Can Hoku Find the Funding?

Sep.23.10 | About: Hoku Corp (HOKUQ)
Revenues are unable to sustain the massive capital expansion needed to fund the completion of Hoku’s (HOKU) polysilicon product plant. The company is desperately searching for financing.
Back in 2007, Hoku broke ground on a plant it now estimates will cost at least $410 million to complete. Currently, the company is $65 million dollars short of completion with less than 10% of operations functioning. Customer agreements require the company to deliver its first shipment of polysilicon product in less than a quarter. Even with the company able to produce an undisclosed amount, it is still facing the impending conclusion that it might need to evaluate the direction of its operations by the end of its current fiscal year ending March 31, 2011. If the company is unable to deliver contractual polisilicon product amounts it is either required to repay the customer advances or it faces the challenge of finding a third-party to supply the product.
The company ranks toward the bottom in terms of its quantitative metrics. Negative operating cash flows and net losses for the last 12 months ranked the company at 29 out of 39. The company ranks 33rd in selling, general, & administrative expenses. The company disclosed the increase in SG&A expenses related to a reactor demonstration. The company’s use of debt ranks it number 17 in the debt-to-equity ratio and number 25 in the cash-to-debt ratio.
Qualitatively the company gets poor marks when it comes to many of those metrics. The company shows poor earnings quality as its largest division in terms of assets and funding has yet to earn any revenue for the company. If unable to secure the necessary financing earnings will continue to suffer. The company receives a “D” for disclosure due to the most recent Form NT 10-K the company filed. The NT was filed to avoid a going concern opinion from its auditor.
Hoku’s need for cash puts added pressure on the company to finish its polysilicon production plant. Negative earnings for the last eight quarters force the company to find additional capital from external sources. The company’s cash flow from operations was a negative $2.7 million in the first quarter of 2011.
In the last two years the company has spent $224.1 million on capital expenditures. The company’s capital expenditures were $23.8 million in the first quarter 2011. The company reported a net property, plant and equipment value of $311.8 million at the end of the first quarter 2011. Assets under construction of $308.8 million account for 99 % of total fixed assets. The company says, “As of June 30, 2010, primarily all of our long lived assets related to the construction-in-progress of our polysilicon plant and PV systems.”
In January 2009, six of the 16 reactors were received from Graeber Engineering Consultants (GEC). The company will use Siemens reactors to produce polysilicon. An additional payment of $3.8 million is required to receive the remaining 10 reactors. The company plans to purchase an additional 12 reactors to reach the company’s capacity goal of 4,000 MT per year. The company said, “[it] is in discussions with GEC to purchase 12 additional reactors necessary for the Company’s planned annual capacity of 4,000 metric tons of polysilicon. The cost of these additional reactors is not expected to be greater than 20.9 million Euros, or $25.5 million.
The estimated total cost of the plant is $410 million. By our calculation, the company is required to spend $101.2 to finish the plant if the $410 million number is accurate. Our calculation shows additional financing of $49.7 million needed. Combining this increase in asset spending with $28.3 million of credit available at the end of June 30, 2010, the expectation of $14.8 million of additional customer prepayments, and a slight increase of cash on hand to $8.3 cash on hand, the net additional funds needed to complete the project is $49.7 million. The company said in its first quarter 2011 Form 10-Q, “As of June 30, 2010, we have funded approximately $285.0 million of our Polysilicon Plant. Even with our recently secured credit line of $28.3 million from China Construction Bank and $14.8 million in expected prepayments, we still need to raise an additional $65.0 million to complete the construction of our Polysilicon Plant based upon our current estimate to complete construction.” The amount needed to finish the project fund ongoing operation will be higher since the company recognized a net loss of $2.7 million and negative operating cash flow of $2.2 million in the first quarter 2011.
The company managed to avoid a going a concern opinion from its auditor, Ernst & Young with an additional $14.8 million dollars of prepayments and $28.3 million credit agreement from China Construction Bank on June, 30 2010. In its Form NT-10K filed on June 30, 2010, the company disclosed this additional financing to be the reason it was filing its Form 10-K late. The company said, “[it] anticipated that unless it secured adequate additional capital, the report of its independent registered public accounting firm on the Company’s consolidated financial statements for the year ended March 31, 2010 would contain an explanatory paragraph indicating substantial doubt about the Company’s ability to continue as a going concern.” The company received a clean opinion in its annual report filed on July 14, 2010, so the additional funding was sufficient for Ernst & Young.
As of April 2010 only two of the reactors are operational. To reach 2,500 MT of capacity 16 reactors must be fully installed by the third quarter of this calendar year. Full capacity of 4000 MT is planned by first quarter of calendar year 2012. However, the company’s ability to ramp-up its production to full capacity is contingent on additional financing of at least $65 million.
Advances from customers are common in the solar energy business, and is more common for Hoku than the rest of the industry. The customer makes an advance payment that generally covers the construction and expansion costs necessary for the company to fulfill increased customer orders. Customer prepayments provide a majority of the company’s financing. In the last seven quarters, prepayments total $166.6 million, including $6.6 million received in the first quarter 2011.
The company says in its March 31, 2010 annual report it has sales agreements for $1.7 billion of polysilicon sales over the next 11 years. Customer prepayments of $133.6 million at June 30, 2010 represent 7.9% of the $1.7 billion in customer sales contracts. Current advances are expected to be used within the next 12 months. For example, as of June 30, 2010 the company expects to ship enough polysilicon to customers to use $16.7 million of prepayments for the fiscal year 2011. The $16.7 million of current advances is 12.5% of the total advances of $133.6 million. Our calculation implies the total contract cash price will reduce ratable at 7.9% as polysilicon is shipped to customers. The actual contractual cash price versus prepayment percentage of customer sales is not disclosed. Using 7.9% as the prepayment percentage of sales for the next four quarters after June 30, 2010 total sales would be $211.9 million and for fiscal 2011 total sales would be $141.7 million. The company has not discussed sales projections.
Disclosure: No positions