(3,227		)
Sale of property plant and equipment		—			25
Purchase of investments		(331		)	(15,532		)
Development of intangible assets		(82		)	(126		)
Other investing activities, net		(76		)	—
Net cash used in investing activities		(12,113		)	(18,860		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of issuance costs		92,702			—
Proceeds from issuance of Series E convertible preferred stock		—			15,043
Proceeds from exercise of stock options		56			72
Proceeds from line of credit		2,789			410
Payments on line of credit		(1,167		)	(410		)
Proceeds from long-term debt		2,896			—
Payments of long-term debt		(377		)	(232		)
Net cash provided by financing activities		96,899			14,883
Effect of exchange rate changes on cash and cash equivalents		1,052			330
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		89,117			(50		)
CASH AND CASH EQUIVALENTS—Beginning of period		13,520			13,715
CASH AND CASH EQUIVALENTS—End of period		$	102,637		$	13,665
NONCASH INVESTING ACTIVITIES:
Change in the accrual related to property, plant and equipment		$	100		$	117

 

See notes to condensed consolidated financial statements.

 

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SEMILEDS CORPORATION

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.  Business

 

Business — SemiLEDs Corporation (“SemiLEDs”) was established on January 4, 2005 as a Delaware corporation. As of February 28, 2011, SemiLEDs had three wholly owned subsidiaries. The most significant of these is SemiLEDs Optoelectronics Co., Ltd., formerly Semi-Photonics, (“Taiwan SemiLEDs”), which is located in Hsinchu, Taiwan where substantially all research, development, manufacturing and marketing takes place and where substantially all of the assets are held.

 

The following chart illustrates the relationship and ownership percentages of the Company’s corporate structure and joint venture entities:

 

 

SemiLEDs and its subsidiaries (collectively, the “Company”) develop, manufacture and sell high performance light emitting diodes (“LEDs”). The Company’s customers are primarily located in Asia, Russia and North America.

 

Initial Public Offering — On December 8, 2010, the Company sold 5,250 thousand shares of common stock at a price of $17.00 per share in an initial public offering. The shares began trading on the NASDAQ Global Market on December 8, 2010. Also, on December 9, 2010, the Company’s underwriters exercised their overallotment option to purchase another 788

 

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thousand shares of common stock. The $95.5 million in net proceeds from the initial public offering, before deducting offering-related expenses paid by the Company of $3.4 million, were received on December 14, 2010, which was the closing date of the offering. Upon the completion of the initial public offering on December 8, 2010, all outstanding shares of convertible preferred stock converted into common stock on a one-for-one basis, as adjusted for the 14-for-1 reverse stock split described below, and shares of convertible preferred stock are no longer authorized to be issued. The convertible preferred stock converted into 13,719 thousand shares of common stock and the Class B common stock converted into 661 thousand shares of common stock. Concurrently, the Company increased the number of authorized shares of common stock to 32,143 thousand with a par value of $0.0000056 per share.

 

Reverse Stock Split — On November 13, 2010, the Company’s Board of Directors approved an Amended and Restated Certificate of Incorporation to affect a 14-to-1 reverse stock split of the Company’s common and convertible preferred stock, subject to shareholder consent. This reverse stock split became effective upon shareholder approval and filing of the Amended and Restated Certificate of Incorporation. Accordingly, the common and convertible preferred stock authorized and outstanding, par values, stock option disclosures, net income per share amounts, and other per share disclosures for all periods presented have been adjusted to reflect the impact of this reverse stock split.

 

2.  Summary of Significant Accounting Policies

 

Basis of Presentation — The Company’s unaudited interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) and applicable provisions of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting and include the accounts of SemiLEDs and its consolidated subsidiaries. All intercompany transactions and balances have been eliminated during consolidation. Certain information and note disclosures normally included in the financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, with the SEC on December 9, 2010. The condensed consolidated balance sheet as of August 31, 2010, included herein, was derived from the audited consolidated financial statements as of that date.

 

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s statement of financial position as of February 28, 2011 and August 31, 2010, the Company’s results of operations for the three and six months ended February 28, 2011 and 2010, and its cash flows for the six months ended February 28, 2011 and 2010. The results for the three or six months ended February 28, 2011 are not necessarily indicative of the results to be expected for the year ending August 31, 2011. All references to February 28, 2011 or to the three or six months ended February 28, 2011 and 2010 in the notes to the condensed consolidated financial statements are unaudited.

 

Use of Estimates — The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such management

 

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estimates include the allowance for doubtful accounts, inventory valuation, valuation of deferred tax assets, stock-based compensation expense, and the carrying amount of property, plant and equipment and intangible assets. The Company bases its estimates on historical experience and also on assumptions that it believes are reasonable. The Company assesses these estimates on a regular basis; however, actual results could differ materially from those estimates.

 

Concentration of Supply Risk — Some of the components and technologies used in the Company’s products are purchased and licensed from a limited number of sources. The loss of any of these suppliers may cause the Company to incur additional transition costs, result in delays in the manufacturing and delivery of its products, or cause it to carry excess or obsolete inventory. The Company relies on a third party for the fulfillment of its customer orders, and the failure of this third party to perform could have an adverse effect upon the Company’s reputation and its ability to distribute its products, which could adversely affect the Company’s business, financial position, results of operations and cash flows.

 

Concentration of Credit Risk — Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and accounts receivable. The Company keeps its cash and cash equivalents with prominent banks and invests only in high-quality fixed income securities. Deposits held with banks may exceed the amount of insurance provided on such deposits.

 

All of the Company’s revenues are concentrated in sales of LED products. A significant portion of the Company’s revenues are derived from a limited number of customers and sales are concentrated in markets in Asia, particularly in China and Taiwan. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company evaluates the need for a reserve for estimated potential credit losses at each reporting period. The allowance for doubtful accounts is based on the Company’s assessment of the collectibility of its customer accounts. The Company regularly reviews the allowance by considering certain factors such as historical experience, industry data, credit quality, age of accounts receivable balances and current economic conditions that may affect a customer’s ability to pay.

 

During the three and six months ended February 28, 2011, sales to the top ten customers represented 72% and 62% of the Company’s revenues and during the three and six months ended February 28, 2010, sales to top ten customers represented 71% and 65% of revenues, net.

 

Revenues generated from sales to customers in China (including Hong Kong) and Taiwan accounted for 60% and 68% of the Company’s revenues during the three and six months ended February 28, 2011 and 86% and 84% during the three and six months ended February 28, 2010.

 

Recently Issued Accounting Pronouncements

 

In June 2009, the FASB issued new guidance concerning the determination of the primary beneficiary of a variable interest entity (“VIE”). This new guidance amends current U.S. GAAP by: requiring ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE; amending the quantitative approach previously required for determining the primary beneficiary of the VIE; modifying the guidance used to determine whether an entity is a VIE; adding an additional reconsideration event (e.g., troubled debt restructurings) for determining whether an entity is a VIE; and requiring enhanced disclosures regarding an entity’s involvement with a VIE. This guidance became effective for the Company beginning in the first quarter of

 

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fiscal 2011. The Company’s adoption of the new accounting guidance did not have an impact on its condensed consolidated financial statements.

 

3.  Balance Sheet Components

 

Inventory

 

Inventory as of February 28, 2011 and August 31, 2010 consists of the following (in thousands):

 

		February 28, 2011			August 31, 2010
Raw materials		$	3,844		$	2,610
Work in process		4,612			3,955
Finished goods		6,726			4,797
Inventory		$	15,182		$	11,362

 

Property, Plant and Equipment

 

Property, plant and equipment as of February 28, 2011 and August 31, 2010 consists of the following (in thousands):

 

		February 28, 2011			August 31, 2010
Buildings and improvements		$	12,501		$	7,148
Machinery and equipment		41,122			32,492
Leasehold improvements		2,752			2,225
Other equipment		1,549			1,230
Construction in progress		6,382			5,561
Total property, plant and equipment		64,306			48,656
Less accumulated depreciation and amortization		(21,064		)	(16,727		)
Property, plant and equipment, net		$	43,242		$	31,929

 

4.  Investments in Unconsolidated Entities

 

The Company’s unconsolidated entities are joint ventures and privately-held companies that the Company accounts for as investments on an equity or cost method basis. The equity method investments consist of SILQ (Malaysia) Sdn. Bhd. (“SILQ”), Xurui Guangdian Co., Ltd. (“China SemiLEDs”), and SS Optoelectronics Co., Ltd. (“SS Optoelectronics”). The Company’s ownership interest and investments in unconsolidated entities as of February 28, 2011 and August 31, 2010 consist of the following (in thousands, except for percentages):

 

		Percentage Ownership		February 28, 2011			August 31, 2010
Equity method investments:
SILQ		50	%	$	277		$	433
China SemiLEDs		49	%	13,860			14,575
SS Optoelectronics		49	%	248			239
Cost method investments		Various		1,050			714
Total investments in unconsolidated entities				$	15,435		$	15,961

 

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There have been no dividends received from unconsolidated entities through February 28, 2011.

 

Equity Method Investments — The following joint ventures are partially owned by the Company or its wholly-owned subsidiaries, however, the Company has determined that it does not control the entities but can exercise significant influence over the operating and financial policies of the joint ventures. The Company accounts for these joint ventures using the equity method of accounting.

 

In September 2009, the Company, through a wholly owned subsidiary, contributed $570,000 to form SILQ, a joint venture in Malaysia. The Company and the other investor in the joint venture each hold a 50% ownership and voting interest in SILQ’s common stock. The Company entered into the joint venture agreement that established SILQ to design, manufacture and sell lighting fixtures and systems.

 

In December 2009, the Company entered into an agreement to establish China SemiLEDs in Guangdong, China for the purposes of conducting research and development and producing LED epitaxial wafers and chips to be sold in China. The Company contributed $14.7 million to acquire a 49% ownership interest in China SemiLEDs.

 

In December 2009, the Company, through a wholly owned subsidiary, entered into an agreement to contribute $980,000 for a 49% ownership interest in SS Optoelectronics, a joint venture in Taiwan. The investment is payable based upon a payment schedule set forth in the agreement as follows: $245,000 upon signing the agreement, $245,000 after the incorporation of the joint venture and $490,000 upon reaching a certain sales level. As of February 28, 2011, the Company has contributed $245,000. The Company entered into the joint venture agreement that established SS Optoelectronics to facilitate sales of the Company’s LED chips to the other investor in the joint venture. However, the application for entry into the Hsinchu Science Park was rejected by the Hsinchu Science Park Administration because the main purpose of SS Optoelectronics was not for research and development or manufacturing as required under the regulations of the Administration. As such, the Company made a determination to dissolve the joint venture in accordance with the joint venture agreement and sent a notice of termination to the other investor in November 2010. Management does not expect that dissolving this joint venture will have a material impact on the Company’s consolidated financial statements.

 

The excess of the Company’s share of net assets of China SemiLEDs over book value is $7.3 million at February 28, 2011. This difference is associated with the investee’s tangible and intangible assets and will be amortized over the life of the assets beginning in the period those assets are put in place, which is expected to be in the third quarter of fiscal 2011. The aggregate fair value of the Company’s investments in the non-marketable stock of its equity method investees is not readily available. These investments are assessed for impairment when events or changes in circumstances indicate that the carrying amounts may not be recoverable.

 

Cost Method Investments —In January 2011, the Company, through a wholly owned subsidiary, invested $331,000 in LumenMax Optoelectronics Co., Ltd., a privately-held company that develops and manufactures LED products, acquiring a 4% ownership interest in LumenMax. The Company accounts for its investment in LumenMax under the cost method of accounting because the Company cannot exercise significant influence over the operating and financial policies of LumenMax. As of February 28, 2011, the Company holds investments in nonmarketable common stock of four unaffiliated companies with a carrying amount of $1,050,000.

 

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As of August 31, 2010, the Company holds investments in nonmarketable common stock of three unaffiliated companies with a carrying amount of $714,000.

 

The fair value of these investments is not readily available. These investments are assessed for impairment when events or changes in circumstances indicate that the carrying amounts may not be recoverable.

 

5.  Long-Term Debt

 

In December 2010, the Company entered into a long-term loan agreement, the proceeds of which were used for the purchase of the first and second floors of a building in Hsinchu, Taiwan. The note payable carries variable interest rate of 1.6% and is secured by the Company’s property, plant and equipment. The note payable requires monthly payments of principal and interest in the amount of $18,000 over the 15-year term of the note with final payment to occur in December 2025. As of February 28, 2011, outstanding balance on this note payable was approximately $2.9 million.

 

6.  Commitments and Contingencies

 

Operating Lease Agreements — The Company has several operating leases with unrelated parties, primarily for land, plant and office space in Taiwan, which are noncancellable and which expire on November 30, 2016 and December 31, 2020. Lease expense related to these noncancellable operating leases was $177,000 and $117,000 during the three months ended February 28, 2011 and 2010 and $345,000 and $233,000 during the six months ended February 28, 2011 and 2010. Lease expense is recognized on a straight-line basis over the term of the lease. The aggregate future noncancellable minimum rental payments for the Company’s operating leases as of February 28, 2011 consist of the following (in thousands):

 

Years Ending August 31,		Operating Leases
2011 (remainder)		$	336
2012		655
2013		718
2014		740
2015		815
Thereafter		1,344
Total		$	4,608

 

Purchase Obligations — The Company had purchase commitments for equipment in the amount of $3.7 million and $6.9 million as of February 28, 2011 and August 31, 2010.

 

Litigation— The Company is subject to various claims arising in the ordinary course of business.

 

On October 14, 2010, Cree, Inc., or Cree, a competitor and a major manufacturer of LED products, filed a complaint against the Company in the United States District Court of Delaware asserting infringement of certain of their patents. The complaint seeks injunctive relief, unspecified monetary damages, pre- and post-judgment interest and attorneys fees. The Company filed an answer to the complaint on November 3, 2010, denying all allegations of infringement. Cree filed a motion on December 10, 2010 to amend its initial complaint to add additional United States patents that it alleges the Company has infringed. On March 22, 2011, the Court granted Cree’s motion to amend and the second amended complaint was placed on file.  The second

 

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amended complaint similarly alleges that the Company has infringed certain of Cree’s patents in the United States and seeks injunctive relief, unspecified monetary damages, pre- and post-judgment interest and attorneys fees.  The Company plans to file answers to the second amended complaint in the near future.  Management believes that the Company has meritorious defenses and the Company intends to contest this lawsuit vigorously. However, in the event that Cree is successful in obtaining some or all of the relief it seeks, it could have a material adverse effect on the Company’s business and reputation. At this time, the Company is unable to estimate the potential financial impact this action could have on it.

 

In August 2009, Gertrude F. Neumark Rothschild, a retired professor from the United States, filed a complaint with the Intellectual Property Court in Taiwan against the Company and seven other companies, asserting that the production process the Company uses to manufacture our LED chips infringes her patent in Taiwan. Mr. Trung T. Doan, the Company’s chief executive officer, was named a co-defendant. In the complaint, Ms. Rothschild seeks monetary damages and an injunction against future infringement. She alleges that the Company and Mr. Trung T. Doan are jointly and severally liable. On June 30, 2010, the complaint was dismissed by the court and on July 30, 2010, Ms. Rothschild appealed the decision. On October 28, 2010, a pleading was filed with the Intellectual Property Court in Taiwan by Ms. Rothschild’s attorneys to withdraw her claim for an injunction against future infringement of her patent because such patent had expired on August 15, 2009. The Company believes the patent in suit is invalid, among other defenses that the Company has asserted. Ms. Rothschild continues to seek initial monetary damages of NT33.0 million (approximately $1.1 million), although the ultimate amount of the damages if she were to prevail on appeal is unpredictable and has not yet been determined.

 

Third parties have from time to time claimed, and others may claim in the future, that the Company has infringed their past, current or future intellectual property rights. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in the Company’s methods of doing business or could require the Company to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm the Company’s business, operating results, cash flows and financial position.

 

Indemnifications — Under the indemnification provisions of certain of the Company’s distributor agreements, the Company agrees to defend the distributors against third-party intellectual property infringement claims. To date, there have been no material claims under such indemnification provisions.

 

7.  Stock-based Compensation

 

As of August 31, 2010, the Company had one stock-based compensation plan (the “2005 Plan”). In November 2010, the Company’s Board of Directors and its stockholders approved the 2010 Equity Inventive Plan (the “2010 Plan”), discussed further below, which became effective upon the completion of the initial public offering on December 8, 2010.

 

The Company’s stock-based compensation expense was $433,000 and $15,000 during the three months ended February 28, 2011 and 2010. The total stock-based compensation expense consists of stock-based compensation expense for stock options and restricted stock awards granted to employees of $256,000 and $15,000, nonemployees of $6,000 and zero, and directors of $139,000 and zero during the three months ended February 28, 2011 and 2010. Stock-based compensation also includes $32,000 and zero during the three months ended February 28, 2011 and 2010 for Series E shares issued, which were converted into common stock on a one-for-one basis, as part of an employment agreement related to the Company’s acquisition of SBDI.

 

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The Company’s stock-based compensation expense was $540,000 and $19,000 during the six months ended February 28, 2011 and 2010.  The total stock-based compensation expense consists of stock-based compensation expense for stock options and restricted stock awards granted to employees of $316,000 and $19,000, nonemployees of $15,000 and zero, and directors of $139,000 and zero during the six months ended February 28, 2011 and 2010. Stock-based compensation also includes $70,000 and zero during the six months ended February 28, 2011 and 2010 for Series E shares issued, which were converted into common stock on a one-for-one basis, as part of an employment agreement related to the Company’s acquisition of SBDI.

 

Equity Incentive Plans — A total of 3,849 thousand shares of common stock was reserved for issuance under the 2005 Plan and 2010 Plan. After the initial public offering, awards shall be made from the 2010 Plan. The 2010 Plan provides for awards in the form of restricted shares, stock units, stock options or stock appreciation rights to the Company’s employees, officers, directors and consultants. Options outstanding under the 2005 Plan will continue to be governed by its existing terms.

 

On January 20, 2011, the Company’s board of directors approved options for 293 thousand shares of the Company’s common stock and 222 thousand stock units to its employees. These options and stock units vest over four years at a rate of 25% on each anniversary of the vesting start date and the options have a contractual term of ten years, subject to earlier expiration in the event of the holder’s service termination. In addition, the Company’s board of directors also approved 71 thousand stock units to its directors that vest 100% on the first anniversary of the vesting start date. The exercise price of the stock options is $19.00, which equals to the closing price of the Company’s common stock on the grant date. The grant-date fair value of the stock units is $19.00 per unit.

 

Determining Fair Value of Stock Options — For the six months ended February 28, 2011 and 2010, the fair value of each grant of stock options was determined by the Company using the methods and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment to determine.

 

Valuation Method — The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model.

 

Expected Term — The expected term represents the period that the Company’s stock options are expected to be outstanding. The expected term for options granted to employees of the Company is derived from historical data on employee exercises and post-vesting employment termination behavior after taking into account the contractual life of the award. The expected term for nonemployee options is equal to the contractual life of the option.

 

Expected Volatility — The expected volatility was based on the implied stock volatilities of several of the Company’s publicly-traded peers over a period equal to the expected terms of the options as the Company did not have a sufficient trading history to use the volatility of its own common stock.

 

Fair Value of Common Stock — The fair value of the Company’s common stock underlying the stock options was based on the trading price of the Company’s shares on the date of grant.

 

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Risk-Free Interest Rate — The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the expected term of the related options.

 

Expected Dividend — The expected dividend has been zero for the Company’s option grants as the Company has never paid dividends and does not expect to pay dividends for the foreseeable future.

 

Determining Fair Value of Stock Units — Grant date fair value is based upon the market price of the Company’s common stock on the date of the grant. This fair value is amortized to compensation expense over the vesting term.

 

8.  Net Income (Loss) Per Share of Common Stock

 

The following tables set forth the computation of the Company’s basic and diluted net income (loss) per share of common stock for the three and six months ended February 28, 2011 and 2010 (in thousands, except for per share amounts). The two-class method was used for the period through December 8, 2010, the period that the convertible preferred shares were outstanding.

 

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		Three Months Ended February 28,						Six Months Ended February 28,
		2011			2010			2011			2010
Numerator:
Basic:
Net income (loss)		$	(1,168	)	$	1,916		$	2,652		$	2,279
8% noncumulative dividends on convertible preferred stock		(123		)	(1,099		)	(1,532		)	(2,197		)
Undistributed earnings allocated to convertible preferred stock		—			(514		)	(1,538		)	(52		)
Net income (loss) attributable to common stock, basic		$	(1,291	)	$	303		$	(418	)	$	30
Diluted:
Net income (loss) attributable to common stock, basic		$	(1,291	)	$	303		$	(418	)	$	30
Undistributed earnings re-allocated to common stock		—			22			—			3
Net income (loss) attributable to common stock, diluted		$	(1,291	)	$	325		$	(418	)	$	33
Denominator:
Basic:
Shares used in computing net income (loss) per share attributable to common stock, basic		25,337			7,028			16,346			6,950
Diluted:
Shares used in computing net income (loss) per share attributable to common stock, basic		25,337			7,028			16,346			6,950
Add weighted average effect of dilutive securities:
Stock options		—			981			—			1,062
Shares used in computing net income (loss) per share attributable to common stock, diluted		25,337			8,009			16,346			8,012
Net income (loss) per share of common stock:
Basic		$	(0.05	)	$	0.04		$	(0.03	)	$	0.00
Diluted		$	(0.05	)	$	0.04		$	(0.03	)	$	0.00

 

The following securities were excluded from the computation of diluted net income (loss) per share of common stock for the periods presented because including them would have been antidilutive (in thousands):

 

		Three Months Ended February 28,				Six Months Ended February 28,
		2011		2010		2011		2010
Convertible preferred stock		—		12,019		—		12,019
Stock units and stock options to purchase common stock		374		—		351		—

 

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9.  Income Taxes

 

The Company’s income (loss) before provision (benefit) for income taxes for the three and six months ended February 28, 2011 and 2010 consist of the following (in thousands):

 

		Three Months Ended February 28,						Six Months Ended February 28,
		2011			2010			2011			2010
Domestic		$	(1,355	)	$	(90	)	$	(1,597	)	$	(187	)
International		(32		)	2,099			4,306			2,586
Income (loss) before provision (benefit) for income taxes		$	(1,387	)	$	2,009		$	2,709		$	2,399

 

As of February 28, 2011 and August 31, 2010, the Company had $252,000 and $252,000 of unrecognized tax benefits related to tax positions taken in prior periods, all of which would impact the Company’s effective tax rate if recognized.

 

Accrued interest and penalties related to unrecognized tax benefits are classified as income tax expense and were immaterial. The Company files income tax returns in the United States, various states and certain foreign jurisdictions. The tax years 2005 through 2010 remain open in most jurisdictions. The Company is not currently under examination by income tax authorities in federal, state or other foreign jurisdictions.

 

10.  Subsequent Event

 

In March 2011, the Company received a one-time payment of $600,000 for the assignment of 13 patents to China SemiLEDs pursuant to a patent assignment and license agreement, as amended, from China SemiLEDs, which will be recorded in the third quarter of fiscal 2011.

 

* * * * *

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 which provides a “safe harbor” for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by and information currently available to the management of SemiLEDs Corporation (“SemiLEDs”) and its subsidiaries (collectively “we,” “our” or the “Company”). The outcome of the events described in these forward-looking statements is subject to risks and uncertainties. Actual results and the outcome or timing of certain events may differ significantly from those projected in these forward-looking statements or management’s current expectations due to the factors cited in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”), the Risk Factors listed under Part II, Item 1A of this Quarterly Report on Form 10-Q, and other factors described from time to time in our other filings with the Securities and Exchange Commission (“SEC”), or other reasons. For this purpose, statements concerning: industry or market segment outlook; market acceptance of or transition to new products or technology; growth drivers; future orders, revenues, backlog, earnings or other financial results; and any statements using the terms “believe,” “expect,” “anticipate,” “estimate,” “should,” “would,” “could,” “can,” “may,” “will,”  “ongoing,” “likely,” and “possible” or similar statements are forward-looking statements. By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.

 

The following discussion and analysis of our financial condition and results of operations is based upon and should be read in conjunction with the unaudited condensed consolidated financial statements and the notes included elsewhere in this Quarterly Report on Form 10-Q, as well as the Risk Factors contained in Part II, Item 1A of this Quarterly Report on Form 10-Q, and other information provided from time to time in our other filings with the SEC.

 

Overview

 

We develop, manufacture and sell LED chips and LED components that we believe are among the industry leading LED products on both a lumens per watt and cost per lumen basis. Our products are used primarily for general lighting applications, including street lights and commercial, industrial and residential lighting.

 

We sell blue, green and ultraviolet (UV) LED chips under our MvpLED brand to a customer base that is heavily concentrated in Asia, in particular China, Taiwan and Korea, as well as in Russia and North America. Our operations include both LED chip and LED component manufacturing. Utilizing our patented and proprietary technology, our manufacturing process begins by growing upon the surface of a sapphire wafer, or substrate, several very thin separate semiconductive crystalline layers of gallium nitride, or GaN, a process known as epitaxial growth, on top of which a mirror-like reflective silver layer is then deposited. After the subsequent addition of a copper alloy layer and finally the removal of the sapphire substrate, we further process this multiple-layered material to create individual LED chips.

 

We produce a wide variety of LED chips, currently ranging from chip sizes of 1520 microns, or µm, by 1520µm to 380µm by 380µm. The majority of our chips are capable of providing over 100 lumens per watt when packaged. We sell our LED chips to packaging customers or to distributors, who in turn sell to packagers. In addition, we package a portion of

 

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our LED chips into LED components, which we sell to distributors and end-customers in selected markets.

 

We are a holding company for various wholly owned subsidiaries and joint ventures. Our most significant subsidiary is our wholly owned operating subsidiary, Taiwan SemiLEDs, where substantially all of our assets are held and located, substantially all of our employees are employed and located, and where all of our research and development and sales activities take place. Taiwan SemiLEDs owns a 100% equity interest in SBDI, a consolidated entity effective April 1, 2010. We also sell a majority of our LED components through the Taiwan branch office of our wholly owned Delaware subsidiary, Helios Crew, which purchases LED components from Taiwan SemiLEDs and resells them to our customers. We have a 49% interest in China SemiLEDs, a joint venture in China. In addition, we own a 50% interest in SILQ, a joint venture established in Malaysia to design, manufacture and sell lighting fixtures and systems. We also own a 49% interest in SS Optoelectronics, a joint venture that we formed in Taiwan with one of our customers. With respect to SS Optoelectronics, we made a determination to dissolve the joint venture in accordance with the joint venture agreement and sent a notice of termination to the other shareholder of SS Optoelectronics in November 2010. SILQ is still in an early development stage and has not had any material operations to date. China SemiLEDs has substantially completed the construction of its manufacturing facilities, purchased equipment and installed LED chip manufacturing lines, hired technical and managerial personnel, and installed financial and administrative equipment and software. We expect China SemiLEDs to commence commercial production and begin to market and sell products in China after April 2011.

 

Our 49% ownership interest in China SemiLEDs is accounted for as an equity method investment and as such is not consolidated for financial reporting purposes. We report our investment in China SemiLEDs on our consolidated balance sheet at cost, after adding or deducting our portion of equity in undistributed earnings or losses. If the fair value of our investment in China SemiLEDs declines below the carrying amount, and the decline is determined to be other-than-temporary, the investment will be written down to fair value. We recognize our proportionate share (based on our percentage ownership) of the net income or loss, as the case may be, from China SemiLEDs under loss from unconsolidated entities in our unaudited condensed consolidated statements of income (loss), which include, in addition to the income or loss attributable to China SemiLEDs, our proportionate share of the income or loss from our other two joint venture entities.

 

Critical Accounting Policies and Estimates

 

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, or US GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during each reporting period. We continually evaluate these estimates and assumptions based on historical experience, knowledge and assessment of current and other conditions, our expectations regarding our future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates.

 

We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements: allowance for doubtful accounts, inventory valuation, valuation of deferred tax assets, stock-based compensation expense, and the carrying amount of property, plant and equipment and intangible assets.

 

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There have been no material changes in the matters for which we make critical accounting policies and estimates in the preparation of our unaudited condensed consolidated financial statements during the six months ended February 28, 2011 as compared to those disclosed in our prospectus filed with the SEC on December 9, 2010 pursuant to Rule 424(b) under the Securities Act.

 

Results of Operations

 

Three Months Ended February 28, 2011 Compared to the Three Months Ended February 28, 2010

 

Revenues, net

 

Our revenues increased by approximately 30% from $7.7 million during the three months ended February 28, 2010 to $10.0 million during the three months ended February 28, 2011. The $2.3 million increase in revenues reflects a $2.8 million increase in revenues attributable to sales of LED components and a $1.2 million increase in other revenues, offset in part by a $1.7 million decrease in revenues attributable to sales of LED chips.

 

The decrease in revenues attributable to sales of LED chips was due to a 16% decrease in the volume of LED chips sold and a 21% decrease in the average selling price of LED chips. The decrease in average selling prices of LED chips resulted from increased supply and competition, which resulted in industry players, including us, having to lower prices for existing products and existing inventory. The pressure on average selling prices was also attributable to lower demand for our LED chips and the loss of a large customer in the three months ended February 28, 2011.

 

The increase in revenues attributable to sales of LED components was due to a 291% increase in the volume of LED components sold, offset in part by a 22% decrease in the average selling price of LED components due to continued market competition and the general trend of lower average selling prices for products that have been available in the market for some time. The significant increase in volume of LED components sold was primarily due to increased customer demand for our LED components, and also due to our ability to produce LED components that met our customers’ demand and technical specifications.

 

The increase in other revenues was primarily due to a $0.5 million increase in the sale of scrap, a $0.3 million service revenue, a $0.1 million increase in the sale of lighting products, as well as increases in the sale of epitaxial wafers and the sale of raw materials.

 

Gross Profit

 

Our gross profit decreased from $3.2 million during the three months ended February 28, 2010 to $2.3 million during the three months ended February 28, 2011. Our gross margin percentage decreased from 41% during the three months ended February 28, 2010 to 23% during the three months ended February 28, 2011, primarily due to a significant decrease in the average selling prices for our LED chips and LED components, as a result of an unfavorable pricing environment in the three months ended February 28, 2011. The decrease was also due to lower capacity utilization and a change in our product mix as we decreased our production of LED chips and increased our production of LED components, which are lower-margin products relative to LED chips, primarily in response to a change in customer demand, as well as a shortage in metal organic chemical compound.

 

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Operating Expenses

 

Research and development. Our research and development expenses increased by 119% from $0.3 million for the three months ended February 28, 2010 to $0.7 million for the three months ended February 28, 2011. The increase was primarily due to an increase in materials and supplies used in research and development of $0.2 million, an increase in salaries attributable to research and development functions of $0.1 million, and an increase in depreciation expenses of $0.1 million. Our research and development expenses were higher for the three months ended February 28, 2011, primarily as a result of our continued research and development efforts focusing on developing higher brightness LED chips, improved LED components, and migration to larger wafer sizes, in particular 4” wafers, which resulted in an increased amount of materials and supplies. In addition, such expenses were higher because they included the research and development expenses including primarily materials and supplies and depreciation related expenses of SBDI, which we acquired in April 2010. The increase in salary related expenses was primarily due to an increase in stock-based compensation cost for our research and development personnel.

 

Selling, general and administrative. Our selling, general and administrative expenses increased by 230% from $0.7 million for the three months ended February 28, 2010 to $2.2 million for the three months February 28, 2011. The increase was mainly attributable to an increase in professional service expenses for legal and accounting services of $0.7 million primarily in relation to our defense against a patent infringement lawsuit and because we now incurred a significantly higher level of legal and accounting expenses as we completed our public offering and as a public company. The increase was also attributable to an increase in salary related expenses of $0.3 million, an establishment of compensation to our directors of $0.2 million, an establishment of insurance for our directors and officers of $0.1 million, and increases in travel related expenses, advertisement, taxes, rent and depreciation expenses of $0.2 million, primarily due to the general expansion of our business. The increase in salary related expenses was primarily a result of the hiring of additional employees for sales, marketing and administrative functions to accommodate the growth and increased activity of our business, as well as an increase in stock-based compensation cost for our sales, marketing and administrative personnel.

 

Other Income (Expense)

 

Loss from unconsolidated entities. We did not record any significant loss from unconsolidated entities during the three months ended February 28, 2010 as such entities, including China SemiLEDs and SILQ, were in an early development stage and did not have any material operations. We recorded a loss from unconsolidated entities of $0.7 million during the three months ended February 28, 2011, which was primarily attributable to the recognition of our portion of the net loss from China SemiLEDs as it began to incur expenses, including research and development and selling, general and administrative expenses, in preparation for commercial production. SILQ and SS Optoelectronics are in an early development stage and have not had any material operations to date. The loss recorded from unconsolidated entities was mainly due to administrative and start-up costs incurred by such entities.

 

Foreign currency transaction loss. We recorded a foreign currency transaction loss of $0.1 million and $0.2 million during the three months ended February 28, 2010 and 2011, respectively, primarily due to the appreciation of the NT dollar against the U.S. dollar.

 

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Provision (Benefit) for Income Taxes

 

Income tax expense (benefit). Our income tax benefit in the three months ended February 28, 2011 was $0.2 million, compared with an income tax expense of $0.1 million in the three months ended February 28, 2010. Our income tax benefit in the three months ended February 28, 2011 reflected the true-up of the most current annual effective tax rate (“ETR”) for fiscal 2011, which is estimated to be approximately 2.1%, as compared to the previously estimated annual ETR, which was 6.7% in the three months ended November 30, 2010. The decrease in annual ETR reflects primarily the impact of a lower level of taxable income than we originally anticipated for Taiwan SemiLEDs, our primary operating subsidiary, for fiscal 2011

 

Six Months Ended February 28, 2011 Compared to the Six Months Ended February 28, 2010

 

Revenues, net

 

Our revenues increased by approximately 60% from $14.4 million for the six months ended February 28, 2010 to $23.0 million for the six months ended February 28, 2011. The $8.6 million increase in revenues reflected a $5.2 million increase in revenues attributable to sales of LED components, a $1.8 million increase in revenues attributable to sales of LED chips, and a $1.6 million increase in other revenues.

 

The increase in revenues attributable to sales of LED chips was due to a 14% increase in the volume of LED chips sold, offset in part by a 5% decrease in the average selling price of LED chips. The increase in volume sold was primarily due to increased end-user demand as a result of increased economic activity in calendar year 2010, as the global economy began to recover from a significant financial and economic downturn which began in late calendar year 2008 and which continued through most of calendar year 2009, and also due to our ability to ramp up our production capacity and produce LED chips that met our customers’ demand and technical specifications. We believe that we had benefited in particular during our first quarter of fiscal 2011, as the improvement in economic conditions and increased business activity and growth was more pronounced. The decrease in average selling prices of LED chips was primarily due to the continued increase in supply and market competition over the period.

 

The increase in revenues attributable to sales of LED components was due to a 247% increase in the volume of LED components sold, offset in part by a 16% decrease in the average selling price of LED components due to continued market competition and the general trend of lower average selling prices for products that have been available in the market for some time. The significant increase in volume of LED components sold was primarily due to increased customer demand for our LED components, and also due to our ability to ramp up our production capacity to produce LED components that met our customers’ demand and technical specifications.

 

The increase in other revenues was primarily due to a $0.6 million increase in the sale of scrap, a $0.3 million service revenue, a $0.3 million increase in the sale of lighting products, as well as increases in the sale of epitaxial wafers and the sale of raw materials.

 

Gross Profit

 

Our gross profit increased from $5.0 million during the six months ended February 28, 2010 to $9.0 million during the six months ended February 28, 2011. Our gross margin

 

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percentage increased from 35% during the six months ended February 28, 2010 to 39% during the six months ended February 28, 2011, primarily due to improved capacity utilization as a result of increased customer demand for our LED chips and LED components, improved production yields across our product lines, and our continued sales of a category of high performance, higher priced and higher margin LED chips which we were able to sell at higher average selling prices during the six months ended February 28, 2011. Average selling prices of our products are impacted to a significant extent by the stage of our products’ life-cycle, with average selling prices being higher early in the life-cycle of a product and prices decreasing over time as products age and new products and higher efficacies are introduced.

 

Operating Expenses

 

Research and development. Our research and development expenses increased by 31% from $0.9 million for the six months ended February 28, 2010 to $1.2 million for the six months ended February 28, 2011. The increase was primarily due to an increase in materials and supplies used in research and development of $0.2 million and an increase in depreciation expense of $0.1 million. Our research and development expenses were higher for the six months ended February 28, 2011, primarily as a result of our continued research and development efforts focusing on developing higher brightness LED chips, improved LED components, migration to larger wafer sizes, in particular 4” wafers, which resulted in an increased amount of materials and supplies. In addition, such expenses were higher because they included the research and development expenses including primarily materials and supplies and depreciation related expenses of SBDI, which we acquired in April 2010.

 

Selling, general and administrative. Our selling, general and administrative expenses increased by 163% from $1.3 million for the six months ended February 28, 2010 to $3.5 million for the six months ended February 28, 2011.  The increase was primarily due to an increase in professional service expenses for legal and accounting services of $0.9 million primarily in relation to our defense against a patent infringement lawsuit and because we now incurred a significantly higher level of legal and accounting expenses as we completed our public offering and as a public company, an increase in salary related expenses of $0.6 million. The increase was also attributable to an establishment of compensation to our directors of $0.3 million, an establishment of insurance for our directors and officers of $0.1 million, and increases in travel related expenses, rent, taxes, and depreciation expenses of $0.2 million, primarily due to the general expansion of our business. The increase in salary related expenses was primarily due to our hiring of additional employees for sales, marketing and administrative functions to accommodate the growth and increased activity of our business, as well as an increase in stock-based compensation cost for our sales, marketing and administrative personnel.

 

Other Income (Expense)

 

Loss from unconsolidated entities. We did not record any significant loss from unconsolidated entities during the six months ended February 28, 2010 as such entities, including China SemiLEDs and SILQ, were in an early development stage and did not have any material operations. We recorded a loss from unconsolidated entities of $0.9 million during the six months ended February 28, 2011, which was primarily attributable to the recognition of our portion of the net loss from China SemiLEDs as it began to incur expenses, including research and development and selling, general and administrative expenses, in preparation for commercial production. SILQ and SS Optoelectronics are in an early development stage and have not had any material operations to date. The loss recorded from unconsolidated entities was mainly due to administrative and start-up costs incurred by those entities.

 

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Foreign currency transaction loss. We recorded a foreign currency transaction loss of $0.4 million and $0.7 million during the six months ended February 28, 2010 and 2011, respectively, primarily due to the appreciation of the NT dollar against the U.S. dollar.

 

Provision for Income Taxes

 

Income tax expense. Our income tax expense in the six months ended February 28, 2011 was $0.1 million, compared with an income tax expense of $0.1 million in six months ended February 28, 2010. Our income tax expense in the six months ended February 28, 2011 reflected the most current annual ETR of 2.1%, which is lower than the previously estimated annual ETR of 6.7% in the three months ended November 30, 2010. The decrease in annual ETR reflects the impact of a lower level of taxable income than we originally anticipated for Taiwan SemiLEDs, our primarily operating subsidiary, for fiscal 2011.

 

Liquidity and Capital Resources

 

From our inception through the completion of our initial public offering in December 2010, we have substantially satisfied our capital and liquidity needs from private sales of our convertible preferred stock and, to a lesser extent, from cash flow from operations, bank borrowings and credit lines. As a result of the offering, we received net proceeds of $95.5 million, before deducting offering-related expenses paid by us of $3.4 million. As of August 31, 2010 and February 28, 2011, we had cash and cash equivalents of $13.5 million and $102.6 million, respectively, which were predominately held in U.S. dollars.

 

During the year ended August 31, 2010 and the six months ended February 28, 2011, we utilized operating lines of credit with certain banks to fulfill our short-term financing needs. The outstanding balances of these lines of credit were $1.0 million and $2.8 million as of August 31, 2010 and February 28, 2011, respectively. These lines of credit had maturity dates of six to eight months from the date of draw down and bore fixed interest rates ranging from 1.2% to 1.5% during these periods.  Unused amounts on these lines of credit were $4.7 million and $3.6 million as of August 31, 2010 and February 28, 2011, respectively.

 

As of August 31, 2010 and February 28, 2011, our long-term debt, which includes long-term notes, totaled $4.5 million and $7.4 million, respectively. These long-term notes carry variable interest rates ranging from 1.6% to 2.0% per annum, are payable in monthly installments, and are secured by our property, plant and equipment. The first note payable requires monthly payments of principal and interest in the amount of $13,000 over the 15-year term of the note with final payment to occur in May 2024 and, as of February 28, 2011, our outstanding balance on this note payable was approximately $1.9 million. The second note payable requires monthly payments of principal and interest in the amount of $29,000 over the five-year term of the note with final payment to occur in August 2014 and, as of February 28, 2011, our outstanding balance on this note payable was approximately $1.2 million. The third note payable requires monthly payments of principal and interest in the amount of $28,000 over the five-year term of the note with final payment to occur in March 2015 and, as of February 28, 2011, our outstanding balance on this note payable was approximately $1.4 million. The fourth note payable requires monthly payments of principal and interest in the amount of $18,000 over the 15-year term of the note with final payment to occur in December 2025 and, as of February 28, 2011, our outstanding balance on this note payable was approximately $2.9 million.  These long-term notes do not have prepayment penalties or balloon payments upon maturity.

 

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We have incurred significant losses since inception, including net losses of $0.8 million and $3.7 million during the years ended August 31, 2008 and 2009, respectively. For the year ended August 31, 2010 and the six months ended February 28, 2011, we generated net income of $10.8 million and $2.7 million, respectively. We believe that, based on our current level of operations and anticipated growth, the net proceeds from our initial public offering, together with our existing liquidity sources and anticipated funds from operations, will satisfy our cash requirements for at least the next 12 months. However, if we are not able to continue to generate positive cash flows from operations, we may need to consider alternative financing sources and seek additional funds through public or private equity financings or from other sources to support our working capital requirements or for other purposes. There can be no assurance that additional financing will be available to us or that, if available, such financing will be available on terms favorable to us.

 

Cash Flow

 

The following summary of our cash flows for the periods indicated has been derived from our unaudited condensed consolidated financial statements, which are included elsewhere in this Quarterly Report on Form 10-Q:

 

		Six Months Ended February 28,
		2011			2010
		(in thousands)
Net cash provided by operating activities		$	3,279		$	3,597
Net cash used in investing activities		(12,113		)	(18,860		)
Net cash provided by financing activities		96,899			14,883

 

Cash Flows Provided By Operating Activities

 

Net cash provided by operating activities during the six months ended February 28, 2011 of $3.3 million was primarily attributable to: (i) our net income of $2.7 million and aggregate non-cash charges of $4.5 million, which primarily included depreciation and amortization expenses of $3.0 million; (ii) offset in part by net growth in operating assets and liabilities during the period of $3.8 million, which primarily included an increase in inventory of $2.9 million as a result of a build-up in inventories, an increase in net accounts receivable of $2.3 million as a result of a longer credit terms extended to our customers, offset in part by an increase in accounts payable of $1.4 million.

 

Net cash provided by operating activities during the six months ended February 28, 2010 of $3.6 million was primarily attributable to: (i) our net income of $2.3 million and aggregate non-cash charges of $2.2 million, which primarily included depreciation and amortization expenses; (ii) offset in part by net growth in operating assets and liabilities during the period of $0.9 million, which included a large increase in accounts receivable of $3.3 as a result of increased sales, offset in part by an increase in accrued liabilities and accounts payable of $1.2 million and $1.0 million, respectively.

 

Cash Flows Used in Investing Activities

 

Net cash used in investing activities during the six months ended February 28, 2011 was $12.1 million, consisting primarily of the purchases of buildings and purchases of machinery and

 

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equipment in an amount of $11.6 million, and our investment in an unaffiliated company of $0.3 million.

 

Net cash used in investing activities during the six months ended February 28, 2010 was $18.9 million, consisting primarily of our investments in China SemiLEDs and two other joint venture entities in the aggregate amount of $15.5 million, and the purchases of machinery and equipment of $3.2 million.

 

Cash Flows Provided by Financing Activities

 

Net cash provided by financing activities during the six months ended February 28, 2011 was $96.9 million, consisting primarily of net proceeds from the issuance of common stock of $92.7 million, proceeds from the issuance of long-term debt of $2.9 million, proceeds from the draw down on lines of credit of $2.8 million, offset in part by payments of lines of credit and long-term debt of $1.2 million and $0.4 million, respectively.

 

Net cash provided by financing activities during the six months ended February 28, 2010 was $14.9 million, consisting primarily of proceeds from the issuance of Series E convertible preferred stock of $15.0 million, proceeds from the draw down on lines of credit of $0.4 million, offset in part by payments on lines of credits and long-term debt of $0.4 million and $0.2 million, respectively.

 

Contractual Obligations

 

The following table sets forth our contractual obligations as of August 31, 2010:

 

		Payment Due In
		Less than 1 year			1-3 years			3-5 years			More than 5 years			Total
		(in thousands)
Operating lease agreements		$	671		$	1,355		$	1,505		$	1,020		$	4,551
Long-term debt, including current portion		1,752			1,459			1,109			1,218			5,538
Purchase obligations for property, plant and equipment		6,919			—			—			—			6,919
Total contractual obligations		$	9,342		$	2,814		$	2,614		$	2,238		$	17,008

 

As of February 28, 2011, our total purchase obligations for property, plant and equipment were $3.7 million.  In addition, during the six months ended February 28, 2011, we incurred additional long-term debt of $2.9 million and drew down another $2.8 million from lines of credit, and also made regular payments on our long-term debt and lines of credit of $1.5 million.

 

Subsequent to August 31, 2010, we entered into an agreement to purchase the first and second floors of a building at our Hsinchu, Taiwan headquarters for approximately $3.9 million.  The purchase of the first and second floors was approved by the Science Park Administration on October 13, 2010 and we obtained title to such property on November 17, 2010.  Following such transfer of title, our operating lease for the first floor was automatically terminated on November 17, 2010 and we now own the entire building.  We incurred additional long-term debt by entering into the fourth note payable agreement for the acquisition of the building in December 2010.

 

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Capital Expenditures

 

We had capital expenditures of $3.2 million and $11.6 million during the six months ended February 28, 2010 and 2011, respectively. Our capital expenditures consisted primarily of purchases of building, machinery and equipment, construction in progress, prepayments for our manufacturing facilities and prepayments for equipment purchases. We expect to continue investing in capital expenditures in the future as we expand our business operations and prudently invest in the coordinated expansion of our production capacity.

 

Off-Balance Sheet Arrangements

 

As of February 28, 2011, we did not engage in any off-balance sheet arrangements. We do not have any interest in entities referred to as variable interest entities.

 

Accounting Changes and Recent Accounting Pronouncements

 

For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, on our unaudited consolidated condensed financial statements, see “Note 2” in the Notes to Condensed Consolidated Financial Statements (unaudited) of this Quarterly Report on Form 10-Q.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

We are exposed to market risks in the ordinary course of our business. These risks include primarily:

 

Interest Rate Risk

 

We had cash and cash equivalents of $102.6 million as of February 28, 2011 which are invested in demand deposits and liquid investments with original maturities of three months or less. Such interest-earning instruments carry a degree of interest rate risk. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. We have not been exposed nor do we anticipate being exposed to material risks due to changes in interest rates. A hypothetical 10% change in interest rates during the six months ended February 28, 2011 would not have had a material impact on our consolidated financial position, results of operations, or cash flows.

 

We had long-term debt of $10.2 million as of February 28, 2011 consisting of notes payable of $7.4 million and lines of credit of $2.8 million. Only the notes payable carry variable interest rates and these interest rates, which ranged between 1.6% to 2.0% as of February 28, 2011, are based on annual time deposit notes plus a specific spread. A hypothetical 10% change in the note payable interest rates during the six months ended February 28, 2011 would not have had a material impact on our consolidated financial position, results of operations, or cash flows.

 

Foreign Currency Exchange Rate Risk

 

A portion of our revenues and expenses are currently transacted by our non-U.S. subsidiaries in currencies other than their functional currencies, which are mostly in U.S. dollars and to a lesser extent in Japanese Yen. Therefore, our exposure to foreign exchange risk primarily relates to currency gains and losses from the time we enter into and settle our sales and purchase transactions. Accordingly, we are subject to foreign currency related risks and incur foreign

 

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