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Executives

Scott Paul – COO

Dustin Shindo – Chairman, President and CEO

Darryl Nakamoto – CFO, Treasurer and Secretary

Analysts

Rob Stone – Cowen & Co.

Adam Krop – Ardour Capital

Hoku Scientific, Inc. (HOKU) F3Q10 (Qtr End 12/31/09) Earnings Call Transcript January 27, 2010 5:00 PM ET

Operator

Good day, and welcome to the Hoku Scientific Q3 2010 earnings conference call. Today's call is being recorded.

At this time, I would like to turn the call over to Mr. Scott Paul. Please go ahead, sir.

Scott Paul

Thank you, Melanie. Good day. This is Scott Paul, Chief Operating Officer of Hoku Scientific.

During this conference call, you will hear forward-looking statements that involve many risks and uncertainties. These statements relate to our ability to secure additional financing necessary to complete our planned polysilicon production facility in Pocatello, Idaho; our ability to receive $55 million in customer prepayments, based on agreed-upon schedules and contingent-upon meeting certain milestones, if at all, under our current polysilicon supply agreements; whether or not Suntech will agree to adjust the milestone dates in its polysilicon supply agreement with us; our ability to meet our commitments under certain supply agreements to deliver polysilicon; our ability to complete a reactor demonstration in the March 2010; our ability to manufacture polysilicon at 2500 metric tons of annualized production capacity, if at all, after receiving the $50 million loan from Tianwei, plus the $55 million in committed prepayments from our customers; our ability to manufacture polysilicon at 4000 metric tons of annualized production capacity, if at all, in the second half of calendar year 2010; our ability to commission our planned chemical plant and manufacture of trichloraosilane or TCS in the second half of calendar year 2010, if at all; our ability to install PV systems in Hawaii; our ability to successfully complete the closing of the $50 million fund, presently contemplated by a non-binding letter of intent with Tianwei; our ability to develop utility-scale PV projects in Hawaii; our future financial performance; our business strategy and plans; and objectives of management for future operations.

In some cases, you can identify forward-looking statements by terms such as anticipate, believe, can, continue, could, estimate, expect, intend, may, plan, potential, predict, project, should, will, would, and similar expressions intended to identify forward-looking statements.

These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, time frames, or achievements to be materially different from any future results, performance, time frames, or achievements expressed or implied by the forward-looking statements.

Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. In evaluating these statements, you should specifically consider the risks described in our filings with the Securities and Exchange Commission. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

During this conference call, we will use non-GAAP financial measures in the course of analyzing our results. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measure, which reconciliation may be found in our press release announcing our third quarter fiscal 2010 results.

This call is the property of Hoku Scientific, and any recording, reproduction, or transmission of this conference call without expressed prior written consent of Hoku Scientific is strictly prohibited.

Now I would like to turn the call over to Dustin Shindo, Chairman of the Board of Directors, President, and Chief Executive Officer of Hoku Scientific.

Dustin Shindo

Thank you, Scott. Good day and thank you for participating in Hoku Scientific’s third quarter fiscal 2010 earnings call.

Joining me on the call today are Darryl Nakamoto, our Chief Financial Officer; Scott Paul, our Chief Operating Officer; and Karl Taft, our Chief Technology Officer.

Before turning the call over to Darryl Nakamoto for a detailed review of our third quarter financial results, I would like to begin with an update on recent developments with Hoku Materials, followed by an update on Hoku Solar.

Most notably, during the past quarter, we successfully closed our financing agreement with Tianwei, and are working closely with our vendors towards our planned reactor demonstration, and subsequent production ramp up at our polysilicon manufacturing plant in Pocatello, Idaho. Last week, we received the first tranche of $20 million in debt financing from Tianwei and we expect to receive the second tranche of $30 million in February 2010. Including the $50 million loan, $50 million in equity, and $30 million in prepayments for polysilicon, Tianwei has committed $131 million to the financing of our polysilicon plant; and has agreed to assist us in identifying any future financing that may be required to complete the construction and operation of the plant.

When we signed the Tianwei financing agreement in September 2009, we expected to receive all of the $50 million by November 2009, which would have enabled us to complete our reactor test demonstration in December 2009, and commence customer shipments by the end of March 2010. After several months delay in receiving the loan proceeds, however, our priority shifted to paying our most overdue invoices from our vendors before spending significant money on new construction. Despite the delay in funding, we have been focused on managing relationships with our vendors and on staffing, training, and equipment preparation for our upcoming reactor demonstration. In particular, we have concentrated our efforts on readying the reactors and on commissioning the necessary control, support, and safety systems required to conduct first production runs.

Assuming receipt of the $30 million second tranche loan from Tianwei in February, we now expect to conduct reactor testing by March 2010, which is subsequent to the December 31, 2009 completion date agreed to under our polysilicon supply agreement with Suntech. Because the demonstration has been delayed, Suntech has not yet made its net scheduled prepayment of $15 million, and may assert the right to terminate our contract. If the agreement is terminated, Suntech could request the refund of its $2 million prepayment. However, Suntech has neither requested a refund nor attempted to terminate the contract, and we expect that they will work with us to make the required adjustments to the milestone date in the existing sales agreement. It should be noted that Suntech invested $20 million in our common stock in calendar year 2008 and that they have previously shown their willingness to be flexible when needed.

Regarding the financing and construction of our polysilicon manufacturing facility, we believe that the $50 million in proceeds from the Tianwei financing, plus the additional $55 million in prepayments expected from our polysilicon customers will be sufficient for the initial 2500 metric tons of production capacity. During the first phase of production, we will use third-party TCS, initial quantities of which have already been procured and delivered to our polysilicon facility. Subject to additional financing, we expect to continue adding reactor capacity throughout calendar year 2010 until we reach annual production capacity of 4000 metric tons in the second half of the calendar year. We also plan to bring our on-site TCS production facility online by the end of calendar year 2010, eliminating our need to procure a third-party process chemical.

We believe we will have a wider range of choices available for long-term financing after we complete the reactor demonstration. Thus, while we continue to actively evaluate our options, we do not expect to commit to a particular financing strategy until that milestone is achieved. In addition, Tianwei has committed to assist us in our efforts to raise the additional capital through one or more debt or equity offerings.

Moving to Hoku Solar, we are very pleased by our letter of intent with Tianwei to explore the investment of $50 million into a fund that would own and operate Hoku Solar’s PV projects in Hawaii, and sell the power generated by those projects to utilities or private consumers through a negotiated power purchase agreement. According to the terms of the nonbinding letter of intent, we will begin working with Tianwei to structure a solar project financing fund that could be as large as $50 million and that would be aimed at funding the installation and operation of large commercial, industrial, and utility-scale PV projects in Hawaii and elsewhere. If the fund is successfully closed, with the coming introduction of a feed-in tariff in Hawaii, we believe it could unlock Hoku Solar’s growth potential.

To conclude, we would like to once again thank our vendors, partners, and customers for their continued support as we work through the delays in the closing of the Tianwei financing. Now that the transaction has been completed and the financing is underway, we look forward to a breakthrough year in calendar 2010, both in our PV system installation and polysilicon manufacturing businesses.

Now, I would like to turn the call over to Darryl Nakamoto, our Chief Financial Officer, for a review of our financial results.

Darryl Nakamoto

Thank you, Dustin. Good day, everyone. I will provide details on our financial results for the third quarter ended December 31, 2009.

Beginning with our statement of operations, our revenue for the quarters ended December 31, 2009 and 2008 was $259,000 and $767,000 respectively, derived primarily from PV system installations and related services. Revenue for the quarter ended December 31, 2009 were lower than expected as a result of our focus on financing for our polysilicon facility and due to slower purchasing cycles for PV systems in Hawaii.

Cost of revenue was $65,000 for the quarter ended December 31, 2009 compared to $592,000 for the same period in fiscal 2009. Cost of service and license revenue primarily consisted of employee compensation and supplies and materials. As of December 31, 2009, deferred revenue of $495,000 was attributable to PV system installation and related service contracts.

Our selling, general and administrative expenses for the quarter ended December 31, 2009 were $1.5 million compared to $1.1 million for the same period in fiscal 2009. The increase of $417,000 was primarily due to the expenditures related to the reactor demonstration, which is expected to be completed in March 2010 of $101,000; retention payments for officers and other key employees of $65,000; and contractor costs of $69,000. In addition, there was an increase in depreciation related to PV systems we installed for the Hawaii State Department of Transportation of $66,000, a lower application of other direct and indirect charges of $66,000, and inventory impairment of solar modules of $39,000.

Our net loss, computed in accordance with GAAP for the quarter ended December 31, 2009 was $1.3 million or $0.06 per diluted share compared to $863,000 or $0.04 per diluted share for the same period in fiscal 2009.

Non-GAAP net loss, which excludes the effect of stock-based compensation for the quarter ended December 31, 2009 was $959,000 or $0.05 per diluted share compared to $646,000 or $0.03 per diluted share for the same period in fiscal 2009. Non-GAAP net loss for the quarters ended December 31, 2009 and 2008 exclude non-cash stock-based compensation of $296,000 and $217,000 respectively.

Finally, turning to our balance sheet, as of December 31, 2009, we had $3.2 million in cash, cash equivalents, and short-term investments compared to $17.4 million as of March 31, 2009.

This concludes our prepared remarks. Now we would like to open the meeting for questions. Melanie, will you please proceed?

Question-and-Answer Session

Operator

Yes, thank you. The question-and-answer session will be conducted electronically. (Operator Instructions).

And we would take our first question from Rob Stone with Cowen & Co.

Rob Stone – Cowen & Co.

Hi, guys. I wonder if you could just comment a little bit on the timing, assuming that you get the remaining debt funding as you described and get to a reactor demonstration in March. How much longer after that do you think it might take to begin the commercial production of poly?

Dustin Shindo

Sure. It is good to hear from you, Rob. Our planned demonstration, as you mentioned, is March 2010. I would call that first poly and then we would begin wrapping up shortly thereafter and would expect to make our first commercial delivery in the next quarter, the June quarter.

Rob Stone – Cowen & Co.

Okay. Now can you comment on how that compares to delivery schedules under your current agreements with customers?

Dustin Shinto

In other words, will we be in reach on delivery on any customer?

Rob Stone – Cowen & Co.

Or are you going to shift third party products for part of a quarter or something like that?

Dustin Shindo

With the exception of ongoing discussions with Suntech, it is not required that we deliver third-party product to anyone, but of course we would have the option to in some cases.

Rob Stone – Cowen & Co.

Okay. You mentioned moving the reactor demonstration milestone with Suntech. What are other significant milestones, if you can mention them, that you might have to read or revise, with Suntech specifically?

Dustin Shindo

With Suntech?

Rob Stone – Cowen & Co.

Yes.

Dustin Shindo

Well, the first shipment date as I mentioned might have to move as well, though I guess that could still be discussed.

Rob Stone – Cowen & Co.

Okay. That is the only major item other than the demonstration date?

Dustin Shindo

Yes.

Rob Stone – Cowen & Co.

Okay, thanks.

Dustin Shindo

Sure.

Operator

(Operator Instructions). And we will go next to Adam Krop with Ardour Capital.

Adam Krop – Ardour Capital

Hi, Dustin, how are you?

Dustin Shindo

Hi, Adam. Good, thanks.

Adam Krop – Ardour Capital

A quick question on the reactor demonstration, given that it is going to likely happen in March of 2010. Should we expect a little bit of depreciation on that to show up in that quarter or when should we be looking for another majority of depreciation to start coming in.

Darryl Nakamoto

Hi, Adam, this is Darryl. How are you doing?

Adam Krop – Ardour Capital

Good, thanks.

Darryl Nakamoto

To answer your question, if there is going to be depreciation, it most likely would be very little. We are not expecting to really put our equipment and service on the demonstration. It would be as we start commercial production.

Adam Krop – Ardour Capital

Okay, so depreciation will really kick in on commercial production, okay.

Darryl Nakamoto

So in the following quarter.

Adam Krop – Ardour Capital

Right. Okay, and Dustin, I just wanted to revisit a little bit the original September transaction with Tianwei. If you can go back to that just briefly, I guess, first of all, can we get an update on I guess how the Board looks at this point, you know, do you still expect to stay on as Chairman? I know they had an option to maybe appoint a Chairman there. And can you provide any further guidance on when the warrants are exercised?

Dustin Shindo

Okay. With respect to the Board of Directors, as you mentioned, as part of this transaction, the Board of Directors structure has changed. So today, there are seven members, five of which are independent – sorry, five not management. Tianwei has selected four of the Directors and essentially, of course, it has majority of the seats on the Board. They do also have the right to select the Chairman. So for the time being, they have left me in that position.

Now with respect to the warrants, I can’t comment to what their plans will be.

Adam Krop – Ardour Capital

Okay. And then on the second tranche, the $30 million, are there any milestones associated with getting the second tranche from Tianwei?

Dustin Shindo

There are not. We just expect to get that in February. It is – I call it a profit sting that takes time. And sorry, just to clarify, the change in Board left us with six outside Directors, one inside.

Adam Krop – Ardour Capital

Okay. And then just one quick question on your expected operating expense going forward, specifically on R&D, what do you expect – can you provide any guidance in terms of R&D once the expense levels, once the reactors are up and running, and are you currently capitalizing R&D expenses right now?

Dustin Shindo

R&D is actually very minimal for our polysilicon plants and in fact, I guess for our PV installing business as well. One of the things that we did strategically in the very beginning was make sure we selected processes that had little technical risk in them, and I guess as a result, there is very little R&D involved. The only R&D expenses that we expect to incur once the plant is up and running, is the R&D related to cost reductions. So I wouldn't call that fundamental R&D necessarily, and that won’t be a very significant amount.

Adam Krop – Ardour Capital

Okay, thanks. And then just one final question on the manufacturing tax credit, can you just comment on kind of the reasoning may be behind it, you weren’t picked for the first round and do you expect the second round to happen here in the foreseeable future?

Dustin Shindo

We are actually unsure why we weren’t selected in the first round. Obviously, that would have been a nice addition for the quarter, but as far as our next round, I am unsure about that.

Adam Krop – Ardour Capital

Okay, thanks.

Dustin Shindo

All right, thanks, Adam.

Operator

It appears the no further questions at this time. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Scott Paul

Thank you for participating in our third quarter fiscal 2010 earnings call. We look forward to speaking with you again when we report our fourth quarter and fiscal year ended March 31, 2010 results.

Operator

That concludes today's conference. We thank you for your participation.

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