Daqo New Energy Corp. (DQ) Q3 2014 Earnings Report, Transcript and Summary

Good morning and welcome to the Daqo New Energy Third Quarter 2014 Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to CFO, Mr. Bing Sun. Please go ahead.

Thank you, everybody, for joining us today for Daqo New Energy's third quarter 2014 unaudited financial results conference call. Daqo New Energy just issued its financial results for the third quarter 2014, which can be found on the company's website. To facilitate today's conference call, we have also prepared 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 third 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.

Thank you, Bing. Thank you, all, for joining the conference call. We are excited to report another successful quarter, which delivered the best ever results in our Xinjiang polysilicon facilities in terms of cost of structure, production volume and shipments and the record third consecutive profitable quarter. In the third quarter of 2014, our operation team in our Xinjiang facilities did excellent job to further optimize the manufacturing process and improve production efficiency and as a result achieved a record high quarterly production volume of 1,748 metric tons without adding any additional equipment in such quarter. As a result, our total production cost was recorded to $13.05 per kilo with the cash cost of $10.72 per kilo. We expect to continue to produce polysilicon in our Xinjiang facilities at this output level, which exceeds our nameplate capacity by 9%. We believe we will continue to maintain this level of production cost until our existing capacities are upgraded to our new hydrochlorination system, which we expect will further lower our production cost to $12 per kilo by end of the second quarter of 2015. In the third quarter of 2014, we shipped 1,598 metric tons polysilicon, increasing from 1,436 metric tons in the previous quarter. We also shipped 18.5 million pieces of wafer, increasing from 17.6 million pieces in the previous quarter. We achieved EBITDA margin of 34.7% and positive operating income of $9.5 million. Our net income attributable to Daqo shareholders was $5.9 million, up from $4.5 million in the second quarter of 2014. As for polysilicon expansion project in Xinjiang, we are on track with the construction and installation work. We expect to fully ramp up the capacity to 12,150 metric tons by end of second quarter 2015 and thereafter reduce our cost to about $12 per kilo. In the third quarter of 2014, the average selling price or ASP for polysilicon was $21.50 per kilo compared to $22.04 per kilo in the second quarter of 2014. In spite of ASP decreasing, we were still able to expand our gross margin due to our continuous cost reduction efforts. We believe the end-market demand in the fourth quarter is likely to be strong. We also believe the positive trend in terms of end-market demand will likely continue into early next year, as we expect the demand in the first quarter of 2015 to be strong in the UK and Japan markets. In mid August, the Chinese government announced that starting from September 1, 2014, the application for solar grade polysilicon processing trade import would be suspended and all existing agreements approved beforehand could remain valid until the end of 2014. As a result, we have seen foreign polysilicon makers increasing their supply of polysilicon into China. However, we do not expect that such behavior by foreign polysilicon makers can continue indefinitely as the Chinese government adopts new regulations for polysilicon import in the future. For the fourth quarter of 2014, we company expects to ship 1,500 metric tons to 1,550 metric tons of polysilicon. The company also expects to ship approximately 16.8 million to 17 million pieces of wafers. We believe that Daqo currently has the lowest cost structure within our industry and first-class quality polysilicon manufacturing facilities. We believe it is difficult for our competitors to replicate our growth and achieve the consistent cost reductions we have achieved. Looking forward, with our current and future expansion and progressive cost reduction roadmap, we believe we are paving the way to become a truly global leader in the industry. I will now turn the call to Mr. Bing Sun to provide updates on financial performance.

Thank you, Dr. Yao. Let's move through the Q3 financial performance. Revenue was $47.3 million, increasing from $43.7 million in the second quarter. The company generated revenue of $32.8 million from polysilicon, increasing from $31 million in the second quarter. The increase from the second quarter was primarily due to higher sales volumes offset by lower ASP. While ASP decreased from $22.04 per kilo in Q2 to $21.50 per kilo in Q3, sales volume increased from 1,406 metric ton in Q2 to 1,528 metric ton in Q3. The company generated $14.5 million from sales of wafers compared to $12.7 million in the second quarter. The increase from the second quarter was primarily due to the increased proportion of sales of internally produced wafers versus wafer OEM. In Q2, we sold a total 18 million pieces of wafer, including 7.6 million pieces of wafer OEM. In Q3, we sold a total of 17 million pieces of wafer including 1.2 million pieces of wafer OEM. Note that after the end of Q3, we have 104 million pieces of wafer in general, which was not including in Q3 revenue. Gross profit was $11.6 million compared to $10.1 million in the second quarter. Gross margin was 24.5% compared to 23.1% in the second quarter. In spite of the ASP decrease, we were still able to expand our gross margin due to our continuous cost reduction efforts In the third quarter of 2014, total costs related to non-operational Chongqing polysilicon plant including depreciation were $3.4 million compared to $3.4 million in the second quarter. Excluding such costs, the non-GAAP gross margin was approximately 31.7% compared to 30.9% in the second quarter. On a standalone basis, non-GAAP gross margin for Xinjiang polysilicon facilities was 42.5% in Q3 compared to 39.6% in Q2. Non-GAAP gross margin for wafer facilities was 7.6% in Q3 compared to 10.6% in Q2. The increase in polysilicon gross margin was due to the cost down efforts. The decrease in wafer margin was due to the change in mixture between OEM wafer and internally-made wafer and also due to the slight decrease in wafer ASP. SG&A expenses were $2.5 million compared to $1.5 million in the second quarter. Included in SG&A expenses were reversal of bad debt provision of $500,000 in the third quarter compared to $1.6 million in the second quarter, due to the subsequent collection of certain long aging outstanding accounts receivables from the prior periods. As a result, operating income was $9.5 million compared to $8.3 million in the second quarter. Operating margin was 20% compared to 19.1% in the second quarter. EBITDA was $16.4 million for the quarter compared to $15.2 million in the second quarter. EBITDA margin was 34.7% for the quarter compared to 34.9% in the second quarter. The improvement for EBITDA compared to the second quarter is primarily due to the efforts on polysilicon manufacturing. Net income attributable to Daqo New Energy shareholders was $5.9 million compared to $4.5 million in the second quarter. Income per ADS was $0.66 compared to income per ADS of $0.57 in the second quarter. Note that basic outstanding ADS shares increased from 7.9 million shares in the second quarter to 8.9 million shares in the third quarter due to the follow-on offering in May 2014. Financial conditions. As of September 30, 2014, the company had $30 million in cash, cash equivalents and restricted cash compared to $77.7 million as of June 30. The decrease in cash from last quarter is due to the scheduled payment of polysilicon expansion project in Xinjiang. As of September 30, 2014, $63.7 million for capital expenditure has been spent on Xinjiang expansion, among which $35.2 million was spent in Q3 of 2014. As of September 30, 2014, accounts receivable balance was $6.8 million compared to $6.8 million as of June 30. Notes receivable balance was $36.8 million compared to $33.6 million as of June 30. Total borrowings were $246.4 million, of which $116.6 million were long-term borrowings, compared to total borrowing of $253.4 million including $112.1 million in long-term borrowings as of June 30. Cash Flows. For the nine months ended September 30, 2014, net cash provided by operating activities was $47.7 million compared to net cash used in operating activities of $16.8 million in the same period of 2013. Net cash provided by operating activities in Q3 was $18.6 million compared to $13.9 million in Q2 of 2014. For the nine months ended September 30, 2014, net cash used in investing activities was $81 million compared to $12.1 million in the same period of 2013. The cash used in investing activities are mainly related to our expansion projects in Xinjiang polysilicon facilities. For the nine months ended September 30, 2014, net cash provided by financing activities was $38.1 million compared to $33.1 million in the same period of 2013. And that concludes the official part of our presentation. Now let's have the Q&A session. Dan?

(Operator Instructions) The first question comes from Philip Shen of ROTH Capital Partners.

I'd like to start off with understanding where ASPs might go in Q4 and Q1. Given the demand outlook you have for Q4 and the early part of next year along with the poly being imported into China under the processing trade rules, how do you expect poly ASPs to trend in Q4 and into Q1?

Currently, as we just announced that the poly ASP is around $21.50 more or less. And you know that in the mid-August, China announced that starting from September 1st the application for solar grade polysilicon processing trade imports would be suspended and all existing agreements approved beforehand could remain valid until the end of 2014. So the foreign polysilicon makers significantly increased their supply into China recently. Even though the poly ASP does not increase much, we heard from our customers and other different channels that the end-market demand in the fourth quarter is very strong. Capacities of top-tier downstream manufacturers have almost been sold out. And the poly trend we believe will very much likely continue to early next year, as demand in the first quarter could be quite strong in the markets such as UK and Japan. Also we expect as Chinese government adopts the new regulation for polysilicon imports starting from next year and the market remains its positive trend, the poly ASP will be strongly supported at the current level. So in general, we don't see much additional poly supply will come to market in the next year. We believe the growth offering will keep the supply/demand in balance and we believe the polysilicon ASP will likely to remain in the range of $20 per kilo to $25 per kilo for the whole year of 2015, and I'm sure that Yao can expand on that.

In operation side, I think our Q4 we'll continue our efforts to the costs down. And as you know, we already achieved the level of $13 per kilo with the current technology before upgrading to hydrochlorination. We have a very limited to room to further keep costs down, but we still have our efforts to, at this cost level, increasing upward for Q4 from Q3 level. As we said, the level is 9% above the nameplate of the capacity for our first phase for Xinjiang facility. So it stays at 6,150 metric ton per year. So we will achieve that more than like almost 10%. So that's our plan so far. And looking for next year, if process trading, as Bing said, will be terminated by next year as the Chinese government indicated, so we expect the supply for polysilicon in Chinese market will be reduced next year from Q1, and in that sense, with the strong support for polysilicon price. And we still believe the demand for downstreaming will be strong in early next year.

Given the high-quality poly that you guys produce, we can imagine that tier-1 customers would likely do more business with you, especially as you expand to 12,000 metric tons. Can you update us on some of the discussions and dynamics you're experiencing with some of your existing customers and potential new customers?

Within the next year, because our second phase will be in line by second quarter, we're trying to ramp up the full capacity. So our 2015 capacity already booked with long-term contract by more than 50%. And in also 50%, our capacity in the 2016 also is secured with long-term contracts and with only three customers so far. So there are more customers talking with us to establish or continue our supply customer relationship. So we still have some room to sign more contracts for 2015 and 2016. But our experience is if more than 50% is signed, I think our demand in the market, as usual like 2013, 2014, we also signed a similar amount of contracts with customers so far. Our inventory level and the historical data shows that. So we believe next two years, our production volume can be securely signed off with our major customers we are doing business with right now. So very optimistic about the added capacity will be shipped in the future for next two years.

We have already signed 60% of our 2015 capacity with long-term contracts with customers and 50% of our 2016 capacity.

The next question comes from Pranab Sarmah from AM Capital.

Congratulations on cutting down your polysilicon product cost to very significant level. I'm a little bit curious, you have cut more than $1 cash cost over one quarter, so how could you manage to do that. Could you explain a little bit of tricks you have done so far?

So what have we done from Q2 to Q3 is actually we increased our TCS production efficiency mainly with the hydrogenation process. Our converters, we call it, are converting the silicon chloride to TCS. Our efficiency and also our volume to conversion is both improved. So there are two effects by doing that. There's two good benefits. One is greatly reduced silicon consumption for the polysilicon manufacturer. We call it silicon MGS consumptions, reduced. Secondly, we also increased the production volume. As you see, we have been improving to the 9% above our nameplate capacity. So for the volume output improvement will reduce depreciation or the fixed costs and some of cost production cash cost as well. And for the TCS efficiency improvement will reduce silicon consumption in terms of cash cost were hugely reduced. Of course when you improve the output, you also reduce the labor cost, et cetera, to normally near increasing amount. So that's why we reduced like $1. But remember, if I compare with Q2, also Q2 had absorbed the shutdown maintenance cost for about one week. So within Q3, we did not have that shutdown as well. So if you compare with Q2 number, that's why we have about $1 reduction.

You have done a very good job in cutting the product cost. Probably you are in target to get your whole production cost target by mid-next year. But still 2,000 ton capacity, you are relatively much smaller player compared the global peers. So what do we look at basically to get a visibility in the global market? It should have a much higher capacity than 12,000 tons. So what your management is thinking on the top level, on Board level, how should you go about that?

We're just focusing on our current expansion trend. We want to execute this current expansion plan well and to get our cost down to $12 level by end of Q2 next year. So that's our current focus right now.

According to current cost, I think our hydrogenation process at this level is probably the best in the industry already. We've upgraded to hydrochlorination process. We still have at least $1 cost down by next year. So this is our focus. I think we already demonstrated that within even 6,000 metric ton capacity, we're doing a cost of about $13 level, so we have a high confidence that with 12,000 metric ton capacity, we can reduce to like at least to $12 per kilo level. That would put us truly in the leader of the cost for the polysilicon manufacturers worldwide.

What is the wafer ASP for 3Q? And do you have any plans for the wafer business, like are you likely to maintain the status quo or you want to expand a bit on there?

For now, we don't have any plans to expand our current wafer capacity. Regarding your question on ASP, ASP per wafer is about $0.87. So Q3 gross margin was 7.6%, which was down a little bit from 10.6% from the second quarter.

So the ASPs are $0.87.

Our next question comes from Pierre Maccagno from Dougherty.

To move from $13 to $12 per kilogram, what are the things that you have to do to achieve that?

Pierre, according to our plan, we upgraded our technology for hydrogenation to hydrochlorination. So we've already reduced about 30% of electricity consumption, which is the major portion of our cash cost right now. As utility costs, electricity, water, steam is our 50% of cash cost. So if we reduced electricity by 30% or we easily can reduce around RMB10, which is equivalent to $1.5 for our current level. So if we can continue our current other performance, if we reduce our 30% of electricity cost, we can easily achieve $12 level. So that's our plan in the cost of structure for next year. Next year, we have two areas we have done before end of Q2. One is bringing our new technology hydrochlorination online for all 12,000 metric tons. And second, of course, we have additional 6,000 metric ton manufacturing capacity.

So the hydrochlorination is not fully ramped as of the third quarter, correct?

No, hydrochlorination would start running the early next year and would be ramped up 100% by second quarter of 2015.

This third quarter, the cost reduction had nothing to do with the hydrochlorination?

No, nothing to do with that. That's the current best performance compared with the second quarter, because we have about one week shutdown for maintenance. So that's why we have improvement. But our major is utilization for silicon or TCS production cost down, causing this cash cost down. And also, as I mentioned, we also improved output for Q3 compared with Q2. This brought our depreciation down too as well.

And could you remind on the polysilicon gross margin?

Polysilicon gross margin, Pierre, like we just talked about, 42.5% on a standalone basis compared to 39.6% in Q2.

And the CapEx for the quarter?

CapEx for the quarter, that's $35.2 million. We spent a total of $63.7 million. For this quarter, we spent $35.2 million. $35.2 million was included in the total of $63.7 million, Pierre.

This $63.7 million includes the last quarter?

For the historical total, total we spent on the Xinjiang project.

It's the total spend up to Q3. Within Q3, we spent $35.2 million.

So regarding wafers, I guess the demand for stronger or do you see that demand increasing?

Wafer demand is very strong. And like this quarter, we believe all our production will be totally sold out.

We also see a very slight increase in the ASP.

Our next question comes from Vincent Chi of SWS Research.

You guys have spent a lot of cash in Q3, which means you have already pushed a lot of improvements here. So could you give us more details in terms of your capacity expansion side for next year?

Right now we're still doing some on-site construction work. And at this moment, Xinjiang's temperature is very close to about zero. So we can do some welding things, but we still do some maybe not really critical welding. After minus-5 degree Celsius, we cannot do much welding, but we still can do other construction work right now. After Christmas, where most of work will be done in-house installation. So during the whole winter, a lot of in-house installation will continue until everything, installation is completed. So the construction, as we said, the project is still on track within the schedule, and we plan for something will be done before the cold weather happening, which we're expecting by end of November. And the all construction work should be completely finished. Expansion will on track. That's why Q3 spending is high, because we're trying to ship into on-site.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Bing Sun for any closing remarks.

Okay. Thanks again, everybody. And as always if you guys have any questions, feel free to contact me directly or you may call Kevin He. Thanks again and bye bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.