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Daqo New Energy Corp. (NYSE:DQ)

Q1 2014 Earnings Conference Call

May 12, 2014 4:15 PM ET

Executives

Gongda Yao – Chief Executive Officer

Bing Sun – Chief Financial Officer

Analysts

Paul Strigler – Esplanade Capital LLC

Bing Sun

Thanks everybody for joining us today for Daqo New Energy’s First Quarter 2014 Unaudited Financial Results Conference Call. Daqo New Energy issued its financial results for the first quarter 2014 just after the market close, which can be found on the Company’s Web site.

To facilitate today’s conference we have put together a PPT presentation for your reference. Today, attending the conference call we have Dr. Yao, our CEO, and myself. The call today will feature an update from Dr. Yao on business and operational developments, and then I will discuss the Company’s financial performance for the first quarter. After that we will open the floor to Q&A from the audience.

Without further delay, I will now turn the call over to Dr. Yao.

Gongda Yao

Thank you, Bing. Today, I’m pleased to report Daqo New Energy’s return to profitability in the first quarter of 2014. We increased the shipment volume by 9.4% quarter-on-quarter to 1,391 metric tons, expanded EBITDA margin to 32.5% from 21.9% in the previous quarter and produced a positive net income attributable to Daqo shareholders of 2.6 million, making the Company’s return to profitability on the net income basis for the first time since the third quarter of 2011. This was achieved despite the costs related to the non-operational Chongqing polysilicon plant of $3.7 million this quarter.

I would also like to highlight that we have continued to reduce our cost achieving a cash cost of $11.8 per kilo excluding depreciation and the production cost of $14.5 per kilo including depreciation in the first quarter, which we believe is among the lowest globally. We will continue to optimize our operation and improve our cost structure in the remaining quarters of 2014.

We expect our average cash cost excluding depreciation and the production cost including depreciation to be approximately $11.3 per kilo and $14 per kilo respectively 2014 fiscal year. After we expanding our polysilicon annual capacity from 6,150 metric tons to 12,150 metric tons and upgrade our production process, we expected to further low our polysilicon cash cost and production cost to approximately $8.7 per kilo and $12 per kilo, respectively by Q2 of 2015.

Specifically, by improving our process and relocating our polysilicon facility from Wanzhou, Sichuan to Shihezi, Xinjiang we continue to strengthen our advantages as a low-cost leader. We have secured exclusive preferential electricity rates from the Shihezi local government until 2020, which we believe are among the lowest in China.

By executing our strategy of reducing costs and producing high quality polysilicon, we have emerged as strong and more profitable company. We also benefit from the continued strong demand in the TV market and the high quality of our product, which increasing, increased ASPs to $21.63 from $18.67 in the previous quarter.

On the capacity front, following the debottlenecking project in December 2013, we have now reached name plate capacity of 6,150 metric ton of polysilicon annually, with production of 1,517 metric ton in the first quarter of 2014, up from 1,445 metric ton and 1,311 metric ton in the fourth and the third quarters of 2013, respectively. We have also commenced construction for the next stage of expansion, which will add a further 6,000 metric ton and take our name plate capacity to 12,150 metric ton once completed.

For this expansion, we are also improving our production profit by adopting hydrochlorination technology which will significantly reduce the conversion temperature thus resulting in much lower electricity consumption and further reducing costs. We expected to completing construction work by end of 2014 with the target of reducing cash cost and production cost to approximately $8.7 per kg and $12 per kg respectively, when capacity is fully ramped up by the second quarter of 2015.

Pay back for the new investment on the expansion project is expected to be less than two years. We have also announced today after market close to purposed offering of 2 million ADS shares. We plan to use the proceeds from the offer to fund the capital expansion of our 6,000 metric ton capacity, expansion at our Xinjiang facility and upgrade of our process technology. CS will be sole book-running manager and underwriter for the offering.

In addition to the polysilicon capacity expansion to 12,150 metric ton that is underway. the company is also considering further capacity expansion in the Xinjiang facility in the medium term, with a goal of expanding capacity to 25,000 metric ton, subject to the market and industry conditions.

Subsequent to competing of the quarter, the company also successfully completed its annual maintenance and the preparation works for the expansion project within a five period-day in early April. This is the two days faster than scheduled, than 12 days faster than the annual maintenance work carried out in 2013, reducing operational downtime and the associated impact on production.

For the second quarter of 2014, the company expects to ship 1,375 metric ton to 1,400 metric ton of polysilicon and 16.6 million to 17 million pieces of wafer. Also for broad marketing situation, NPD Solarbuzz data indicates new solar PV demand increased by over 9 gigawatts during the first quarter of 2014, which was 35% more than previous first quarter record set in 2013.

The record level of demand achieved in the first quarter was driven by strong growth in Japan and the United Kingdom, which together accounted for more than one-third of global solar PV demand in the first quarter of 2014. The first quarter of 2014 also new set new quarterly record for the PV deployed. Solar PV demand during the first quarter typically accounts for up to 20% annual demand. We expect that the China and the United States market to ramp up significantly in the second half of 2014, which will help the industry to achieve 45 gigawatts of installations in 2014. We’re also expecting end market demand to support an average selling price for polysilicon of $20 per kilo to $25 per kilo during 2014.

Overall, we believe we have prudently managed the business and diligently worked towards improving the company’s scale. cost structure and the technology, having turned the corner, both financially and operationally, we believe the company is in an excellent position to drive future growth and navigate any future market challenges, which may rise.

I will now turn the call to Mr. Bing Sun to provide update on financial performance. Bing please?

Bing Sun

Thank you Dr. Yao. Let’s now walk through the company’s Q1 financial performance. Revenue was $42.1 million, compared to $77 million in the first quarter of last year and a $14.5 million in the first quarter of 2013. The company generated a revenue of $30.1 million from polysilicon, a 24% increase relative to revenue of $24.2 million in the fourth quarter of last year.

The increase in revenue was primarily attributable to higher sales volumes and higher average selling prices. ASP increased 16.8% to $21.63 per kilo in Q1 from $18.67 per kilo in Q4 of last year, while sales volume increased 6.3% to 1,391 metric ton in Q1 from 1,309 in Q4 of last year.

You should note that we are selling 100% of our production and in fact, our capacity constraints are limiting our sales growth potentials right now. the company generated $12 million from sales of a wafer, compared to $12.8 million in the first quarter of last year. the slight decrease in wafer revenue is due to our decision this quarter to change our sales mix between our own wafers and the OEM wafers.

Producing more OEM wafers allow us to transfer cash, which can be used for the polysilicon capacity expansion project that is underway. On the other hand, producing more OEM wafers increases our gross margins. In Q1 of 2014, we sold significantly more OEM wafers, selling 943,000 pieces of OEM wafers versus 300,000 pieces in Q4 of last year.

Conversely, we only sold 800,000 pieces of our own wafer in Q1 versus 1.3 million pieces in the previous quarter. Gross profit was $9 million, compared to approximately $1 million in the fourth quarter of last year and the gross loss of $12.9 million in the first quarter of 2013.

Gross margin was 21.4%, compared to 2.6% in the fourth quarter of last year, and the negative 89% in the first quarter of 2013. The continuous improvement in gross margin is mainly attributable to higher average selling price and the lower production cost for both polysilicon and wafer.

In addition, I want to highlight that during the first quarter, we increased the estimated useful life of our machinery and equipment from 10 years to 15 years and our buildings and structures from 20 years to 30 years. we believe this better reflects the economical lives of these assets and are supported in this decision by detailed independent third-party analysis.

In addition, the revised useful life estimates remain consistent with industry average. The change in useful lives reduced the depreciation expense in the first quarter of 2014 by approximately $4.7 million, and we expect a similar impact on our quarterly basis going forward.

In the first quarter of 2014, total costs relating to non-operational Chongqing polysilicon plant, including depreciation was $3.7 million, compared to $5.9 million in the fourth quarter of last year. Excluding such costs, the non-GAAP gross margin was approximately 30.2%, compared to 18.5% in the fourth quarter of last year.

Other operating income was $6.6 million, compared to operating loss of $4.1 million in the fourth quarter of last year and operating loss of $16.6 million in the first quarter of 2013. This is the first quarter since the third quarter of 2011 that we have achieved the positive operating income. Operating margin was 15.7%, compared to negative 11% in the first quarter of last year and negative 114.7% in the first quarter of 2013.

EBITDA was $13.7 million for the quarter, compared to $8.1 million in the fourth quarter of last year and a negative $2.4 million in the first quarter of 2013. EBIDTA margin was at 32.5% for quarter, compared to 21.9% for the first quarter of last year and a negative 16.6% in the first quarter of 2013.

As a result of the fact is discussed above, net income attributable to Daqo New Energy’s shareholders were $2.6 million, compared to a net loss contributable Daqo New Energy’s shareholders of $8 million and $18.7 million in the fourth quarter and the first quarter of 2013 respectively. This is the first quarter since the third quarter of 2011 that we have achieved positive net income. Income per ADS was $0.38, compared to loss per ADS of $1.16 and $2.70 in the fourth and first quarter of 2013 respectively.

Cash flows, for the three months ended March 31, 2014, we generated a positive operating cash flow of $15.2 million, compared to $300,000 and $8.8 million in the two preceding quarters. This also compares favorably with negative operating cash flow of $24.3 million in the first quarter of 2013.

The improvement in operating cash flow was primarily due to the recovery in sales prices driven by a recovery broader solar market, as well as our continuous cost reduction efforts at our Xinjiang facilities. for the three moths ended March 31, 2014, net cash used in investing activities was $11 million, compared to the net cash provided by investing activities of $400,000 in the same period of last year.

For the three months ended March 31, 2014, net cash used in financing activity was $3.8 million, net cash provided by financing activity in the same period last year was $22.8 million. CapEx, as Dr. Yao previously mentioned, we have already commenced the construction of the expansion project in Xinjiang. as of the end of April 2014, we have spent approximately $22 million on the expansion projects with further $59 million to be spent through the remainder 2014. We will be spending a further $16 million of the capacity has been fully ramped up.

And that concludes the official part of our presentation. Now let’s have the Q&A session. Over to you, Amy.

Question-and-Answer Session

Operator

(Operator Instructions) our first question comes from (indiscernible) of ROTH Capital.

Unidentified Analyst

Excellent, hey, Gongda and Bing, first I want to – congratulations for a very strong quarter and turning profitable.

Gongda Yao

Thank you, Ming.

Bing Sun

Thank you.

Unidentified Analyst

Yes. So, my first question is related to your cost reduction. So the cost reduction roadmap of region cash cost of $8.7 per kilo by 2Q 2015 was quite impressive. Can you give us some more color on the key areas where you plan to achieve those cost reduction?

Gongda Yao

Okay. So let me try to ask your question. So we think the capacity increasing by 6,000 metric ton, I mentioned that, we have utilize the idle equipment improvement, so we only need invest about $100,000 million. So with and so our depreciation cost per kilo basis were not increasing after our expansion first of all.

Secondly, in electricity consumption by using hydrochlorination process was reduced by 30% roughly, which will give us about $1.5 per kilo saving for the cost of basis. So, as of 2014, as I said we were trying to reach our target goal we’ve been commented of 6,150 metric ton capacity that cost should be like below average about $15.

So we think electricity saving about $1.5 and then we have other savings like efficiency using of material et cetera. So and plus the depreciation savings, so we’ll reach by $12 in the second quarter of 2015.

Unidentified Analyst

Okay. Great.

Bing Sun

And Mr. Shen, I just want to add a few comments, introductory I just have said after we adopted hydrochlorination technology our electricity usage will be reduced by approximately once and that alone present $1.60 of the total reduction in total production cost. Okay. Thanks Mr. Shen.

Unidentified Analyst

Excellent color, so I appreciate that. My second question is relate to the SG&A even adding back to $1.8 million reversal of AR write-off, your SG&A was still in a (indiscernible) that’s $700,000 from last quarter. So can you give us some color where that reduction from and also can you give us some color on trend, how should we model next quarter SG&A?

Bing Sun

Yes. Let me try to answer your question Mr. Shen. You’re absolutely right, for this quarter SG&A is relatively low, it’s only a $1.5 million. And normally the number should stay at around $3 million on quarterly basis and going forward and for spelling expenses as a percentage, it’s actually per demerger sales free to charge. So it’s correlation through the total sales volume, and for R&D it will remain as approximately 3% of the revenue because in order to maintain preferential taxes status we will have to keep R&D at 3%.

So in summary, for SG&A excluding the fluctuation in bad debt reversal, it should remain at $3 million on quarterly basis, and it will not increase following the expansion project and hope that answers your question.

Unidentified Analyst

Yes, sure, we really appreciate the color and congratulations again. And I look forward to seeing you at (indiscernible) conference in Shanghai.

Gongda Yao

Thank you, Ming.

Bing Sun

Thank you.

Unidentified Analyst

Thanks, bye-bye.

Operator

(Operator Instructions) and our next question comes from Paul Strigler at Esplanade.

Paul Strigler – Esplanade Capital LLC

Hey guys. Question about the equity rates here, I thought on prior calls you mentioned you would be debt financing the expansion with a loan from your parent company the DQ Group. Did I misunderstand? Or did something change about how you decided to finance the project?

Bing Sun

Let me try to answer your question first, and then Dr. Yao will add on to my comments. To be accurate we didn’t mention we will use debt financing in prior quarters conference calls. Previously, we mentioned that we will consider various options and including debt financing from parental company and also we are considering using the operating cash flow following the better performance this year. And of course, equity financing is always an option for us and Dr. Yao, can comment further on that.

Gongda Yao

Yes, Paul and we are talking about the three options in the last conference call is the backlog and the biggest shareholder loan and as well as the equity market. Yes, driving on all those sides and to meet our expansion need. Also as I previously company will not stop at 6,000 metric ton expansion, we’re considering further after next expansion finished by Q2 2015. So definitely to meet those expansion plan company need to consider all possibility to funding those project of moving out in the future. So I hope this has answered your question.

Paul Strigler – Esplanade Capital LLC

Understood, thanks a lot guys.

Bing Sun

Thank you, Paul.

Gongda Yao

Thank you.

Operator

At this time we show no further questions. Mr. Bing Sun would you like to make any closing remarks.

Bing Sun

Okay. As always we appreciate everybody participating in our conference call and if you guys have any further questions you can always call me or call Kevin and thanks again for your participation. Let’s keep in touch, bye-bye.

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