Hoku Materials: Behind Schedule, Over Budget

| About: Hoku Corp (HOKUQ)

The mismanagement of Hoku Materials [a division of Hoku Corporation (HOKU)] becomes more apparent with each filing by the company. After nearly four years of construction, the plant is “behind schedule and over budget.”

The estimated total cost of the polysilicon plant has grown to $700 million, a 70.7% increase over the company’s previous estimate. The company has until May 2011 to provide polysilicon or it will miss another supply agreement deadline. Each of the company’s six supply agreements has been amended multiple times.

We question if patience is wearing thin by customers who have very little to show for their investment of $140.2 million in prepayments. This includes amended contracts of at least 9,100 MT of production during the next 11 years. Tianwei New Energy, majority shareholder since December 2009, and significant customer, has taken control of operations investing a large amount of time and capital. Tianwei expects a return on investment and of December 2010; it is able to sell its controlling interest in Hoku to any third party without approval from other shareholders.

The company ranks toward the bottom in nine of the 12 quantitative metrics. Negative operating cash flows and net losses for the last-12 months ranked the company at 28th. With negative operating cash flows and substantial quarterly capital expenditures necessary to finish the production plant in Pocatello, the company ranks 28th in free cash flow to net income for the last-12 months. The company ranks 37th in selling, general, & administrative expenses, as expenses overshadow the company’s minimal revenues. The revenue 3-year CAGR metric ranks 33. The company has no visible research & development activity which ranks it at number 30. The company’s use of debt ranks it number 12 in the debt-to-equity ratio and number 25 in the cash-to-debt ratio.

The company announced on its February 10, 2011 earnings release that the actual costs of building the plant is not the $410 million figure disclosed in its previous quarterly report for its second fiscal quarter of 2011. In the company’s Form 10-Q for the period ended September 30, 2010 filed on November 8, 2010, the company said,

We previously estimated the total cost for construction of approximately $410 million; however we have now determined that the total costs will be greater than our previous estimates.

How much greater was not disclosed in its second quarter filing of fiscal 2011. The current estimate for the cost of facility is now $600 million to complete Phase I of 2,500 metric ton (MT) of capacity. Phase II with the complete capacity of 4,000 MT will cost another $100 million to complete. All told the $700 million dollar price tag is 70.7% more than its previous estimate, significantly greater than previous estimates.

In its 2011 fiscal third quarter earnings release filed in Form 8-K on February 10, 2011, the company’s CEO said,

Construction activities continued during our third quarter at the fastest clip since we broke ground in 2007, averaging more than 500 construction craftsmen on-site every working day, and spending nearly $20 million each month in construction costs alone. Most of the major process equipment has been delivered to the site and installed, including all sixteen of our polysilicon deposition reactors to enable production of 2,500 metric tons of polysilicon per year. Detailed engineering and procurement is substantially complete – the remaining work is primarily construction, mostly piping and electrical. That said, we are behind schedule, and we are over budget.

The company’s lack of capital early in the construction process led to significant delays in the company’s ability to ramp up production. The perpetual delay of the commencement of productions operations was extended by an additional three to six months. The earliest estimated date for production commencement is July 2011.

The company dismissed Ernst & Young as its auditor on November 29, 2010. The company did not provide a reason for the change, and Ernst & Young responded to the announcement with a standard letter in agreement with disclosure. The only issue of note was the company managed to avoid a going a concern opinion from its auditor, Ernst & Young with an additional financing of $43.1 million while filing an NT for its 2010 annual report. The company announced KPMG will audit its 2011 annual financial statements.

Additional analysis of Hoku Corp. and its peer group can be found here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.