Earnings Call Transcript - DQ Q3 2020

Operator, Operator

Hello, and welcome to the Daqo Energy Third Quarter 2020 Results Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Kevin He, Investor Relations for Daqo Energy. Please go ahead.

Kevin He, Investor Relations

Hello, everyone. I’m Kevin He, the Investor Relations of Daqo New Energy. Thank you for joining our conference call today. Daqo New Energy just issued its financial results for the third quarter of 2020, which can be found on our website at www.dqsolar.com. To facilitate today’s conference call, we have also prepared a PPT presentation for your reference. Today, attending the conference call, we have Mr. Longgen Zhang, our Chief Executive Officer; and Mr. Ming Yang, our Chief Financial Officer. The call today will feature an update from Mr. Zhang on market and operations, and then Mr. Yang will discuss the company’s financial performance for the third quarter of 2020. After that, we will open the floor to Q&A from the audience. Before we begin the formal remarks, I would like to remind you that certain statements on today’s call, including expected future operational and financial performance and industry growth, are forward-looking statements that are made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those contained in any forward-looking statements. Further information regarding these and other risks is included in the reports or documents we have filed with or furnished to the Securities and Exchange Commission. These statements only reflect our current and preliminary view as of today and may be subject to change. Our ability to achieve these projections is subject to risks and uncertainties. All information provided in today’s call is as of today, and we undertake no duty to update such information, except as required under applicable law. Also during the call, we will occasionally reference monetary amounts in U.S. dollar terms. Please keep in mind that our functional currency is the Chinese RMB. We offer these translations into U.S. dollars solely for the convenience of the audience. Without further ado, I now turn the call over to our CEO, Mr. Zhang. Please proceed, Longgen.

Longgen Zhang, CEO

Thank you, Kevin. Hello, everyone. Thank you for joining our conference call today. During the third quarter of 2020, we successfully completed the annual maintenance and several technology improvement projects at our polysilicon manufacturing facilities. We have resumed full production in August with excellent operational results. For the third quarter, we produced 18,406 metric tons of polysilicon, among which approximately 97.7% was mono-grade. We continued our relentless drive to lower production costs and reached a record-low cost in Renminbi terms. During the third quarter, we completed our digital transformation project, resulting in a fully digitized manufacturing system that allows us to continuously improve our process control and analyze our manufacturing data to achieve better results in system stability, manufacturing efficiencies, production costs, and product quality in the future. As our facilities are now running with increased efficiency, we expect to achieve a higher production volume of approximately 19,500 to 20,500 metric tons in the fourth quarter, with a potential cost reduction of approximately 3% compared to the third quarter. During the quarter, polysilicon ASPs increased rapidly due to the quick recovery in solar PV demand from both domestic and foreign markets. Our ASP was $9.13 per kg, a significant improvement from approximately $7.04 per kg in the second quarter. With robust market demand for mono-grade polysilicon, we expect our ASP to improve meaningfully in the fourth quarter compared to the third quarter. In recent weeks, due to strong solar module and installation demand, we began to see a solar glass capacity shortage becoming a bottleneck for the solar industry and limiting module production. We expect the shortage of solar glass to ease over the coming months as additional solar glass capacity comes online. The temporary constraint on the industry’s utilization rate will be removed, which will eventually increase demand for polysilicon. Solar is now becoming one of the most competitive sources of energy, even compared to traditional power generation methods. Globally, we are seeing strong momentum in adopting and implementing renewable energy policies that would strongly benefit the solar end market. Last month, Mr. Xi Jinping, the President of China, announced China’s initiative to scale up national contributions to peak carbon dioxide emissions by 2030 and achieve carbon neutrality by 2060. We believe favorable policies benefiting solar will be implemented during the upcoming 14th five-year-plan, driving a substantial increase in solar installations in China. Additionally, a growing number of countries and regions, including the most important economies in the world, have announced goals and plans to reduce carbon emissions and widely adopt renewable energies. In particular, we are starting to see the trend of utility-scale solar generation combined with power storage providing base-load energy and displacing coal power plants. We believe this is the beginning of solar displacing traditional fossil-fuel-based generation driven by economics and renewable energy mandates. We are strongly committed to contributing our efforts as a raw material provider for mainstream solar PV modules, and we are fully confident that we will benefit from this fast-growing market. Now I will discuss outlook and guidance for our company. The company expects to produce approximately 19,500 to 20,500 metric tons of polysilicon and sell approximately 20,500 to 21,500 metric tons of polysilicon to external clients during the fourth quarter of 2020. For the full year of 2020, the company expects to produce approximately 75,800 metric tons to 76,800 metric tons of polysilicon, including the impact of the company’s annual facility maintenance.

Ming Yang, CFO

Thank you, Longgen, and hello, everyone. Thank you for joining our call today. Now I will discuss our company’s financial performance for the third quarter of 2020. Revenues were $125.5 million, compared to $133.5 million in the second quarter of 2020 and $83.9 million in the third quarter of 2019. The sequential decrease in revenue was primarily due to lower polysilicon sales volume despite higher average selling prices. Gross profit was $45.3 million, compared to $22.7 million in the second quarter of 2020 and $18.1 million in the third quarter of 2019. Gross margin was 36%, compared to 17% in the second quarter of 2020 and 21.5% in the third quarter of 2019. The increase in gross margin was primarily due to improvement in production costs and higher ASP. Selling, general, and administrative expenses were $9.2 million, compared to $10.1 million in the second quarter of 2020 and $8.2 million in the third quarter of 2019. SG&A expenses during the quarter included $4 million in non-cash share-based compensation costs related to the company’s share incentive plan. Research and development expenses were $1.7 million, compared to $2 million in the second quarter of 2020 and $1.2 million in the third quarter of 2019. R&D expenses can vary from period to period and reflect R&D activities that take place during the quarter. As a result of the foregoing, income from operations was $33.3 million, compared to $10.8 million in the second quarter of 2020 and $8.8 million in the third quarter of 2019. Operating margin was 26.6%, compared to 8.1% in the second quarter of 2020 and 10.5% in the third quarter of 2019. Interest expense was $5.4 million, compared to $6.7 million in the second quarter of 2020 and $2.6 million in the third quarter of 2019. EBITDA for the quarter was $51.6 million, compared to $26.8 million in the second quarter of 2020 and $19.7 million in the third quarter of 2019. EBITDA margin was 41.1%, compared to 20.0% in the second quarter of 2020 and 23.5% in the third quarter of 2019. Net income attributable to Daqo New Energy shareholders was $20.8 million in the third quarter of 2020, compared to $2.4 million in the second quarter of 2020 and $5 million in the third quarter of 2019. Earnings per basic ADS was $0.29 in the third quarter of 2020, compared to $0.03 in the second quarter of 2020, and $0.07 in the third quarter of 2019. Now for the company’s financial condition. As of September 30, 2020, the company had $109.8 million in cash and cash equivalents and restricted cash, compared to $115.8 million as of June 30, 2020. As of September 30, 2020, the notes receivable balance was $1.9 million, compared to $8.2 million as of June 30, 2020. As of September 30, 2020, total borrowings were $271 million, of which $140 million were long-term borrowings, compared to total borrowings of $264.8 million, including $116.9 million as long-term borrowings, as of June 30, 2020. For the nine months ended September 30, 2020, net cash provided by operating activities was $71.1 million, compared to $101.6 million in the same period of 2019. For the nine months ended September 30, 2020, net cash used in investing activities was $80.3 million, compared to $202.3 million in the same period of 2019. The net cash used in investing activities in 2020 and 2019 was primarily related to capital expenditures on our Phase 3B and Phase 4A polysilicon projects. For the nine months ended September 30, 2020, net cash provided by financing activities was $1.1 million, compared to $76.6 million in the same period of 2019. And that concludes our prepared remarks. We will now open the call to questions from the audience. Operator, please begin.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Gary Zhou of Credit Suisse. Please go ahead.

Gary Zhou, Analyst

Thanks, management. Congratulations on the strong results. So, this is Gary from CS. I have three questions. Firstly, on your cost reduction guidance for the fourth quarter, which is down around 3% quarter-on-quarter. May I ask, is this production cost or cash cost? And are these based on RMB terms or U.S. dollar terms? Secondly, I noticed that in the third quarter this year there was, based on my calculations, around 4,700 metric tons of inventory tie-up if I simply calculate the difference between your production cost and the sales volume. Looking at the fourth quarter guidance, your sales volume is only about 1,000 metric tons higher than your production volume. Is it company strategy to think it is reasonable to have some inventory given the potentially very strong polysilicon demand next year? Lastly, do you expect to see more trends regarding long-term polysilicon contracts in the future? Recently, we’ve seen some news from your peers typically starting to secure their polysilicon supply for the next year. Thank you.

Ming Yang, CFO

Hello, Gary. Thank you for your question. Regarding your question about the 3% cost reduction quarter-on-quarter, that would be in all U.S. dollar terms. For this particular quarter, Q4 relative to Q3, there are actually two headwinds: one is the U.S. dollar exchange rate, which has changed significantly during the quarter, and the other is some increase of the multi-grade silicon costs. But even with these two increases, we still expect about a 3% reduction in cost in U.S. dollar terms because of our increased manufacturing efficiency and especially reduction in our energy usage. As for the third quarter in terms of inventory, I think your numbers are fairly close to our actual numbers. Every quarter, we use about 500 to 600 metric tons of our own polysilicon to manufacture silicon seed rods, which we then reuse in our production of polysilicon to keep our costs low. So considering that impact, we expect to draw down approximately 1,500 to maybe over 2,000 tons of inventory. I believe overall demand for mono-grade polysilicon is strong from our customers. There is some impact from the glass shortage, which is affecting the overall industry utilization and module volume shipments. If there weren’t a glass shortage, we would see even better demand for polysilicon. But overall, transaction volume is very healthy for the industry currently. For long-term contracts, Longgen will take this question.

Longgen Zhang, CEO

Gary, regarding your second question about inventory, we believe right now that downstream capacity has expanded so quickly, and we see signs of continued demand in Q4. Our guidance is slightly conservative because we believe we can, by the end of Q3, move more than 5,500 metric tons. We will sell more than our production, and it’s possible to shift some production to next year. Regarding high ASP, we are focused on market value evaluation. Secondly, concerning long-term contracts, we currently have agreements with three clients: LONGi, Shangji, and Jinko, and we collect deposits from 3.5% to 6%. We anticipate signing one or two more long-term contracts that will cover three years. Many clients want to secure long-term agreements with us, especially since no additional capacity is expected before the end of next year while demand continues to increase. However, to initiate a long-term contract, we require a minimum three-year commitment and a lower initial quantity, with the understanding that quantity will increase in future years. Therefore, we’ve implemented a 4% deposit requirement for those contracts to ensure commitment.

Gary Zhou, Analyst

Thank you very much, management. Just to quickly follow up on the first question: If I calculate the exchange rate, I think that in Q4, the RMB may appreciate versus the U.S. dollar by roughly around 3% to 4%. Is it fair to say that in RMB terms, we are expecting almost a 7% quarter-on-quarter cost reduction in Q4? And what is our expectation for further cost reductions into next year? Thank you.

Longgen Zhang, CEO

I think, Gary, if you look at our Q3, the cash cost is $4.88 compared to Q2's $4.87. However, for the U.S. dollar, the cash cost has increased. But in terms of Renminbi, our cash cost is RMB33.75 per kg compared to RMB34.53 per kg in Q2. The production cost is RMB40.3 per kg compared to RMB41.04 per kg in Q2. So, yes, if costs continue to decrease combined with RMB appreciation, we will see further reductions. Ming, do you have any additional input?

Ming Yang, CFO

Yes, Gary, you're correct. We expect approximately a 7% cost reduction in RMB terms for Q4.

Gary Zhou, Analyst

Okay, thank you very much. That's all my questions.

Operator, Operator

The next question comes from Alan Han of JPMorgan. Please go ahead.

Alan Han, Analyst

This is Alan from JPMorgan. I have a couple of minor questions on the ASP side of things. In the third quarter of this year, your average ASP selling price was around $9.13 per kilogram, which is slightly lower than what we have been seeing in the spot market. I’d like to understand why? Also, what’s the price outlook for Q4 and 2021?

Longgen Zhang, CEO

Our Q3 ASP is $9.13 per kg. Most of this pricing was determined based on contracts signed earlier, while higher pricing was only recognized in September. This lag can cause our average to fall below spot pricing. In Q4, we expect prices to significantly increase as costs continue to decrease, resulting in improved gross margins. Regarding the pricing outlook for 2021, we anticipate that during Q1, the selling price will range between RMB82 to RMB85 but could increase due to the glass capacity limitations. By the second and third quarters, we believe prices will be above RMB90, potentially reaching upwards of RMB100.

Alan Han, Analyst

Got it. And just one more follow-up question on the technology front, concerning FBR technology. What is your sense on the competitive threat of FBR technology?

Longgen Zhang, CEO

Currently, FBR technology is being utilized by only one company in China, and there are quality concerns regarding high sodium and carbon content, which results in lower quality products classified as multi-silicon. Therefore, we don't believe FBR will replace the modified Siemens process in the short term. The cash costs are still too high compared to the prices we observe.

Alan Han, Analyst

Understood. Thank you for your answers.

Longgen Zhang, CEO

Thank you.

Ming Yang, CFO

Great, thank you, Alan.

Operator, Operator

The next question comes from Philip Shen of ROTH Capital Partners. Please go ahead.

Philip Shen, Analyst

Hi, thank you for taking my questions. What is the outlook for 2021 volume? While you’re not providing official guidance, do you think you can achieve a run rate of about 80,000 metric tons, or is there potential upside?

Longgen Zhang, CEO

It's too early to provide guidance for 2021. Your projection is correct in terms of our current capacity, but we expect to continually improve operational efficiencies. We will provide more precise guidance in future earnings calls.

Philip Shen, Analyst

Thank you. Regarding capacity expansion, how are you thinking about this with respect to pricing and the potential IPO proceeds?

Longgen Zhang, CEO

We are actively working on our listing in the STAR Market, which we hope will occur before the end of Q1 2020. The IPO proceeds will enable us to continue with the expansion project of 40,000 metric tons, which we expect to begin trial production before the end of next year, leading to full capacity by Q1 2022.

Philip Shen, Analyst

Great, thank you. Can you please discuss the recent increase in pricing for metallurgical grade silicon?

Ming Yang, CFO

The increase in metallurgical grade silicon pricing is due to rising demand as the economy recovers and seasonality in winter production. Currently, prices are approximately 5% to 7% higher than in the previous quarter. We can absorb this into our overall cost and still forecast further cost reduction due to improved manufacturing efficiencies.

Philip Shen, Analyst

Will the pressure from metallurgical grade silicon pricing ease starting in Q2?

Ming Yang, CFO

Yes, we believe that Q1 will maintain the current cost levels, but expect a drop in prices in Q2.

Philip Shen, Analyst

Okay, that's it for me. Thanks.

Longgen Zhang, CEO

Great, thank you.

Ming Yang, CFO

Thank you, Phil.

Operator, Operator

The next question comes from Tony Fei with BOCI Research. Please go ahead.

Tony Fei, Analyst

Hi management, this is Tony Fei from BOCI. I have three questions. First, regarding your long-term contracts, do you experience any financial consequences from delayed agreements with your wafer customer? Will this happen again? Secondly, I’d like to hear an update on your certification process for N-type polysilicon amid HJT capacity ramp-ups. Lastly, will you continue to pay down debt given your strong operating cash flow?

Longgen Zhang, CEO

Most long-term contracts today in China do not lock in prices, just quantities. Even if there are delays, it’s rooted in establishing long-term relationships. So far, we've collected deposits from 3% to 6% to help ensure commitment on these contracts. For HJT and N-type silicon, the equipment cost remains high, but we’ve had some inquiries and demand is increasing. Our focus remains on delivering the best quality P-type polysilicon. We expect to expand our manufacturing for N-type if the equipment cost decreases. Regarding debt reduction, as our EBITDA increases, we will reduce leverage ratios and pay down loans while preparing for future expansions.

Tony Fei, Analyst

Yes, thank you for the clarification.

Ming Yang, CFO

Thank you.

Operator, Operator

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

Kevin He, Investor Relations

Thank you, everyone, again, for participating in today’s conference call. Should you have any further questions, please don’t hesitate to contact us. Thank you, and goodbye.

Operator, Operator

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