SemiLEDs Corp - Quarter Report: 2015 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, 2015

 

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 x  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: 28,452,993 shares of common stock, par value $0.0000056 per share, outstanding as of April 7, 2015.

 

 

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SEMILEDS CORPORATION

FORM 10-Q for the Quarter Ended February 28, 2015

 

INDEX

 

		Page No.
Part I. Financial Information
Item 1.	Financial Statements	1
	Unaudited Condensed Consolidated Balance Sheets as of February 28, 2015 and August 31, 2014	1
	Unaudited Condensed Consolidated Statements of Operations for the three and six months ended February 28, 2015 and 2014	2
	Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended February 28, 2015 and 2014	3
	Unaudited Condensed Consolidated Statement of Changes in Equity for the six months ended February 28, 2015	4
	Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended February 28, 2015 and 2014	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	29
Part II. Other Information
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3.	Defaults Upon Senior Securities	32
Item 4.	Mine Safety Disclosures	32
Item 5.	Other Information	32
Item 6.	Exhibits	32
Signatures		33
Index to Exhibits		34

 

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PART I — FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

SEMILEDS CORPORATION AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets

(In thousands of U.S. dollars and shares, except par value)

 

		February 28, 2015			August 31, 2014
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	6,734		$	12,649
Accounts receivable, net of allowance for doubtful accounts of $1,304 and $1,369 as of February 28, 2015 and August 31, 2014, respectively		2,852			2,130
Accounts receivable from related parties, net of allowance for doubtful accounts of $1,344 and $1,397 as of February 28, 2015 and August 31, 2014, respectively		55			41
Inventories		7,519			9,212
Prepaid expenses and other current assets		1,375			1,909
Total current assets		18,535			25,941
Property, plant and equipment, net		23,866			27,063
Intangible assets, net		1,492			1,586
Goodwill		56			59
Investments in unconsolidated entities		2,074			2,204
Other assets		487			764
TOTAL ASSETS		$	46,510		$	57,617
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Current installments of long-term debt		$	1,695		$	1,934
Accounts payable		2,294			2,675
Accrued expenses and other current liabilities		3,430			4,860
Total current liabilities		7,419			9,469
Long-term debt, excluding current installments		3,295			4,256
Total liabilities		10,714			13,725
Commitments and contingencies (Note 5)
EQUITY:
SemiLEDs stockholders’ equity
Common stock, $0.0000056 par value—75,000 shares authorized; 28,453 shares and 28,424 shares issued and outstanding as of February 28, 2015 and August 31, 2014, respectively		—			—
Additional paid-in capital		171,653			170,953
Accumulated other comprehensive income		3,936			5,583
Accumulated deficit		(139,863		)	(132,630		)
Total SemiLEDs stockholders’ equity		35,726			43,906
Noncontrolling interests		70			(14		)
Total equity		35,796			43,892
TOTAL LIABILITIES AND EQUITY		$	46,510		$	57,617

 

See notes to unaudited condensed consolidated financial statements.

 

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SEMILEDS CORPORATION AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Operations

(In thousands of U.S. dollars and shares, except per share data)

 

		Three Months Ended February  28,						Six  Months Ended  February  28,
		2015			2014			2015			2014
Revenues, net		$	4,566		$	4,171		$	7,494		$	7,588
Cost of revenues		5,217			7,308			9,688			13,062
Gross loss		(651		)	(3,137		)	(2,194		)	(5,474		)
Operating expenses:
Research and development		612			1,219			1,360			2,345
Selling, general and administrative		1,876			2,263			4,027			4,907
Gain on disposal of long-lived assets, net		(287		)	—			(287		)	—
Total operating expenses		2,201			3,482			5,100			7,252
Loss from operations		(2,852		)	(6,619		)	(7,294		)	(12,726		)
Other income (expenses):
Equity in losses from unconsolidated entities, net		(21		)	(67		)	(56		)	(130		)
Interest expenses, net		(24		)	(1		)	(48		)	(38		)
Other income, net		29			52			59			106
Foreign currency transaction gain (loss), net		(36		)	207			64			10
Total other income (expenses), net		(52		)	191			19			(52		)
Loss before income taxes		(2,904		)	(6,428		)	(7,275		)	(12,778		)
Income tax expense		1			—			1			—
Net loss		(2,905		)	(6,428		)	(7,276		)	(12,778		)
Less: Net loss attributable to noncontrolling interests		(3		)	(19		)	(43		)	(77		)
Net loss attributable to SemiLEDs stockholders		$	(2,902	)	$	(6,409	)	$	(7,233	)	$	(12,701	)
Net loss per share attributable to SemiLEDs stockholders:
Basic and diluted		$	(0.10	)	$	(0.23	)	$	(0.25	)	$	(0.46	)
Shares used in computing net loss per share attributable to SemiLEDs stockholders:
Basic and diluted		28,483			27,882			28,465			27,833

 

See notes to unaudited condensed consolidated financial statements.

 

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SEMILEDS CORPORATION AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Comprehensive Loss

(In thousands of U.S. dollars)

 

		Three Months Ended February 28,						Six Months Ended February 28,
		2015			2014			2015			2014
Net loss		$	(2,905	)	$	(6,428	)	$	(7,276	)	$	(12,778	)
Other comprehensive loss, net of tax:
Foreign currency translation adjustments, net of tax of $0 for all periods presented		(489		)	(1,006		)	(1,645		)	(485		)
Comprehensive loss		$	(3,394	)	$	(7,434	)	$	(8,921	)	$	(13,263	)
Comprehensive loss attributable to noncontrolling interests		$	(2	)	$	(20	)	$	(41	)	$	(75	)
Comprehensive loss attributable to SemiLEDs stockholders		$	(3,392	)	$	(7,414	)	$	(8,880	)	$	(13,188	)

 

See notes to unaudited condensed consolidated financial statements.

 

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SEMILEDS CORPORATION AND SUBSIDIARIES

Unaudited Condensed Consolidated Statement of Changes in Equity

(In thousands of U.S. dollars and shares)

 

		Common Stock					Additional Paid-in			Accumulated Other Comprehensive			Accumulated			Total SemiLEDs Stockholders’			Non-Controlling			Total
		Shares		Amount			Capital			Income			Deficit			Equity			Interests			Equity
BALANCE—September 1, 2014		28,424		$	—		$	170,953		$	5,583		$	(132,630	)	$	43,906		$	(14	)	$	43,892
Issuance of common stock under equity incentive plans		29		—			—			—			—			—			—			—
Stock-based compensation		—		—			825			—			—			825			—			825
Purchase of common shares in Ning Xiang		—		—			(125		)	—			—			(125		)	125			—
Comprehensive income (loss):
Foreign currency translation adjustment		—		—			—			(1,647		)	—			(1,647		)	2			(1,645		)
Net loss		—		—			—			—			(7,233		)	(7,233		)	(43		)	(7,276		)
BALANCE—February 28, 2015		28,453		$	—		$	171,653		$	3,936		$	(139,863	)	$	35,726		$	70		$	35,796

 

See notes to unaudited condensed consolidated financial statements.

 

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SEMILEDS CORPORATION AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(In thousands of U.S. dollars)

 

		Six Months Ended February 28,
		2015			2014
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(7,276	)	$	(12,778	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,509			3,129
Stock-based compensation expense		825			1,048
Bad debt expense		—			49
Provisions for inventory write-downs		386			737
Equity in losses from unconsolidated entities, net		56			130
Gain on disposal of long-lived assets, net		(287		)	—
Income recognized on patents assignment		—			(26		)
Changes in operating assets and liabilities:
Accounts receivable, net		(851		)	(365		)
Inventories		943			(1,182		)
Prepaid expenses and other		291			(821		)
Accounts payable		(294		)	529
Accrued expenses and other current liabilities		(334		)	(81		)
Net cash used in operating activities		(4,032		)	(9,631		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(1,024		)	(1,411		)
Purchase of investments		—			(76		)
Payments related to acquisition of business		—			(2,069		)
Payments for development of intangible assets		(27		)	(126		)
Decrease (increase) in restricted cash		347			(97		)
Other investing activities, net		8			(83		)
Net cash used in investing activities		(696		)	(3,862		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt		(918		)	(1,115		)
Proceeds from line of credit		—			170
Payments on line of credit		—			(170		)
Payment of loan from related party		—			(101		)
Other financing activities		—			3
Net cash used in financing activities		(918		)	(1,213		)
Effect of exchange rate changes on cash and cash equivalents		(269		)	(55		)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(5,915		)	(14,761		)
CASH AND CASH EQUIVALENTS—Beginning of period		12,649			36,272
CASH AND CASH EQUIVALENTS—End of period		$	6,734		$	21,511
NONCASH INVESTING AND FINANCING ACTIVITIES:
Accrual related to property, plant and equipment		$	788		$	350
Proceeds from sale of property, plant and equipment included in other current liabilities		$	884		$	—

 

See notes to unaudited condensed consolidated financial statements.

 

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SEMILEDS CORPORATION AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

 

1. Business

 

SemiLEDs Corporation (“SemiLEDs” or the “parent company”) was incorporated in Delaware on January 4, 2005 and is a holding company for various wholly and majority owned subsidiaries. SemiLEDs and its subsidiaries (collectively, the “Company”) develop, manufacture and sell high performance light emitting diodes (“LEDs”). The Company’s core products are LED chips and LED components, but lighting products have also become an increasingly important part of the Company’s business. A portion of the Company’s business consists of the sale of contract manufactured LED products. The Company’s customers are concentrated in a few select markets, including Taiwan, the United States and China.

 

As of February 28, 2015, SemiLEDs had eight wholly owned subsidiaries and a 93% equity interest in Ning Xiang Technology Co., Ltd. (“Ning Xiang”). The most significant of these consolidated subsidiaries is SemiLEDs Optoelectronics Co., Ltd. (“Taiwan SemiLEDs”) located in Hsinchu, Taiwan where a substantial portion of research, development, manufacturing, marketing and sales activities currently take place and where a substantial portion of the assets are held and located. Taiwan SemiLEDs owns a 100% equity interest in Taiwan Bandaoti Zhaoming Co., Ltd., formerly known as Silicon Base Development, Inc., which is engaged in the research, development, manufacture, marketing and sale of LED components. As of February 28, 2015, the Company also owned a 93% interest in Ning Xiang, which consisted of a 51% interest acquired in August 2011, an additional 15% interest acquired in April 2013, an additional 21% interest acquired in November 2013 and an additional 6% interest acquired in December 2014. Ning Xiang is engaged in the design, manufacture and sale of lighting fixtures and systems.

 

SemiLEDs’ common shares are listed on the NASDAQ Global Select Market under the symbol “LEDS” since December 8, 2010.

 

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 (“U.S. GAAP”) and applicable provisions of the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted as permitted by the rules and regulations of the SEC. 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 Annual Report on Form 10-K filed with the SEC on December 12, 2014. The unaudited condensed consolidated balance sheet as of August 31, 2014 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 consolidated balance sheet as of February 28, 2015, the statements of operations and comprehensive loss for the three and six months ended February 28, 2015 and 2014, the statement of changes in equity for the six months ended February 28, 2015, and the statements of cash flows for the six months ended February 28, 2015 and 2014. The results for the three or six months ended February 28, 2015 are not necessarily indicative of the results to be expected for the year ending August 31, 2015.

 

The accompanying unaudited interim condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The realization of assets and the satisfaction of liabilities in the normal course of business are dependent on, among other things, the Company’s ability to operate profitably, to generate cash flows from operations, and to pursue financing arrangements to support its working capital requirements.

 

The Company has suffered losses from operations of $24.8 million and $42.7 million, gross losses on product sales of $11.3 million and $14.7 million, and net cash used in operating activities of $15.7 million and $14.5 million for the years ended August 31, 2014 and 2013, respectively. Loss from operations for the three and six months ended February 28, 2015 were $2.9 million and $7.3 million, respectively. Gross loss on product sales for the three and six months ended February 28, 2015 were $0.7 million and $2.2 million, respectively. Net cash used in operating activities for the six months ended February 28, 2015 was $4.0 million. Further, at February 28, 2015, the Company’s cash and cash equivalents is down to $6.7 million. These facts and conditions raise initial substantial doubt about the Company’s ability to continue as a going concern. However, management believes that it has developed a liquidity plan, as summarized below, that, if executed successfully, should provide sufficient liquidity to meet the Company’s obligations as they become due for a reasonable period of time, and allow the development of its core business.

 

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·                                Raise approximately $5 million cash through the private placement of additional common shares of the Company to an investor (See Note 9).

 

·                                Improve operating cash flows through cost reductions and the sales of new higher margin products. Management has implemented cost reductions that include the closing and relocation of the manufacturing operations at the Company’s Sinwu facility, the consolidation of the Company’s facilities, and workforce reductions, and executives taking a salary reduction until the Company returns to profitability. The commercial sales of its UV LED product with a leading cosmetic manufacturer, which started in its fiscal second quarter of 2015, have improved the Company’s gross margin, operating results and cash flows.

 

·                                Reduce planned capital expenditures and reduce research and development expenditure expenses. Management continues to monitor prices and, consistent with its existing contractual commitments, may decrease its activity level and capital expenditures further. This plan reflects its strategy of controlling capital costs and maintaining financial flexibility.

 

·                                Utilize the Company’s available line of credit if necessary.

 

·                                Raise additional cash through further equity offerings, sales of assets and/or issuance of debt as considered necessary.

 

While the Company’s management believes that the measures described in the above liquidity plan will be adequate to satisfy its liquidity requirements for the twelve months ending February 29, 2016, there is no assurance that the liquidity plan will be successfully implemented. Failure to successfully implement the liquidity plan may have a material adverse effect on its business, results of operations and financial position, and may adversely affect its ability to continue as a going concern. These unaudited interim condensed consolidated financial statements do not include any adjustments related to the recoverability and classification of recorded assets or the amounts and classification of liabilities or any other adjustments that might be necessary should the Company be unable to continue as a going concern.

 

Principles of Consolidation—The unaudited interim condensed consolidated financial statements include the accounts of SemiLEDs and its consolidated subsidiaries. All intercompany transactions and balances have been eliminated during consolidation.

 

Use of Estimates—The preparation of unaudited interim condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited interim condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include the collectibility of accounts receivable, inventory net realizable values, realization of deferred tax assets, valuation of stock-based compensation expense, the useful lives of property, plant and equipment and intangible assets, the recoverability of the carrying amount of property, plant and equipment, intangible assets, goodwill and investments in unconsolidated entities, the fair value of acquired tangible and intangible assets, income tax uncertainties, provision for potential litigation costs and other contingencies. Management bases its estimates on historical experience and also on assumptions that it believes are reasonable. Management assesses these estimates on a regular basis; however, actual results could differ materially from those estimates.

 

Certain Significant Risks and Uncertainties—The Company is subject to certain risks and uncertainties that could have a material and adverse effect on the Company’s future financial position or results of operations, which risks and uncertainties include, among others: it has incurred significant losses over the past few years, any inability of the Company to compete in a rapidly evolving market and to respond quickly and effectively to changing market requirements, any inability of the Company to grow its revenue and/or maintain or increase its margins, it may experience fluctuations in its revenues and operating results, any inability of the Company to protect its intellectual property rights, claims by others that the Company infringes their proprietary technology, and any inability of the Company to raise additional funds in the future.

 

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 and some of the Company’s products are produced by a limited number of contract manufacturers. The loss of any of these suppliers and contract manufacturers may cause the Company to incur transition costs to another supplier or contract manufacturer, result in delays in the manufacturing and delivery of the Company’s products, or cause it to carry excess or obsolete inventory. The Company relies on a limited number of such suppliers and contract manufacturers for the fulfillment of its customer orders. Any failure of such suppliers and contract manufacturers to perform could have an adverse effect upon the Company’s reputation and its ability to distribute its products or satisfy customers’ orders, which could adversely affect the Company’s business, financial position, results of operations and cash flows.

 

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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 in demand deposits with prominent banks of high credit quality and invests only in money market funds. Deposits held with banks may exceed the amount of insurance provided on such deposits. As of February 28, 2015 and August 31, 2014, cash and cash equivalents of the Company consisted of the following (in thousands):

 

Cash and Cash Equivalents by Location		February 28, 2015			August 31, 2014
United States:
Denominated in U.S. dollars		$	2,513		$	7,838
Taiwan:
Denominated in U.S. dollars		2,493			2,909
Denominated in New Taiwan dollars		801			834
Denominated in other currencies		296			300
China (including Hong Kong):
Denominated in U.S. dollars		262			262
Denominated in Renminbi		368			505
Denominated in H.K. dollars		1			1
Total cash and cash equivalents		$	6,734		$	12,649

 

The Company’s revenues are substantially derived from the 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 a few select markets. Management performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. Management evaluates the need to establish an allowance for doubtful accounts for estimated potential credit losses at each reporting period. The allowance for doubtful accounts is based on the management’s assessment of the collectibility of its customer accounts. Management 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.

 

Net revenues generated from sales to the top ten customers represented 79% and 66% of the Company’s total net revenues for the three and six months ended February 28, 2015, respectively, and 60% and 49% of the Company’s net revenues for the three and six months ended February 28, 2014, respectively.

 

The Company’s revenues have been concentrated in a few select markets, including Taiwan, the United States, and China (including Hong Kong). Net revenues generated from sales to customers in these markets, in the aggregate, accounted for 87% and 85% of the Company’s net revenues for the three and six months ended February 28, 2015, respectively, and 40% and 49% of the Company’s net revenues for the three and six months ended February 28, 2014, respectively.

 

Noncontrolling Interests—Noncontrolling interests are classified in the consolidated statements of operations as part of consolidated net income (loss) and the accumulated amount of noncontrolling interests in the consolidated balance sheets as part of equity. Changes in ownership interest in a consolidated subsidiary that do not result in a loss of control are accounted for as an equity transaction. If a change in ownership of a consolidated subsidiary results in loss of control and deconsolidation, any retained ownership interests are remeasured with the gain or loss reported in net earnings.

 

Transactions with noncontrolling interests had the following effect on equity attributable to SemiLEDs stockholders (in thousands):

 

		Three Months Ended February 28, 2015			Six Months Ended February 28, 2015
Net loss attributable to SemiLEDs stockholders		$	(2,902	)	$	(7,233	)
Transfers to noncontrolling interests:
Decrease in SemiLEDs additional paid in capital for purchase of common shares in Ning Xiang		(125		)	(125		)
Change from net loss attributable to SemiLEDs stockholders and transfer to noncontrolling interests		$	(3,027	)	$	(7,358	)

 

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Recent Accounting Pronouncements

 

On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on September 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. Management is evaluating the effect that ASU 2014-09 will have on the Company’s consolidated financial statements and related disclosures. Management has not yet selected a transition method nor has it determined the effect of the standard on the Company’s ongoing financial reporting.

 

In June 2014, the FASB issued ASU No. 2014-12 “Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period.  The Update requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.  Earlier adoption is permitted. The new standard is effective for the Company on September 1, 2016. Management has not yet selected a transition method nor has it determined the effect of the standard on the Company’s financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15 “Presentation of Financial Statements— Going Concern (Subtopic 205-40) (Topic 718): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”.  The Update provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes.  This Update is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures.  The Update is effective for the Company on September 1, 2017 and management has elected not to early adopt it.  When the Update is effective, it could have a material effect on management’s assessment of the Company’s ability to continue as a going concern.

 

3. Balance Sheet Components

 

Inventories

 

Inventories as of February 28, 2015 and August 31, 2014 consisted of the following (in thousands):

 

		February 28, 2015			August 31, 2014
Raw materials		$	1,758		$	2,792
Work in process		1,158			1,420
Finished goods		4,603			5,000
Total		$	7,519		$	9,212

 

Inventory write-downs to estimated net realizable values were $158 thousand and $386 thousand for the three and six months ended February 28, 2015, respectively, and $550 thousand and $737 thousand for the three and six months ended February 28, 2014, respectively.

 

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Property, Plant and Equipment

 

Property, plant and equipment as of February 28, 2015 and August 31, 2014 consisted of the following (in thousands):

 

		February 28, 2015			August 31, 2014
Buildings and improvements		$	13,824		$	14,518
Machinery and equipment		61,004			68,038
Leasehold improvements		2,774			2,914
Other equipment		3,883			2,652
Construction in progress		1,947			2,395
Total property, plant and equipment		83,432			90,517
Less: Accumulated depreciation, amortization and impairment		(59,566		)	(63,454		)
Property, plant and equipment, net		$	23,866		$	27,063

 

Intangible Assets

 

Intangible assets as of February 28, 2015 and August 31, 2014 consisted of the following (in thousands):

 

		February 28, 2015
		Weighted Average Amortization Period (Years)		Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount
Patents and trademarks		14		$	1,426		$	294		$	1,132
Acquired technology		5		685			325			360
Total				$	2,111		$	619		$	1,492

 

		August 31, 2014
		Weighted Average Amortization Period (Years)		Gross Carrying Amount			Accumulated Amortization and Impairment			Net Carrying Amount
Patents and trademarks		14		$	1,411		$	257		$	1,154
Acquired technology		5		719			287			432
Total				$	2,130		$	544		$	1,586

 

Goodwill

 

In July 2013, the Company recognized goodwill on the acquisition of an LED production business. All of the goodwill was assigned to the Company’s reporting unit associated with the manufacture and sale of LED chips and LED components.

 

4. Investments in Unconsolidated Entities

 

The Company’s ownership interest and carrying amounts of investments in unconsolidated entities as of February 28, 2015 and August 31, 2014 consisted of the following (in thousands, except percentages):

 

		February 28, 2015					August 31, 2014
		Percentage Ownership		Amount			Percentage Ownership		Amount
Equity method investments:
SILQ (Malaysia) Sdn. Bhd. (“SILQ”).		33	%	$	148		33	%	$	217
Xurui Guangdian Co., Ltd. (“China SemiLEDs”)		49	%	—			49	%	—
Cost method investments		Various		1,926			Various		1,987
Total investments in unconsolidated entities				$	2,074				$	2,204

 

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There were no dividends received from unconsolidated entities through February 28, 2015.

 

Equity Method Investments

 

As of February 28, 2015, the Company owned a 33% interest in SILQ (Malaysia) Sdn. Bhd., or SILQ, a joint venture in Malaysia which is engaged in the design, manufacture and sale of lighting fixtures and systems. Originally, the Company and the other investor each owned a 50% equity interest in the joint venture. In January 2014, the Company participated in SILQ’s capital increase and contributed $76 thousand. Following the capital increase, the Company’s equity interest in SILQ was diluted from 50% to 49%, and consequently, the Company recognized a gain on dilution of its investment of $26 thousand. The dilution gain was recognized as additional paid in capital in the consolidated statement of changes in equity. In April 2014, the Company sold part of its equity interest in SILQ to the other investor for a cash consideration of $114 thousand and recognized a gain on sale of investment of $37 thousand. The gain was reported in the consolidated statements of operations in equity in losses from unconsolidated entities. Upon consummation of the sale, the Company’s equity interest in SILQ was reduced from 49% to 33%. The Company subsequently invested $130 thousand in SILQ’s capital increase and its equity interest remains unchanged.

 

Cost Method Investments

 

The fair values of the Company’s cost method investments are not readily available. All cost method investments are assessed for impairment when events or changes in circumstances indicate that the carrying amounts may not be recoverable.

 

5. Commitments and Contingencies

 

Operating Lease Agreements—The Company has several operating leases with unrelated parties, primarily for land, plant and office spaces in Taiwan, which are including cancellable and noncancellable and which expire at various dates between January 2016 and December 2020. Lease expense related to these noncancellable operating leases was $145 thousand and $308 thousand for the three and six months ended February 28, 2015, respectively, and $299 thousand and $582  thousand for the three and six months ended February 28, 2014, respectively. 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, 2015 consisted of the following (in thousands):

 

Years Ending August 31,		Operating Leases
Remainder of 2015		$	250
2016		417
2017		421
2018		260
2019		89
Thereafter		119
Total		$	1,556

 

Purchase Obligations—The Company had purchase commitments for inventory, property, plant and equipment in the amount of $3.1 million and $3.9 million as of February 28, 2015 and August 31, 2014, respectively.

 

Litigation—The Company is directly or indirectly involved from time to time in various claims or legal proceedings arising in the ordinary course of business. The Company recognizes a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. There is significant judgment required in assessing both the likelihood of an unfavorable outcome and whether the amount of loss, if any, can be reasonably estimated. As of February 28, 2015, there was no pending or threatened litigation that could have a material impact on the Company’s financial position, results of operations or cash flows.

 

6. Stock-based Compensation

 

The Company currently has one equity incentive plan (the “2010 Plan”), which 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. In April 2014, SemiLEDs’ stockholders approved an amendment to the 2010 Plan that increased the number of shares authorized for issuance under the plan by an additional 2,500 thousand shares. Prior to SemiLEDs’ initial public offering, the Company had another stock-based compensation plan (the “2005 Plan”), but awards are made from the 2010 Plan after the initial public offering. Options outstanding under the 2005 Plan continue to be governed by its existing terms.

 

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A total of 6,349 thousand shares of common stock was reserved for issuance under the 2005 Plan and 2010 Plan as of both February 28, 2015 and August 31, 2014. There were 4,174 thousand and 4,492 thousand shares of common stock available for future issuance under the 2005 Plan and 2010 Plan under the equity incentive plans as of February 28, 2015 and August 31, 2014, respectively.

 

In January 2015, SemiLEDs granted 50 thousand restricted stock units that vest over four years at a rate of 25% on each anniversary of the vesting start date of January 9, 2015, subject to earlier expiration in the event of the holder’s termination. The grant-date fair value of the restricted stock units was $1.07 per unit.

 

In April 2014, SemiLEDs granted 75 thousand restricted stock units to its directors that vest 100% on the earlier of the first anniversary of the vesting start date of April 21, 2014 and the date of the next annual meeting. The grant-date fair value of the restricted stock units was $1.05 per unit.

 

In May 2014, SemiLEDs granted 410 thousand restricted stock units that vest over four years at a rate of 25% on each anniversary of the vesting start date of May 9, 2014, and 122 thousand restricted stock units that vest 100% on May 9, 2015, subject to earlier expiration in the event of the holder’s termination. SemiLEDs also granted 366 thousand performance-based restricted stock units that vest upon the attainment of certain performance targets in the fiscal years ending August 31, 2015, 2016 or 2017. The grant-date fair value of these restricted stock units was $1.01 per unit.

 

The grant date fair value of stock options is determined using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires inputs including the market price of SemiLEDs’ common stock on the date of grant, the term that the stock options are expected to be outstanding, the implied stock volatilities of several of the Company’s publicly-traded peers over the expected term of stock options, risk-free interest rate and expected dividend. Each of these inputs is subjective and generally requires significant judgment to determine. The grant date fair value of stock units is based upon the market price of SemiLEDs’ common stock on the date of the grant. This fair value is amortized to compensation expense over the vesting term.

 

Stock-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. A forfeiture rate of zero is estimated for stock-based awards with vesting term that is less than or equal to one year from the date of grant.

 

A summary of the stock-based compensation expense for the three and six months ended February 28, 2015 and 2014 was as follows (in thousands):

 

		Three Months Ended February 28,						Six Months Ended February 28,
		2015			2014			2015			2014
Cost of revenues		$	93		$	195		$	215		$	390
Research and development		48			111			111			222
Selling, general and administrative		237			209			499			436
		$	378		$	515		$	825		$	1,048

 

7. Net Loss Per Share of Common Stock

 

The following stock-based compensation plan awards were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been anti-dilutive (in thousands of shares):

 

		Three Months Ended February 28,				Six Months Ended February 28,
		2015		2014		2015		2014
Stock units and stock options to purchase common stock		286		645		316		709

 

8. Income Taxes

 

The Company’s loss before income taxes for the three and six months ended February 28, 2015 and 2014 consisted of the following (in thousands):

 

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		Three Months Ended February 28,						Six Months Ended February 28,
		2015			2014			2015			2014
U.S. operations		$	(192	)	$	(425	)	$	(503	)	(988	)
Foreign operations		(2,712		)	(6,003		)	(6,772		)	(11,790	)
Loss before income taxes		$	(2,904	)	$	(6,428	)	$	(7,275	)	(12,778	)

 

Unrecognized Tax Benefits

 

As of both February 28, 2015 and August 31, 2014, the Company had no unrecognized tax benefits related to tax positions taken in prior periods. The Company files income tax returns in the United States, various U.S. states and certain foreign jurisdictions. The tax years 2005 through 2014 remain open in most jurisdictions. The Company is not currently under examination by income tax authorities in federal, state or foreign jurisdictions.

 

9. Subsequent Events

 

On March 9, 2015, the Company received the first payment of one million Renminbi (approximately $161 thousand) from Mr. Xiaoqing Han, the Chairman and CEO of Beijing Xiaoqing Environmental Protection Group in the Company’s Shenzen branch’s bank account in China and subsequently received $100 thousand in its bank account in the United States in regard to the Common Stock Purchase Agreement effective December 18, 2014, by and between SemiLEDs Corporation and Mr. Xiaoqing Han.

 

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

 

Forward Looking Statements

 

This Quarterly Report on Form 10-Q, or this Quarterly Report, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All statements other than statements of historical facts contained in this Quarterly Report, including statements regarding the future results of operations of SemiLEDs Corporation, or “we,” “our” or the “Company,” and financial position, strategy and plans, and our expectations for future operations, are forward-looking statements. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. The words “believe,” “may,” “should,” “plan,” “potential,” “project,” “will,” “estimate,” “continue,” “anticipate,” “design,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, and actual results and the timing of certain events could differ materially and adversely from those anticipated or implied in the forward-looking statements as a result of many factors. These factors include, among other things,

 

·                                Declining cash position.

 

·                                Our ability to reduce our net losses and to restore our operations to profitability.

 

·                                Our ability to complete the pending sale of $5 million of common stock or, alternatively, collect the $3 million liquidated damages.

 

·                                Our ability to successfully introduce new products that we can produce and that customers will purchase in such amounts as to be sufficiently profitable to cover the costs of developing and producing these products, as well as providing us additional net income from operations.

 

·                                Our ability to improve our liquidity and access alternative sources of funding.

 

·                                Our ability to effectively develop, maintain and expand our sales and distribution channels, especially in the niche LED markets, including the UV LED and architectural lighting that we focus on.

 

·                                Our ability to successfully manage our operations in the face of the cyclicality, rapid technological change, rapid product obsolescence, declining average selling prices and wide fluctuations in supply and demand typically found in the LED market.

 

·                                Competitive pressures from existing and new companies.

 

·                                Our ability to grow our revenues generated from the sales of our products and to control our expenses.

 

·                                Our ability to implement our cost reduction programs effectively.

 

·                                Loss of any of our key personnel, or our failure to attract, assimilate and retain other highly qualified personnel.

 

·                                Intellectual property infringement or misappropriation claims by third parties against us or our customers, including our distributor customers.

 

·                                The failure of LEDs to achieve widespread adoption in the general lighting market, or if alternative technologies gain market acceptance.

 

·                                Our ability to improve our gross margins.

 

·                                The loss of key suppliers or contract manufacturers.

 

·                                The inability of contract manufacturers to produce products that satisfy our requirements.

 

·                                Our ability to effectively expand or upgrade our production facilities or do so in a timely or cost-effective manner.

 

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·                                Difficulty in managing our future growth or in responding to a need to contract operations, and the associated changes to our operations.

 

·                                Adverse development in those selected markets, including Taiwan, the United States and China, where our revenues are concentrated.

 

·                                Our ability to develop and execute upon a new strategy to exploit the China market.

 

·                                The reduction or elimination of government investment in LED lighting or the elimination of, or changes in, policies in certain countries that encourage the use of LEDs over some traditional lighting technologies.

 

·                                Our ability to cost-effectively produce LED chips using larger wafer sizes.

 

·                                Our ability to implement our product innovation strategy effectively, particularly in view of the prohibition against our (and/or our assisting others in) making, using, importing, selling and/or offering to sell in the United States our accused products and/or any device that includes an accused product after October 1, 2012 as a result of the injunction agreed to in connection with the Cree Inc., or Cree, litigation.

 

·                                Loss of customers.

 

·                                Failure of our strategy of marketing and selling our products in jurisdictions with limited intellectual property enforcement regimes.

 

·                                Lack of marketing and distribution success by our third-party distributors.

 

·                                Our customers’ ability to produce and sell products incorporating our LED products.

 

·                                Our failure to adequately prevent disclosure of trade secrets and other proprietary information.

 

·                                Ineffectiveness of our disclosure controls and procedures and our internal control over financial reporting.

 

·                                Our ability to profit from existing and future joint ventures, investments, acquisitions and other strategic alliances.

 

·                                Impairment of goodwill, long-lived assets or investments.

 

·                                Undetected defects in our products that harm our sales and reputation and adversely affect our manufacturing yields.

 

·                                The availability of adequate and timely supply of electricity and water for our manufacturing facilities.

 

·                                Our ability to comply with existing and future environmental laws and the cost of such compliance.

 

·                                The non-compete provisions between us and Xurui Guangdian Co., Ltd., or China SemiLEDs, constraining our ability to grow in China, or actions by China SemiLEDs or the other shareholders of China SemiLEDs that are detrimental to us.

 

·                                The ability of SemiLEDs Optoelectronics Co., Ltd., or Taiwan SemiLEDs, to make dividends and other payments to us.

 

·                                Our ability to obtain necessary regulatory approvals to make further investments in Taiwan SemiLEDs.

 

·                                Catastrophic events such as fires, earthquakes, floods, tornados, tsunamis, typhoons, pandemics, wars, terrorist activities and other similar events, particularly if these events occur at or near our operations, or the operations of our suppliers, contract manufacturers and customers.

 

·                                The effect of the legal system in the People’s Republic of China, or the PRC.

 

·                                Labor shortages, strikes and other disturbances that affect our operations.

 

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·                                Deterioration in the relations between the PRC and Taiwan governments.

 

·                                Fluctuations in the exchange rate among the U.S. dollar, the New Taiwan, or NT, dollar, the Japanese Yen and other currencies in which our sales, raw materials and component purchases and capital expenditures are denominated.

 

·                                Our ability to obtain additional equity capital or credit when necessary for our operations, the difficulty of which may increase if our common stock is delisted from The NASDAQ Stock Market.

 

·                                The effect of the disclosure requirements under the provisions of the Dodd-Frank Act relating to “conflict minerals,” which could increase our costs and limit the supply of certain metals used in our products and affect our reputation with customers and shareholders.

 

·                                The impact on the trading price of our common stock if we are delisted for failure to meet the NASDAQ continued listing requirements if our stock trades below $1 per share.

 

·                                The costs and other effects of litigation.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We have not assumed any obligation to, and you should not expect us to, update or revise these statements because of new information, future events or otherwise.

 

For more information on the significant risks that could affect the outcome of these forward-looking statements, see Item 1A “Risk Factors” in Part I of our Annual Report on Form 10-K for the fiscal year ended August 31, 2014, or the 2014 Annual Report, and those contained in Part II, Item 1A of this Quarterly Report, and other information provided from time to time in our filings with the Securities and Exchange Commission, or the SEC.

 

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 interim condensed consolidated financial statements and the notes and other information included elsewhere in this Quarterly Report, in our 2014 Annual Report, and in other filings with the SEC.

 

Company Overview

 

We develop, manufacture and sell light emitting diode (LED) chips and LED components. Our products are used primarily for general lighting applications, including street lights and commercial, industrial and residential lighting. Our LED chips may also be used in specialty industrial applications, such as ultraviolet, or UV, curing of polymers, LED light therapy in medical/cosmetic applications, counterfeit detection, LED lighting for horticulture applications, architectural lighting and entertainment lighting.

 

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 vertical LED chips.

 

We sell blue, white, green and UV LED chips to a customer base that is heavily concentrated in a few select markets, including Taiwan, the United States and China (including Hong Kong). We also sell our new “Enhanced Vertical,” or EV, LED product series in blue, white, green and UV. We sell our LED chips to packagers or to distributors, who in turn sell to packagers. In addition, we package a portion of our LED chips into LED components, which we sell to distributors and end-customers in selected markets. Our lighting products customers are primarily original design manufacturers, or ODMs, of lighting products and the end-users of lighting devices. We also contract other manufacturers to produce for our sale certain LED products, and for certain aspects of our product fabrication, assembly and packaging processes, based on our design and technology requirements and under our quality control specifications and final inspection process.

 

We have developed advanced capabilities and proprietary know-how in:

 

·                                reusing sapphire substrate in subsequent production runs;

 

·                                optimizing our epitaxial growth processes to create layers that efficiently convert electrical current into light;

 

·                                employing a copper alloy base manufacturing technology to improve our chip’s thermal and electrical performance;

 

·                                utilizing nanoscale surface engineering to improve usable light extraction; and

 

·                                developing a LED structure that generally consists of multiple epitaxial layers which are vertically-stacked on top of and a copper alloy base.

 

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These technical capabilities enable us to produce LED chips that can provide efficacies of greater than 120 lumens per watt when packaged. We believe these capabilities and know-how should also allow us to reduce our manufacturing costs and our dependence on sapphire, a costly raw material used in the production of sapphire-based LED devices. In addition, we believe our technological know-how and capabilities will help facilitate our migration to larger wafer sizes.

 

We were incorporated in the State of Delaware on January 4, 2005 and sold our first LED chips in November 2005. We are a holding company for various wholly and majority owned subsidiaries. Our most significant subsidiary is our wholly owned operating subsidiary, SemiLEDs Optoelectronics Co., Ltd., or Taiwan SemiLEDs, where a substantial portion of our assets are held and located, where a substantial portion of our research, development, manufacturing, marketing and sales activities take place, and where most of our employees are based. Taiwan SemiLEDs owns a 100% equity interest in Taiwan Bandaoti Zhaoming Co., Ltd., formerly known as Silicon Base Development, Inc., which is engaged in the research, development, manufacture, marketing and sale of LED components. As of February 28, 2015, we also owned a 93% interest in Ning Xiang Technology Co., Ltd., or Ning Xiang, which consisted of a 51% interest acquired in August 2011, an additional 15% interest acquired in April 2013, an additional 21% interest acquired in November 2013 and an additional 6% interest acquired in December 2014.

 

We also have interests in unconsolidated joint ventures that we have accounted for as equity method investments and as such have not consolidated for financial reporting purposes. As of February 28, 2015, we owned a 33% interest in SILQ (Malaysia) Sdn. Bhd. or SILQ, a joint venture established in Malaysia to design, manufacture and sell lighting fixtures and systems. Originally, we and the other investor each owned a 50% equity interest in the joint venture. In January 2014, we participated in SILQ’s capital increase and contributed $76 thousand. Following this capital increase, our equity interest in SILQ was diluted from 50% to 49%. In April 2014, we sold part of our equity interest in SILQ to the other investor in SILQ for a cash consideration of $114 thousand. Upon consummation of the sale, our equity interest in SILQ was reduced from 49% to 33%. We subsequently invested $130 thousand in SILQ’s capital increase and our equity interest remains unchanged.

 

Key Factors Affecting Our Financial Condition, Results of Operations and Business

 

The following are key factors that we believe affect our financial condition, results of operations and business:

 

·                          Industry growth and demand for products and applications using LEDs.  The overall adoption of LED lighting devices to replace traditional lighting sources is expected to influence the growth and demand for LED chips and impact our financial performance. We believe the potential market for LED lighting will continue to expand. LEDs for efficient generation of UV light are also starting to gain attention for various medical, germicidal and industrial applications. Since a substantial portion of our LED chips, LED components and our lighting products are used by end-users in general lighting applications and specialty industrial applications such as UV curing, medical/cosmetic, counterfeit detection, horticulture, architectural lighting and entertainment lighting the adoption of LEDs into these applications will have a strong impact on the demand of LED chips generally and, as a result, for our LED chips, LED components and LED lighting products. Fluctuations in demand for LED lights products will also affect the results of Ning Xiang.

 

·                          Average selling price of our products.  The average selling price of our products may decline for a variety of factors, including prices charged by our competitors, the efficacy of our products, our cost basis, changes in our product mix, the size of the order and our relationship with the relevant customer, as well as general market and economic conditions. Competition in the markets for LED products is intense, and we expect that competition will continue to increase, thereby creating a highly aggressive pricing environment. For example, some of our competitors have in the past reduced their average selling prices, and the resulting competitive pricing pressures have caused us to similarly reduce our prices, accelerating the decline in our revenues and the gross margin of our products. When prices decline, we must also write down the value of our inventory. Furthermore, the average selling prices for our LED products have typically decreased over product life cycles. Therefore, our ability to continue to innovate and offer competitive products that meet our customers’ specifications and pricing requirements, such as higher efficacy LED products at lower costs, will have a material influence on our ability to improve our revenues and product margins, although in the near term the introduction of such higher efficacy LED chips may further reduce the selling prices of our existing products or render them obsolete. Reduction in the average selling price of LED lights products will also affect the results of Ning Xiang.

 

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·                          Changes in our product mix.  We anticipate that our gross margins will fluctuate from period to period as a result of the mix of products that we sell and the utilization of our manufacturing capacity in any given period, among other things. For example, as a strategic plan, we placed greater emphasis on the sales of LED components rather than the sales of LED chips where we have been forced to cut prices on older inventory. In particular, we sold a significant volume of a category of lower-priced LED components designed to meet our customers’ demand. While such a shift in product mix decreased our average selling price, the significant sales volume helped to improve revenues and gross margin in fiscal 2012 and 2013. However, lower than expected sales volume as a result of intense competition harmed our revenues and gross margin in fiscal 2014. We intend to continue to pursue opportunities for profitable growth in areas of business where we see the best opportunity for our EV LED product series of LED chips (particularly the UV market) and adjust the lower-priced LED components strategy as appropriate. However, as we expand and diversify our product offerings and with varying average selling prices, a change in the mix of products that we sell in any given period may increase volatility in our revenues and gross margin from period to period.

 

·                          Our ability to reduce cost to offset lower average prices.  Competitors may reduce average selling prices faster than our ability to reduce costs, and competitive pricing pressures may accelerate the rate of decline of our average selling prices. To address increased pricing pressure, we have improved and increased our production yields to reduce the per-unit cost of production of our products. However, such cost savings currently have limited impact on our gross profit, as we currently suffer from the underutilization of manufacturing capacity and must absorb a high level of fixed costs, such as depreciation. While we intend to focus on managing our costs and expenses, over the long term we expect to be required to invest substantially in LED development and production equipment if we are to grow.

 

·                          Our ability to continue to innovate.  As part of our growth strategy, we plan to continue to be innovative in product design, to deliver new products and to improve our manufacturing efficiencies. Our continued success depends on our ability to develop and introduce new, technologically advanced and lower cost products, such as more efficient, higher brightness LED chips. If we are unable to introduce new products that are commercially viable and meet rapidly evolving customer requirements or keep pace with evolving technological standards and market developments or are otherwise unable to execute our product innovation strategy effectively, we may not be able to take advantage of market opportunities as they arise, execute our business plan or be able to compete effectively. In November 2013, we launched a 10-watt M63 RGBW integrated 6363 LED, capable of delivering over 410 total lumens of combined red, green, blue and white light output. The M63 RGBW LED component integrates our EV LED structure, ReadyWhite™ Phosphor Technology and ceramic packaging technologies, designed for a wide range of color-changing applications, including entertainment lighting (such as stage lights, backdrops and spotlighting), large scale displays, and architectural lighting. This compact multi-color LED component offers our customers easy color mixing and higher integration that simplifies the design of lighting fixtures and reduces the number of LED components used. In August 2014, we introduced a line of 80x80mil EV LED chips, which include white, blue, and UV variations, and provide packagers and integrators with a wider variety of high-efficiency/high-output choices to address the growing number of applications in both the commercial lighting and industrial spaces. In addition, we launched an Enhanced Flip Chip, or EF, LED series and our newest line of white chip scale packages, the ReadyMount™ Enhanced CSP, or EC series. The EF series launched with the EF-B40, a blue 40-mil flip chip that simplifies the packaging and integration process by eliminating wire-bonding while increasing both lumen-density and decreasing the lumen-per-dollar value proposition while enabling packagers to use standard surface mount assembly techniques. By combining SemiLEDs’s Enhanced Flip chip approach with our innovative ReadyWhite™ phosphor technology, the EC delivers unprecedented flexibility, reliability and manufacturability in a single 1.4mm x 1.4mm low profile device. Rated for input power of up to 3W, the EC is a fully packaged white emitter SMD component, ready for surface mounting on any board level module or COB application, lowering capital costs and enabling extremely high lumen density configurations. Recently we announced our Phosphor Converted or PC LED chip series, including PC Red, PC Green, and PC Amber in a 40mil (1mm x 1mm) chip combining with our ReadyWhite™ phosphor technology minimize blue pass through in our product therefore allow more options for our customers in these color ranges.

 

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·                          General economic conditions and geographic concentration.  Many countries including the United States and the European Union members have instituted, or have announced plans to institute, government regulations and programs designed to encourage or mandate increased energy efficiency in lighting. These actions include in certain cases banning the sale after specified dates of certain forms of incandescent lighting, which are advancing the adoption of more energy efficient lighting solutions such as LEDs. The global financial crisis that began in late 2007 caused extreme disruption in the financial markets. Although the disruption in the financial markets moderated thereafter, the global financial markets continue to reflect uncertainty about a sustained economic recovery. When the global economy slows or a financial crisis occurs, consumer and government confidence declines, with levels of government grants and subsidies for LED adoption and consumer spending likely to be adversely impacted. Our revenues have been concentrated in a few select markets, including Taiwan, the United States and China (including Hong Kong). Given that we are operating in a rapidly changing industry, our sales in specific markets may fluctuate from quarter to quarter. Therefore, our financial results will be impacted by general economic and political conditions in such markets. For example, the risk of a financial crisis in Russia has risen because of a precipitous fall in the rouble in mid-December 2014. Our business in Russia and/or related markets could be adversely affected as a result of economic uncertainty or slowdown. Furthermore, the reduction in LED street and tunnel lighting projects financed by the Chinese government and aggressive support by the Chinese government for the LED industry through significant government incentives and subsidies to encourage the use of LED lighting and to establish the LED-sector companies has resulted in production overcapacity in the market and intense competition. In addition, we have historically derived a significant portion of our revenues from a limited number of customers. Some of our largest customers and what we produce/have produced for them have changed from quarter to quarter primarily as a result of the timing of discrete, large project-based purchases and broadening customer base, among other things. For the three and six months ended February 28, 2015, sales to our three largest customers, in the aggregate, accounted for 61% and 43% of our revenues, respectively.

 

·                          Intellectual property issues.  Competitors of ours and other third parties have in the past and will likely from time to time in the future allege that our products infringe on their intellectual property rights. Defending against any intellectual property infringement claims would likely result in costly litigation and ultimately may lead to our not being able to manufacture, use or sell products found to be infringing. In June 2012, we settled an intellectual property dispute involving Cree. We agreed to dismiss amended complaints filed against each other without prejudice. We agreed to the entry of a permanent injunction that was effective October 1, 2012 that precludes us from (and/or from assisting others in) making, using, importing, selling and/or offering to sell in the United States certain accused products and/or any device that includes such an accused product after that date and to payment of a settlement fee for past damages. All accused products sold before the date of settlement are released under this agreement and our customers and distributors are specifically released. All remaining claims between Cree and us were withdrawn without prejudice, with each retaining the right to assert them in the future. However, other third parties may also assert infringement claims against our customers with respect to our products, or our customers’ products that incorporate our technologies or products. Any such legal action or the threat of legal action against us, or our customers, could impair such customers’ continued demand for our products. This could prevent us from growing or even maintaining our revenues, or cause us to incur additional costs and expenses, and adversely affect our financial condition and results of operations.

 

·                          Declining cash position.  Our cash and cash equivalents decreased to $6.7 million as of February 28, 2015 due to the combination of our net loss, payments related to long-term debt and a decrease in accounts payable balances, and cash outlays for fixed assets to expand our Chu-Nan Facility for the relocation and consolidation of our manufacturing operations at Sinwu, Taiwan. We have initiated actions to accelerate operating cost reductions and improve operational efficiencies. In the first half of our fiscal 2015, we have started to realize the benefits of operating cost reductions, such as savings on lease and overhead costs related to the Sinwu Facility, lower payroll expenses due to workforce reductions and normal attrition, and improvement in operational efficiencies through the consolidation of facilities. Additionally, the commercial sales of our new UV LED product, which started in our fiscal second quarter of 2015, have generated a positive impact on our gross margin, operating results and cash flows. Based on our current financial projections, we believe that we will have sufficient sources of liquidity to fund our operations and capital expenditure plans for the next 12 months. For information concerning our liquidity plans, see Note 2, ‘‘Summary of Significant Accounting Policies’’ of the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1, Financial Statements, of this Quarterly Report.

 

Recent Developments

 

On August 26, 2014, we received a letter from The NASDAQ Stock Market notifying us that we were not in compliance with the minimum bid price requirement set forth in NASDAQ Listing Rule 5450(a)(1) for continued listing on the NASDAQ Global Select Market. The NASDAQ Listing Rules require listed securities to maintain a minimum bid price of $1.00 per share and, due to our common stock having traded for 30 consecutive business days below the minimum closing bid price requirement, we no longer met that requirement at that time. In accordance with NASDAQ Listing Rule 5810(c)(3)(A), we were provided a cure period until February 23, 2015, to regain compliance with NASDAQ Listing Rule 5450(a)(1). To regain compliance, our common stock was required to have a closing bid price of at least $1.00 for a minimum of 10 consecutive business days. On February 2, 2015, we regained compliance with NASDAQ Listing Rule 5450(a)(1). However, our stock price has once again traded below $1.00 per share, so we could lose compliance if our stock price does not increase.

 

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In March, 2015, we announced our Phosphor Converted or PC LED chip series, including PC Red, PC Green, and PC Amber in a 40mil (1mm x 1mm) chip combining with our ReadyWhite™ phosphor technology minimize blue pass through in our product therefore allow more options for our customers in these color ranges.

 

We entered into a definitive common stock purchase agreement effective December 18, 2014 (the “Agreement”) with Mr. Xiaoqing Han, the Chairman and CEO of Beijing Xiaoqing Environmental Protection Group. The transaction is currently pending due to Mr. Han’s difficulty in transferring funds from his banking system. While Mr. Han arranges for full payment to be sent from his banks, he has advised us that he will transfer the balance by installments. Our Board of Director is considering Mr. Han’s request to permit him additional time to purchase the shares. Pursuant to the terms of the Agreement, if Mr. Han did not purchase the shares before February 25, 2015, then he is required, upon written request by us, to pay us $3 million in liquidated damages plus the legal fees incurred by us relating to the sale. On March 9, 2015, we received the first payment of one million Renminbi (approximately $161 thousand) in our Shenzen branch’s bank account in China and subsequently received $100 thousand in our bank account in the United States. There can be no assurance if, or when, Mr. Han will be able to complete the purchase or if we can collect any judgment for liquidated damages should we obtain one.

 

Critical Accounting Policies and Estimates

 

There have been no material changes in the matters for which we make critical accounting policies and estimates in the preparation of our unaudited interim condensed consolidated financial statements for the six months ended February  28, 2015 as compared to those disclosed in our 2014 Annual Report.

 

Exchange Rate Information

 

We are a Delaware corporation and, under SEC requirements, must report our financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. At the same time, our subsidiaries use the local currency as their functional currency. For example, the functional currency for Taiwan SemiLEDs is the NT dollar. The assets and liabilities of the subsidiaries are, therefore, translated into U.S. dollars at exchange rates in effect at each balance sheet date, and income and expense accounts are translated at average exchange rates during the period. The resulting translation adjustments are recorded to a separate component of accumulated other comprehensive income (loss) within equity. Any gains and losses from transactions denominated in currencies other than their functional currencies are recognized in the consolidated statements of operations as a separate component of other income (expense). Due to exchange rate fluctuations, such translated amounts may vary from quarter to quarter even in circumstances where such amounts have not materially changed when denominated in their functional currencies.

 

The translations from NT dollars to U.S. dollars were made at the exchange rates as set forth in the statistical release of the Bank of Taiwan. On August 29, 2014, the exchange rate was 29.90 NT dollars to one U.S. dollar. On February 26, 2015, the exchange rate was 31.41 NT dollars to one U.S. dollar. On April 7, 2015, the exchange rate was 31.04 NT dollars to one U.S. dollar.

 

The following table sets forth, for the periods indicated, information concerning the number of NT dollars for which one U.S. dollar could be exchanged.

 

		NT dollars per U.S. dollar
		Average(1)		High		Low		Period-End
Fiscal 2013		29.57		30.20		28.95		29.93
Fiscal 2014		29.94		30.60		29.36		29.90
September 2014		30.11		30.48		29.86		30.42
October 2014		30.40		30.45		30.36		30.44
November 2014		30.71		30.95		30.47		30.95
December 2014		31.41		31.79		31.04		31.65
January 2015		31.63		32.00		31.21		31.50
February 2015		31.49		31.60		31.39		31.41
March 2015		31.45		31.66		31.28		31.30
April 2015 (through April 7, 2015)		31.18		31.30		31.04		31.04

 

(1)                                 Annual averages calculated from month-end rates and monthly averages calculated from daily closing rates.

 

No representation is made that the NT dollar or U.S. dollar amounts referred to herein could have been or could be converted into U.S. dollars or NT dollars, as the case may be, at any particular rate or at all.

 

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