I've been bearish on SemiLEDs (NASDAQ:LEDS) for some four years now, and I've long thought a short sale of LEDS was some of the easiest money in the market. After all, this is a company that posted a gross margin of negative 29% in fiscal 2015 (ending August), and that was a sharp improvement from the -78% figure posted in FY14. SemiLEDs has burned nearly $100 million since its IPO in late 2010, its revenue has fallen by over two-thirds over the past few years, and its category isn't even that strong after a ton of optimism toward LED adoption earlier this decade (a key reason LEDS was able to go public in the first place, despite being essentially invisible in its own industry.)
I've hardly reversed my opinion, and all things being equal I'd still expect the stock to go to zero at some point. But a new plan to outsource component manufacturing, sell the company headquarters, and focus on the UV LED space seems to have taken a step forward in Q1, and SemiLEDs at the least appears to have bought itself more time, leading me to cover my short last month. With market cap still around $11 million, and gross margin still negative, LEDS is hardly a screaming buy. But - really for the first time in years - there's a hope that SemiLEDs can survive.
The Liquidity Plan
SemiLEDs ended fiscal 2015 with just $4.8 million in cash, after a year in which it had burned over $6 million (and over $18 million the year before). In response, SemiLEDs decided to change tack, announcing its intent to sign an agreement with an ODM (original design manufacturer) who would produce the chips, allowing SemiLEDs to slash opex by moving its employees to the partner. The company also announced in its 10-K an agreement to sell its headquarters for $5.2 million, including a $3 million payment received in mid-December and two year-end payments in 2016 and 2017 (at which point the sale would close).
There was some logic to the moves, even if there was reason to be skeptical; SemiLEDs announced a $5 million cash infusion a year prior (from a buyer who oddly offered $1 per share for a stock trading at $0.46), only to see the buyer renege. The sale-leaseback of the headquarters was at an unspecified rate, and it remained unclear exactly what the edge was for the buyer (beyond, possibly, a below-market price). But per the Q1 10-Q, SemiLEDs has signed the ODM agreement and the impact was apparent. Gross margin only improved modestly - to -49% from -53% - but that was largely due to an increased writedown of inventory. Backing that out, gross margin was closer -35% against an adjusted -45% the year before. Opex fell substantially, by 42% year-over-year and nearly 8% Q/Q.
Again, margins remained negative, and LEDS still burned nearly $1 million in cash in the quarter. But including the $3 million payment for the headquarters, the company now has about $6.5 million in cash, and a $78,000 monthly debt payment goes away in July, lowering annual debt (interest and principal) expense to about $350,000 from ~$1.3 million.
And the move to UV components appears to be having some success, even if there remains a material risk that it is simply too little, too late. LED component sales increased 76% year-over-year (although they were down modestly on a sequential basis). The UV LED components - sold to an unnamed "leading cosmetic manufacturer" drove that growth, with volume up 36% and, in another positive sign, pricing up 12%. Lighting products sales were up modestly (although that appears likely to be lumpiness more than the beginning of a trend) and chip sales collapsed, falling 76% to just $175,000, as the company's chip business is basically down to selling existing low-end inventory at a discount.
Again, this is hardly the type of news that justifies a bull case, even at $0.38 per share, and revenue guidance of $2.4-$3.0 million for Q2, given in the company's prepared remarks, implies a ~40% decline year-over-year at the midpoint. But if the overwhelming majority of that decline is from chip sales which were unprofitable anyway, and if opex is down to $1+ million a quarter, LEDS may make further progress next quarter in its attempt to reach breakeven.
When Can You Buy This Stock?
I still think LEDS likely winds up at zero at some point; the company simply is too small (trailing twelve-month revenue is a bit over $14 million) and too far behind to be a material player in the LED space, as solid as I think the category's long-term opportunity is. There have been false starts in new end markets before, including camera flash and lighting, both of which fizzled out.
But LEDS' vertical chip structure is somewhat unique, and the UV LED niche is small but profitable, leading to some hope that SemiLEDs could carve out a small corner, or get enough of a foothold to sell the technology to a larger player interested in the space. If the company can moderate gross loss further and cut another ~$0.5 million in cash opex, cash burn should be rather minimal, and the company can survive through at least CY2017. From a tech standpoint, there is some reason for optimism; LEDS went from $17 (its IPO price) to $28 because there was hope from at least some investors that it could be a player in the space.
Of course, LEDS would also settle a case involving patent infringement with Cree (NASDAQ:CREE) less than two years after its IPO, a huge red flag relative to its technological capabilities. And the numbers have been so poor - gross margins have been negative since FY11 - that there really has never been any reason to drive a bull case toward the stock. Right now, that's still the case for the most part; but there's reason to think SemiLEDs can at least hang around longer than seemed possible even two quarters ago. That's at least some progress.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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