20-F 1 v371885_20f.htm FORM 20-F

 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________

 

FORM 20-F

____________________

(Mark One)

 

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________

 

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report __________

 

Commission file number: 001-34602

 

____________________

 

DAQO NEW ENERGY CORP.
(Exact name of Registrant as specified in its charter)

 

____________________

 

N/A

(Translation of Registrant’s name into English)

 

Cayman Islands

(Jurisdiction of incorporation or organization)

 

666 Longdu Avenue

Wanzhou, Chongqing F4 404000

The People’s Republic of China

(Address of principal executive offices)

 

Bing Sun, Chief Financial Officer

Tel: +(86 23) 6486 6666

Fax: +(86 23) 6486 6688

666 Longdu Avenue

Wanzhou, Chongqing F4 404000

The People’s Republic of China

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

 
 


 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of Each Class

Name of Exchange on Which Registered

American depositary shares, each representing 25 ordinary shares New York Stock Exchange
Ordinary shares, par value US$0.0001 per share*  
   
 

 

*Not for trading, but only in connection with the listing on New York Stock Exchange of the American depositary shares.

 

____________________

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None
(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None
(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 173,427,853 ordinary shares, par value US$0.0001 per share, as of December 31, 2013.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.    Yes      No  

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes       No  

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   Accelerated filer   Non-accelerated filer  

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP   International Financial Reporting Standards as issued by the International Accounting Standards Board   Other  

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.    Item 17      Item 18  

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

 

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes      No  

 

 
 

 

TABLE OF CONTENTS

 

INTRODUCTION 1
FORWARD-LOOKING STATEMENTS 1
PART I 2
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 2
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 2
ITEM 3. KEY INFORMATION 2
ITEM 4. INFORMATION ON THE COMPANY 29
ITEM 4A. UNRESOLVED STAFF COMMENTS 44
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 44
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 63
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 73
ITEM 8. FINANCIAL INFORMATION 75
ITEM 9. THE OFFER AND LISTING 76
ITEM 10. ADDITIONAL INFORMATION 77
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 85
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 86
PART II 88
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 88
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 88
ITEM 15. CONTROLS AND PROCEDURES 88
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 89
ITEM 16B. CODE OF ETHICS 89
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 89
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 89
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 89
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 90
ITEM 16G. CORPORATE GOVERNANCE 90
ITEM 16H. MINE SAFETY DISCLOSURE 90
PART III 90
ITEM 17. FINANCIAL STATEMENTS 90
ITEM 18. FINANCIAL STATEMENTS 90
ITEM 19. EXHIBITS 90
SIGNATURES 93

 

i
 

 

INTRODUCTION

 

Except where the context otherwise requires:

 

·“we,” “us,” “our company,” “our” and “Daqo Cayman” refer to Daqo New Energy Corp., its subsidiaries and, until December 30, 2013, its consolidated variable interest entity,

 

·“ADSs” refers to our American depositary shares, each of which represents 25 ordinary shares. On December 21, 2012, we effected a change of the ADS to ordinary share ratio from one ADS representing five ordinary shares to one ADS representing 25 ordinary shares. The ratio change had the same effect as a 1-for-5 reverse ADS split,

 

·“China” or “PRC” refers to the People’s Republic of China, excluding, for the purpose of this annual report only, Taiwan, Hong Kong and Macau,

 

·“shares” or “ordinary shares” refers to our ordinary shares, par value $0.0001 per share, and

 

·“RMB” or “Renminbi” refers to the legal currency of China; “$,” “dollars” or “U.S. dollars” refers to the legal currency of the United States; and “EUR” or “Euro” refers to the legal currency of the European Union.

 

Our financial statements are expressed in U.S. dollars, which is our reporting currency. Certain of our financial data in this annual report on Form 20-F are translated into U.S. dollars solely for the reader’s convenience. Unless otherwise noted, all convenience translations from Renminbi to U.S. dollars in this annual report on Form 20-F were made at a rate of RMB6.0537 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on December 31, 2013. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, at the rate stated above, or at all.

 

FORWARD-LOOKING STATEMENTS

 

This annual report on Form 20-F contains forward-looking statements that reflect our current expectations and views of future events. These forward looking statements are made under the “safe-harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. Known and unknown risks, uncertainties and other factors may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

 

You can identify some of these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include statements relating to:

 

·our business and operating strategies;

 

·our expansion and capital expenditure plans;

 

·our operations and business prospects;

 

·our financial condition and results of operations;

 

·the industry regulatory environment as well as the industry outlook generally;

 

1
 

 

·future developments in the polysilicon manufacturing and photovoltaic and semiconductor industries; and

 

·government subsidies and economic incentives for solar energy application.

 

This annual report on Form 20-F also contains estimates, projections and statistical data related to the polysilicon markets and photovoltaic industry in several countries, including China. This market data speaks as of the date it was published and includes projections that are based on a number of assumptions and are not representations of fact. If any one or more of the assumptions underlying the market data proves to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

 

The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. Except as required by U.S. federal securities law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report and the documents that we reference in this annual report and have filed as exhibits to this annual report, completely and with the understanding that our actual future results may be materially different from what we expect. Other sections of this annual report include additional factors which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.

 

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following selected data from the consolidated statement of operations for our company for the three years ended December 31, 2011, 2012 and 2013 and the balance sheet data as of December 31, 2012 and 2013 have been derived from our audited consolidated financial statements included elsewhere in this annual report. Our selected data from the consolidated statement of operations for the two years ended December 31, 2009 and 2010 and our consolidated balance sheet data as of December 31, 2009, 2010 and 2011 have been derived from our audited consolidated financial statements, which are not included in this annual report. We consolidated financial statements of Daqo New Material Co., Ltd., or Daqo New Material, from July 1, 2008 to December 30, 2013, because under Financial Accounting Standards Board Accounting Standards Codification 810-10-15, “Variable Interest Entities,” we were deemed to be Daqo New Material’s primary beneficiary for accounting purposes. As a result of the voluntary termination of our contractual arrangements with Daqo New Material, starting from December 31, 2013, Daqo New Material was de-consolidated from the balance sheet as of December 31, 2013.

 

The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, our consolidated financial statements and related notes, and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results are not necessarily indicative of results to be expected in any future period.

 

2
 

 

   Year Ended December 31, 
   2009   2010   2011   2012   2013 
   (in thousands of US$, except share, per share and per ADS data) 
Consolidated Statement of Operations Data:                    
Revenues   $111,193   $252,815   $232,170   $86,858   $109,000 
Cost of revenues    (69,252)   (144,651)   (144,946)   (124,290)   (135,103)
Gross profit (loss)    41,942    108,164    87,224    (37,432)   (26,103)
Operating expenses (1)    (5,210)   (12,530)   (36,472)   (51,086)   (174,528)
(Loss) income from operations    36,732    95,634    50,752    (88,518)   (200,631)
(Loss) income before income taxes    30,484    85,744    43,490    (102,992)   (219,819)
Income tax expense    (240)   (13,257)   (2,718)   (10,253)   (1,272)
Net (loss) income from continuing operations    30,244    72,487    40,772    (113,245)   (221,091)
Total income (loss) from discontinued operation    (308)   (3,339)   (5,858)   (2,392)   - 
Net (loss) income    29,936    69,148    34,914    (115,637)   (221,091)
Net income (loss) attributable to noncontrolling interest    (899)   576    1,590    (3,708)   (150,147)
Net income (loss) attributable to Daqo New Energy shareholders   $30,835   $65,271   $33,324   $(111,929)  $(70,944)
Earnings (loss) per ADS(2)                          
-- Continuing operations   $7.5   $12.00   $5.50   $(15.75)  $(10.25)
--Discontinued operations       $(0.50)  $(0.75)  $(0.25)    
Basic    7.5   $11.50   $4.75   $(16.00)  $(10.25)
--Continuing operations    7.5   $12.00   $5.50   $(15.75)  $(10.25)
--Discontinued operations       $(0.50)  $(0.75)  $(0.25)    
Diluted    7.5   $11.50   $4.75   $(16.00)  $(10.25)
Ordinary shares used to calculating earnings per ordinary share                          
Basic—ordinary shares    100,000,000    117,839,487    175,714,103    175,067,343    173,068,420 
Diluted—diluted shares    104,151,834    140,726,323    175,714,103    175,067,343    173,068,420 
 
 

Note:

(1)Includes share-based compensation expenses in the amount of $2.2 million, $2.2 million and $1.9 million for the years ended December 31, 2011, 2012 and 2013, respectively.

 

(2)Effective on December 21, 2012, Daqo adjusted the ratio of its American depositary shares (“ADSs”) representing ordinary shares from one (1) ADS for five (5) ordinary shares to one (1) ADSs for twenty-five (25) ordinary shares. All per ADS figures in this report give effect to the forgoing ADS to share ratio change.

 

   Year Ended December 31, 
   2009   2010   2011   2012   2013 
Other Financial and Operating Data:                         
Polysilicon production volume (in MT)    1,523    3,771    4,524    3,349 (1)    4,805 
Polysilicon sales volume (in MT)    1,498    3,650    3,947 (3)    3,262 (2) (3)    4,283 (3) 
Unit cost of polysilicon sold (in $/kg)    43.9    31.3    29.9    31.9 (2)    17.02 (4) 
 

Note:

(1)Excluding 617 MT polysilicon produced in Xinjiang facilities during the pilot production period.

 

(2)Excluding 323 MT polysilicon sold, and the cost of such polysilicon sold, as applicable, from Xinjiang facilities during the pilot production period.

 

(3)The polysilicon sales volume here only refers to external sales. Internal sales to our in-house wafer facilities were 454 MT, 315 MT and 770 MT in 2011, 2012 and 2013, respectively.

 

(4)The unit cost here only refers to the polysilicon made in Xinjiang facilities.

 

3
 

 

The following table presents a summary of our consolidated balance sheet data as of the dates set forth below:

 

    As of December 31,  
      2009       2010       2011       2012       2013  
      (in thousands of $)    
Consolidated Balance Sheet Data:                                        
Cash and cash equivalents   $ 81,414     $ 203,636     $ 92,697     $ 6,679     $ 7,831  
Restricted cash     8,810       64       11,600       10,650       8,826  
Total current assets     120,917       241,738       179,453       96,511       91,144  
Property, plant and equipment, net     399,985       399,558       636,475       677,895       488,504  
Total assets   $ 523,923     $ 650,971     $ 878,477     $ 816,308       610,200  
Short-term borrowings, including current portion of long-term borrowings   $ 43,826     $ 71,601     $ 111,805     $ 120,280     $ 118,871  
Total current liabilities     142,675       171,010       217,841       260,311       299,124  
Long-term borrowings     144,936       83,001       165,646       187,521       134,870  
Total liabilities     287,829       254,548       426,450       475,430       472,873  
Mezzanine equity     55,603                          
Total Daqo New Energy Corp. shareholders’ equity     52,496       263,481       311,178       202,106       137,327  
Noncontrolling interest     127,996       132,942       140,848       138,772        
Total equity     180,492       396,423       452,026       340,878       137,327  
Total liabilities and equity   $ 523,923     $ 650,971     $ 878,477     $ 816,308       610,200  

 

B. Capitalization and Indebtedness
   
Not applicable.
   
C. Reasons for the Offer and Use of Proceeds
   
Not applicable.
   
D. Risk Factors
   
Risks Relating to Our Business

 

Our ability to return to growth and profitability depend on the demand for photovoltaic products and the development of photovoltaic technologies, among other things.

 

The solar industry is at a relatively early stage of development, and the extent of acceptance of photovoltaic products is uncertain. The photovoltaic industry does not have data as far back as the semiconductor industry or other more established industries, for which trends can be assessed more reliably from data gathered over a longer period of time. Demand for photovoltaic products may not develop or may develop to a lesser extent than we anticipate. Many factors may affect the viability of widespread adoption of photovoltaic technology and demand for photovoltaic products, including:

 

·decreases in government subsidies and incentives to support the development of the photovoltaic industry;

 

·the international trade conflicts and the consequential imposed tariffs for solar photovoltaic, or PV, products;

 

·relative cost-effectiveness, performance and reliability of photovoltaic products compared to conventional and other renewable energy sources and products;
   
·success of other alternative energy sources, such as wind power, hydroelectric power and biofuel;

 

4
 

 

·fluctuations in economic and market conditions that affect the viability of conventional and other renewable energy sources, such as increases or decreases in the prices of oil and other fossil fuels;

 

·the ability of photovoltaic product manufacturers to finance their business operations, expansions and other capital expenditures;

 

·capital expenditures by end users of photovoltaic products, which tend to decrease when the economy slows down; and

 

·deregulation or other regulatory actions affecting the electric power industry and the broader energy industry.

 

In the event that demand for solar products does not expand as we expect or photovoltaic technologies do not develop in a manner that increases the demand for polysilicon, average selling prices may cease their current upward trend and begin moving downward, and our future growth and profitability will be materially and adversely affected.

 

After a few years of polysilicon oversupply, a number of polysilicon manufacturers with non-competitive cost structures went out of business, reducing the severity of the oversupply. But, with prices increasing, some polysilicon manufacturers may reenter the market, which could cause polysilicon prices to decline and materially and adversely affect our profitability.

 

Our polysilicon sales prices are affected by a variety of factors, including global supply and demand conditions. Over the years, many polysilicon manufacturers have significantly increased their capacity to meet customer demand and continue to expand capacities in order to achieve economies of scale. However, the slow and uneven economic recovery from the global financial crisis as well as the significant decrease in global petroleum prices since their peak in mid-2008 have reduced or delayed the general demand for photovoltaic products. In late 2008 and 2009, newly available polysilicon supply and slowed global photovoltaic market growth resulted in an excess supply of polysilicon, which led to a significant decline in polysilicon prices. Although global photovoltaic demand recovered substantially from the second half of 2010 through the first half of 2011, the market price for polysilicon experienced another significant decline in the second half of 2011 due to excess supply and decreasing demand. In 2012, the market price for polysilicon continued to decline. As a result of the polysilicon supply and demand fluctuation, we reduced the selling price of our polysilicon and thus experienced a continued decrease in revenues derived from polysilicon in 2012. In 2013, global demand for polysilicon began to increase, and polysilicon manufacturers with competitive cost structures benefited from a continuing increase in sales prices and global demand. If sales price continue to go up, some polysilicon manufacturers with less competitive cost structures may be able to reenter the market, which could cause polysilicon prices to decline and thus materially and adversely affect our profitability.

 

We may not be able to continue to receive the same level of support from Daqo Group, which may have a material adverse effect on our business and results of operations.

 

Since our inception, we have substantially benefited from financial support from Daqo Group, one of the largest electrical equipment manufacturers in China. As of December 31, 2013, we had amounts due to Daqo Group and its subsidiaries of $88.5 million. In addition, Daqo Group has granted us a permanent and royalty-free license to use the “Daqo” brand, which is a well-recognized brand in the electrical industry in China. We have benefited from the strong brand recognition of “Daqo” in our business development efforts, as evidenced by our ability to secure major customers based in China within a short period after we commenced commercial production of polysilicon. Daqo Group has agreed in writing not to engage in the business of manufacturing, marketing or distributing polysilicon or any other solar power products anywhere in the world or compete in any manner with our businesses without our consent for an indefinite term. Daqo Group provides financial support to us to meet certain of our working capital requirements and obligations as they come due. However, we cannot assure you that we will continue to receive the same level of support, or any support at all, from Daqo Group in the future. If Daqo Group ceases to support us, our business, results of operations and prospects may be materially and adversely affected. In addition, any negative publicity associated with Daqo Group will likely have an adverse impact on our reputation, which could materially and adversely affect our business. In the event of any disagreements with Daqo Group, we may have to resort to legal proceedings in China to enforce our rights, which could be costly, time consuming and involve uncertain outcomes.

 

5
 

 

We experienced a significant decrease in our revenues in 2012 and incurred substantial net losses in 2012 and 2013.

 

As a result of the slump in the global demand for and sales price of polysilicon, we experienced a significant decrease in our revenues for our continuing operations and suffered large net losses in 2012. Despite improvements in our revenue in 2013 compared to 2012, in 2013 we still incurred a net loss of $221.1 million including $158.4 million of fixed-asset impairment loss, compared to $115.6 million including $42.8 million of fixed-asset impairment loss in 2012. While global demand for and the sales price of polysilicon have been recovering since the first quarter of 2013 from their historical lows in 2012, we cannot predict when we will be able to regain a positive net income. If we cannot obtain positive revenue growth and regain profitability in the near future, our status as a going concern will be jeopardized.

 

We had a significant working capital deficit as of December 31, 2013. Daqo Group provides financial support to us to meet certain of our working capital requirements and obligations as they come due. If we are not able to generate adequate operating cash flow or obtain adequate financial support from Daqo Group or from other sources, we will face the risk of not being able to continue as a going concern.

 

The challenging solar photovoltaic market situation in the past two years characterized by low prices through the whole value chain has caused our polysilicon and wafer businesses to experience significant financial losses. Even though the industry started to recover slowly during 2013 and into 2014, we are unable to predict if the current upward trend will continue. As of December 31, 2013, we had a working capital deficit (being our total consolidated current liabilities less our total consolidated current assets) of $208.0 million. In addition, we have made significant capital expenditures on our expansion project at our Xinjiang polysilicon facilities.

 

Our continuation as a going concern is dependent upon financial support from Daqo Group Co., Ltd., or Daqo Group, a related party of ours, and our ability to continue to obtain other sources of financing. Daqo Group provides financial support to us to meet certain of our working capital requirements and obligations as they come due. In addition, we had committed and available bank standby credit facilities of $56.2 million as of December 31, 2013. If the industry reverses its current upward trend in prices we will face significant pressure on our working capital and we will face the risk of not being able to continue as a going concern.

 

Our consolidated financial statements do not reflect any adjustments relating to recoverability and classification of recorded assets or the amounts and classification of liabilities or any other adjustments that might be necessary should we be unable to continue as a going concern. Our inability to continue as a going concern would materially and adversely affect our financial condition, results of operations and business prospects.

 

The reduction in or elimination of government subsidies and economic incentives for solar energy applications could cause demand for our products and our revenues to decline.

 

When upfront system costs are factored into cost per kilowatt hour, the current cost of solar power substantially exceeds the cost of traditional forms of energy in many locations. As a result, national and local governmental authorities in many countries, including China, have provided subsidies and economic incentives in the form of feed-in tariffs, rebates, tax credits and other incentives to distributors, system integrators and manufacturers of photovoltaic products to promote the use of solar energy and to reduce dependency on other forms of energy. We believe that the near-term growth of the market for solar energy applications depends in large part on the availability and size of government subsidies and economic incentives. The reduction or elimination of government subsidies and economic incentives may hinder the growth of this market or result in increased price competition for solar energy products, which could cause our revenues to decline. These government subsidies and economic incentives could be reduced or eliminated altogether. For example, in 2010, Spain announced its plan to cut the subsidized electricity prices paid to new photovoltaic solar power plants by up to 45%, which significantly reduced installations of new solar energy projects in the country. In 2010, Germany introduced an approximately 24% to 26% solar feed-in tariffs reduction for rooftop systems and 20% to 25% reduction for ground-based systems. In early 2012, Germany further reduced its feed-in tariffs by 15% to up to 24.43 Euro cents per kilowatt hour for rooftop systems and up to 18.76 Euro cents per kilowatt hour for ground-based systems. On July 5, 2012, Italian officials published a ministerial decree which revised the system of incentives for the production of electricity from PV plants. Pursuant to the ministerial decree, the incentives for new PV plants will cease once the relevant total expenditure reaches EUR6.7 billion. In addition, new feed-in tariffs for existing plants will apply beginning in 2013, and the overall public expenditure for renewable energy should not exceed EUR5.8 billion per year. In 2013, the German government announced plans to reduce the expansion of solar power after Germany added 7,500 megawatts and 7,600 megawatts of capacity in 2011 and 2012, respectively, to bring its total to 32,600 MW, which is nearly as much as the rest of the world combined. The German government wants to see the FIT cut by up to 30 percent in a one-off move, after a series of annual cuts of about 15 percent in recent years. Such actions may result in a significant fall in the demand for photovoltaic products. In addition, government financial support of photovoltaic products has been, and may continue to be, challenged on constitutional grounds and found unlawful in certain countries. The escalation of the European sovereign debt crisis since 2011 and the slowdown of the Chinese economy in 2012 and 2013 may continue to exert downward pressure on the amount of government subsidiaries for solar energy applications in these two regions. In 2013, although global solar PV installations increased by over 16% compared to 2012, the European markets shrank significantly due to subsidy cuts in major markets like Germany, Italy and Spain. Reductions in, or elimination of, government subsidies and economic incentives for solar energy applications before the photovoltaic industry reaches the economies of scale necessary for solar power to become cost-effective in a non-subsidized market place could result in decreased demand for solar generation products and, as a result, for polysilicon, which could cause our revenues to decline.

 

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Our limited operating history may not serve as an adequate basis to judge our future prospects and results of operations.

 

We have a limited operating history. We commenced polysilicon manufacturing in 2008 and wafer manufacturing in 2011. Several of our senior management and key employees have worked together at our company for only a relatively short period of time, and a number of our senior officers were promoted to their posts in October 2012. Our future success will depend on our ability to expand our manufacturing capacity significantly beyond its current level and further expand our customer base. To address these risks, we must, among other things, continue to respond to competition and volatile market developments, attract, retain and motivate qualified personnel, implement and successfully execute expansion plans and improve our technologies. We cannot assure you that we will be successful in addressing such risks.

 

Although we were profitable in 2011, we experienced significant decreases in revenue and incurred substantial net losses in 2012 and 2013. Our limited operating history makes the prediction of future results of operations difficult, and therefore, it is unclear if we could regain positive revenue growth or become profitable again in the future. Our business model, technology and ability to achieve satisfactory manufacturing yields for polysilicon at higher volumes are unproven. Compared to companies with a long and well-established operating history and companies operating in less volatile sectors, our results of operations are more susceptible to the impact of adverse operating environment and supply and demand risks.

 

Our revenues and results of operations have fluctuated and are likely to fluctuate in the future.

 

Fluctuations of our revenues and results of operations may occur on a quarterly and on an annual basis and may be due to a number of factors, many of which are beyond our control. These factors include, among others, fluctuation in the global average selling prices of photovoltaic products, fluctuation in the volume of our products shipped, changes in end-user demand for the photovoltaic products manufactured and sold by us or our customers, the gain or loss of significant customers, the availability of governmental subsidies or financial support and changes in our electricity, natural gas, raw material or labor costs. For example, although our net loss improved in 2013 relative to 2012, it may worsen again if one or more of these factors become unfavorable to our business. Furthermore, wafers traditionally have had lower profit margins than polysilicon, and we may need to price aggressively to gain market share or remain competitive in this business, which may further reduce our net margins and cause our financial results to fluctuate from time to time.

 

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Therefore, you should consider our future prospects in light of the risks and uncertainties experienced by early stage companies in a rapidly evolving and increasingly competitive market in China.

 

We need a significant amount of cash to fund our future capital expenditure requirements and working capital needs; if we cannot obtain additional sources of liquidity when needed, our growth prospects and future profitability may be materially and adversely affected.

 

We need a significant amount of cash to fund our operations. In particular, we will need substantial additional funding to finance our expansion project at our Xinjiang polysilicon facilities, which includes relocating existing equipment from Chongqing, to meet our working capital requirements, and to repay any short-term or long-term bank borrowings when due. We will also require cash resources to fund our research and development activities in order to remain competitive on cost and technology. In addition, we will need to contribute registered capital to our Chongqing and Xinjiang facilities in the amount of $26.4 million and $61.6 million, respectively.

 

In the past, we relied in part on long-term bank borrowings and advance payments from customers to finance our working capital requirements. However, we expect that we may not be able to obtain a substantial amount of, or any, advance payments from customers in the future as the photovoltaic markets remains competitive. Payment collection in the solar photovoltaic industry remains challenging. Any delay or failure in collecting amounts owed from customers will adversely affect our company’s cash flow situation. In addition, future acquisitions, expansions, market changes or other developments may cause us to require additional financing. We expect to incur additional debt in the future. Our ability to obtain external financing in the future is subject to a number of uncertainties, including:

 

·our future financial condition, results of operations and cash flows;

 

·general market conditions for financing activities by companies in our industry;

 

·economic, political and other conditions in China and elsewhere; and

 

·development and duration of the current global economic slowdown.

 

If we are unable to obtain funding in a timely manner or on commercially acceptable terms, or at all, our growth prospects and ability to return to profitability may be materially and adversely affected.

 

We may not be successful in our efforts to continue to manufacture polysilicon in a cost-effective manner.

 

The technology used to manufacture polysilicon is complex, requires costly equipment and is continuously being modified in an effort to improve yields and product performance. We may face significant challenges relating to polysilicon production in the future. Microscopic impurities such as dust and other contaminants, difficulties in the manufacturing process, disruptions in the supply of utilities or defects in the key materials or tools used to manufacture polysilicon could interrupt manufacturing, reduce yields or cause a portion of the polysilicon to be rejected by our customers, which would materially and adversely affect our profitability.

 

Our effective capacity and ability to produce high volumes of polysilicon depend on the cycle time for each batch of polysilicon. We may encounter problems in our manufacturing process or facilities as a result of, among other things, production failures, construction delays, human error, equipment malfunction or process contamination, all of which could seriously harm our operations. We are dependent on the availability of inexpensive electricity to keep our production costs down. We may experience production delays if any modifications we make in the manufacturing process to shorten production cycles are unsuccessful. Moreover, failure to achieve acceptable manufacturing levels may make our polysilicon costs uncompetitive, which could materially and adversely affect our business, financial condition and results of operations.

 

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Further development in alternative polysilicon production technologies or other changes in the photovoltaic industry could render our production process too costly or obsolete, which could reduce our market share and cause our sales and profits to decline.

 

Although the vast majority of the polysilicon produced in the world utilizes the chemical vapor deposition process, or the “modified Siemens process,” several alternative production processes have been developed that may have significantly lower production costs. Compared with other polysilicon production processes, a disadvantage of the modified Siemens process is the large amount of electricity required. For example, MEMC and REC currently operate or are constructing facilities that use the “fluidized bed reactor” method for producing polysilicon. Tokuyama has developed a polysilicon technology called the “vapor-to-liquid deposition” process. Other polysilicon manufacturers are establishing facilities using upgraded metallurgical grade silicon process to produce solar-grade polysilicon. Moreover, some polysilicon manufacturers who are using “modified Siemens process” have adopted newer technologies such as Hydrochlorination, which could enable them to produce polysilicon in a more cost effective way compared to the traditional “modified Siemens process.”

 

Further developments in competing polysilicon production technologies may result in lower manufacturing costs or higher product performance than those achieved from the modified Siemens process, including the one we employ. We will need to invest significant financial resources in research and development to expand our market position, keep pace with technological advances in polysilicon production and effectively compete in the future. Failure to further refine our technology could make our production process too costly or obsolete, which could reduce our margins and market share, cause our revenues to decline and materially and adversely affect our results of operations.

 

Technological changes in the solar power industry could render our products uncompetitive or obsolete, which could reduce our market share and cause our sales and profits to decline.

 

The solar power industry is characterized by evolving technologies and standards. These technological evolutions and developments place increasing demands on the improvement of our products, such as polysilicon and wafers. Other companies may develop production technologies that enable them to produce silicon wafers of higher quality at a lower cost than our products. Technologies developed or adopted by others may prove more advantageous than ours for commercialization of solar power products and may render our products obsolete. As a result, we may need to invest significant resources in research and development to maintain our market position, keep pace with technological advances in the solar power industry, and effectively compete in the future. Our failure to further refine and enhance our products and processes or to keep pace with evolving technologies and industry standards could cause our products to become uncompetitive or obsolete, which could materially and adversely reduce our market share and affect our results of operations.

 

Alternative technologies in cell manufacturing may reduce the demand for polysilicon.

 

The vast majority of silicon-based photovoltaic cell manufacturers use chunk or granular polysilicon. However, alternative technologies have been commercialized. One such technology, thin-film cell production, uses little to no silicon in the production of solar cells. Thin-film solar cells are currently less costly to produce than silicon-based solar cells. Significant expansion of thin-film solar cell production has been announced which may put pressure on the entire value chain of silicon-based solar cell production. This expansion may in turn restrict the market for silicon-based solar cells, which would reduce the demand for our polysilicon. If the demand for polysilicon is adversely affected by increased demand for, and improvements to, alternative technologies, our revenues and results of operations could be materially and adversely affected.

 

Our future success depends substantially on our ability to significantly expand our polysilicon production capacity and output, and to relocate equipment to our Xinjiang facilities, which exposes us to a number of risks and uncertainties.

 

Our future success depends on our ability to significantly increase both polysilicon production capacity and output, and to relocate equipment to our Xinjiang facilities. If we fail to do so, we may not be able to benefit from economies of scale to reduce our costs per kilogram of polysilicon, to maintain our competitive position or to improve our profitability. Further, our expansion plans are dependent on the successful installation of the equipment we are relocating to our Xinjiang facilities. Our ability to establish additional production capacity and increase output is subject to significant risks and uncertainties, including:

 

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·the need to raise significant additional funds to purchase additional production equipment or to build additional manufacturing facilities, which we may not be able to obtain on commercially viable terms or at all;

 

·cost overruns and delays as a result of a number of factors, many of which are beyond our control, such as increases in the price of electricity or problems with equipment delivery;

 

·delays or denial of required approvals by relevant government authorities;

 

·failure to obtain production inputs in sufficient quantities or at acceptable cost;

 

·significant diversion of management’s attention and other resources; and

 

·failure to execute our expansion plan effectively.

 

Our future commercial production and expansion project in Xinjiang, China may not be successful.

 

We finished construction of our Phase 2a polysilicon facilities in Shihezi, Xinjiang Uyghur Autonomous Region in September 2012 and successfully reached our targets in terms of capacity and cost structure by the end of the first quarter of 2013. We are conducting an expansion plan to increase our polysilicon annual capacity from 6,150 MT to 12,150 MT. We also plan to upgrade our off-gas treatment process from traditional Hydrogenation technology to Hydrochlorination technology. Simultaneous with our 2014 annual maintenance, we will prepare our Xinjiang facilities for expansion. Although the Xinjiang location provides many strategic advantages, including lower electricity costs, we face a number of uncertainties in relation with our future commercial production and expansion project in Xinjiang.

 

There are many risks associated with our future production in Xinjiang, any of which could cause significant disruption to production, including:

 

·failure to successfully adopt and implement Hydrochlorination technology, given our lack of experience with the technology or the provider;

 

·being unable to complete our expansion plan as scheduled;

 

·failure to successfully install equipment relocated from the Phase 1 polysilicon facilities;

 

·being unable to fully ramp-up the newly added capacity or achieve our targets for cost and quality;

 

·extremely cold temperatures;

 

·lack of workers in Xinjiang experienced with polysilicon manufacturing;

 

·difficulties in timely transporting products to our customers, most of whom are located in other areas of China that are a significant distance from Xinjiang; and

 

·political or social unrest.

 

One or more of these factors could harm our Xinjiang operations and consequently, could adversely affect our overall operating results.

 

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We operate in an increasingly competitive market, and we may not be able to compete successfully with competitors who have greater resources than us.

 

The photovoltaic market is expected to become increasingly competitive. Our competitors include international polysilicon and wafer manufacturers, such as Hemlock, Wacker, OCI, REC, MEMC, Green Energy Technology and Sino-American Silicon and Chinese domestic polysilicon and wafer manufacturers, such as GCL-Poly, TBEA, China Silicon Corporation, Sichuan Xinguang Silicon Science and Technology, LDK Solar, ReneSola, JinkoSolar and Comtec Solar Systems. In addition, some solar cell and module manufacturers, including some of our existing and potential customers, have established or have announced the intention of establishing polysilicon production or affiliate relationships with manufacturers of polysilicon. We compete with these in-house capabilities, which could limit our ability to expand our sales or even reduce our sales to our existing customers. Many of our competitors have substantially greater financial, technical, manufacturing and other resources than we do. Our competitors’ greater size and longer operating history provide them with a competitive advantage with respect to manufacturing costs because of their economies of scale and their ability to purchase raw materials at lower prices. Our competitors may have stronger relationships or may enter into exclusive relationships with some of our key customers. As a result, they may be able to respond more quickly to changing customer demands or to devote greater resources to the development, promotion and sales of polysilicon than we can. Failure to adapt to changing market conditions and to compete successfully with existing or new competitors may materially and adversely affect our financial condition and results of operations.

 

We depend on a limited number of customers and sales contracts for a significant portion of our revenues, and the loss of any customer or cancellation of any contract may cause significant fluctuations or declines in our revenues.

 

In 2011, 2012 and 2013, our top three customers in aggregate accounted for approximately 38.7%, 40.9% and 38.5% of our total revenues, respectively. We anticipate that our dependence on a limited number of customers will continue for the foreseeable future. Consequently, any one of the following events may cause material fluctuations or declines in our revenues:

 

·reduction, delay or cancellation of orders from one or more of our significant customers;

 

·loss of one or more of our significant customers and failure to identify additional or replacement customers; and

 

·failure of any of our significant customers to make timely payment for our products.

 

If we are unable to manage our growth effectively, our business and financial results may be adversely affected.

 

We experienced a period of growth and expansion, despite significant setbacks in revenue in 2012 and 2013. We generated revenue of $232.2 million, $86.9 million and $109.0 million in 2011, 2012 and 2013, respectively. To accommodate our growth, we anticipate that we will need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of our accounting and other internal management systems, all of which require substantial management efforts. We also will need to continue to expand, train, manage and motivate our workforce and manage our customer relationships. All of these endeavors will require substantial management efforts and skill and require significant additional expenditures. We cannot assure you that we will be able to manage our growth effectively, and any failure to do so may have a material adverse effect on our business and financial results. Moreover, even if we do expand our polysilicon manufacturing capacity and our wafer business as planned, we may be unable to generate sufficient customer demand for our photovoltaic products to support our increased production levels or successfully integrate our polysilicon and wafer manufacturing businesses to achieve operational efficiency, which could adversely affect our business and results of operations.

 

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Polysilicon production is energy-intensive, and if our energy costs rise or if our electricity and other utility supplies are disrupted, our results of operations will be materially and adversely affected.

 

The polysilicon production process, particularly the modified Siemens process that we use, is highly dependent on a constant supply of electricity and other utilities, such as steam, natural gas and water, to maintain the optimal conditions for polysilicon production. If electricity or other utility supplies are not maintained at the desired level, we may experience significant delays in the production of polysilicon. In the past, there were shortages in electricity supply in various regions across China, especially during peak seasons, such as in the summer. In addition, the uncommonly cold weather in China in the winter of 2010 resulted in a surge in natural gas demand, which in turn caused severe gas shortages in many regions, including Chongqing, where one of our polysilicon manufacturing sites is located. The local governmental authorities in the worst-hit areas took measures to reduce or restrict the amount of natural gas supplied to non-residential users. We primarily use natural gas for our in-house steam production and steam is critical for our manufacturing process. Although the natural gas shortage did not directly affect our operations, if shortages becomes more severe in the future, our natural gas supply may be reduced or suspended, which would significantly disrupt our manufacturing process. In addition to shortages, we are subject to potential risks of interruptions in energy supply due to power outages, equipment failure, weather conditions or other causes which could force us to cease production for a prolonged period of time. In the event that electricity or other utility supplies to our manufacturing facilities are disrupted, our business, results of operations and financial condition could be materially and adversely affected. Even if we have access to sufficient sources of electricity and other utilities, any significant increase in the costs of utilities could adversely affect our profitability, as we consume substantial amounts of electricity and other utilities in our manufacturing process. If electricity and other utility costs were to rise, our results of operations could be materially and adversely affected.

 

Our current indebtedness could adversely affect our business, financial condition and results of operations.

 

As of December 31, 2013, we had outstanding borrowings of $253.7 million with a weighted average floating interest rate of 6.87%, and we expect to incur additional debt in the future. We borrowed the majority of these bank loans from Bank of China and China Construction Bank with guarantees from Daqo Group, a related party of ours. We cannot assure you that we will be able to renew these borrowings when they become due or to obtain other loans or credits from other banks or other lenders on terms satisfactory to us or at all to satisfy the substantial capital expenditure requirements associated with our capacity expansion, whether on our own or with the continuing support from Daqo Group. In addition, the indebtedness could have an adverse effect on our future operations, including, among other things: (1) reducing the availability of our cash flow to fund our working capital, capital expenditures or other general corporate purposes as a result of interest or principal payments; (2) subjecting us to the risk of interest rate increases on our indebtedness which bears floating interest rates; and (3) placing us at a competitive disadvantage compared to our competitors that have less debt or are otherwise less leveraged. Any of these factors could have a material and adverse effect on our business, financial condition and results of operations.

 

We face risks and uncertainties expanding our business through alliances, joint ventures or acquisitions.

 

We may in the future, if presented with appropriate opportunities, acquire or invest in technologies, businesses or assets that are strategically important to our business or form alliances with key players in the photovoltaic industry to further expand our business. Such acquisitions and investments could expose us to potential risks, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden liabilities, the inability to generate sufficient revenues to offset the costs and expenses of acquisitions, and potential loss of, or harm to, our relationships with employees, customers and suppliers as a result of integration of new businesses. Investments in new businesses may also divert our cash flow from servicing our debts and making necessary capital expenditures. In addition, we may incur impairment losses on our acquisitions and investments in equity securities. The diversion of our management’s attention and any difficulties encountered with respect to the acquisitions, investments or alliances or in the process of integration could have an adverse effect on our ability to manage our business. For example, in 2011, we formed alliances with JNE Solar Inc., a party unrelated to us prior to this transaction, in Hamilton, Ontario, through our wholly owned subsidiary, Daqo New Energy Holdings (Canada) Ltd., to build and operate a solar module production facility in Hamilton, Ontario, Canada. Due to negative developments in the solar photovoltaic market, we discontinued this project and terminated the joint venture in April 2012 without incurring any loss to us. Furthermore, our experience in the polysilicon manufacturing industry may not be as relevant or applicable in downstream markets. We may also face intense competition from companies with greater experience or established presence in the targeted downstream markets or competition from our industry peers with similar expansion plans. Any failure to integrate any acquired businesses or joint ventures into our operations successfully and any material liabilities or potential liabilities of any acquired businesses or joint ventures that are not identified by us during our due diligence process for such acquisitions or investments could materially and adversely affect our business and financial condition.

 

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If we are unable to operate effectively or operational disruptions occur, our business, results of operations and financial condition could be adversely affected.

 

Production of polysilicon requires the use of volatile materials and chemical reactions sensitive to temperature and pressure and requires the use of external controls to maintain safety. For example, in the production of polysilicon, we use trichlorosilane, or TCS, which is a highly combustible substance if brought into contact with moisture in the air and is therefore potentially destructive and extremely dangerous if mishandled or used in uncontrolled circumstances. The occurrence of a catastrophic event involving TCS as a result of a natural disaster or human error at one of our polysilicon production facilities could threaten, disrupt or destroy a significant portion or all of our polysilicon production capacity at such facility for a significant period of time. Additionally, the smooth operation of our polysilicon production facilities depends significantly on our ability to maintain temperatures and pressure at appropriate levels, the supply of steam at a consistent pressure level, the availability of adequate electricity and our ability to control the application of such electricity. Accordingly, mistakes in operating our equipment or an interruption in the supply of electricity or steam at our production facilities could result in the production of substandard polysilicon or substantial shortfalls in production and could reduce our production capacity for a significant period of time. In addition, we voluntarily shut down our manufacturing facilities from time to time on an as-needed basis for maintenance and quality check purposes. For example, we temporarily shut down the Phase 1 facilities in April 2010 for periodic maintenance, in December 2010 for periodic maintenance and capacity enhancement, and in December 2011 for periodic maintenance. In September 2012, we halted production at the Phase 1 polysilicon facilities for maintenance and technology improvement projects, which lasted until we decided to relocate the equipment at this facility to Xinjiang in the second quarter of 2013 . In April 2013, we temporarily shut down our Phase 2 facilities in Xinjiang for periodic maintenance and technology improvements. These abovementioned shutdowns have reduced and may further reduce the volume and increase the cost of polysilicon we produce. In addition, we may need to use hazardous equipment for our wafer manufacturing process. Such equipment requires skill and experience for safe operation. We could experience events such as equipment failures, explosions or fires due to employee errors, equipment malfunctions, accidents, and interruptions in electricity or water cooling supplies, natural disasters or other causes. In addition, such events could cause damage to properties, personal injuries or even deaths. As a result, we may in the future experience production curtailments or shutdowns or periods of reduced production. The occurrence of any such events or disruptions could result in loss of revenues and could also damage our reputation, any of which could have a material adverse effect on our business, operating results and financial condition.

 

Our operations are subject to natural disasters, adverse weather conditions, operating hazards, environmental incidents and labor disputes.

 

We may experience earthquakes, floods, mudslides, snowstorms, typhoon, power outages, labor disputes or similar events beyond our control that would affect our operations. Our manufacturing processes involve the use of hazardous equipment, including, but not limited to, furnaces, squaring machines and wire saws. We also use, store and generate volatile and otherwise dangerous chemicals and waste during our manufacturing processes, which are potentially destructive and dangerous if not properly handled or in the event of uncontrollable or catastrophic circumstances, including operating hazards, fires and explosions, natural disasters, adverse weather conditions and major equipment failures.

 

In addition, our polysilicon and wafer production and storage facilities are located in either Chongqing or Xinjiang, China. The occurrence of any natural disaster, unanticipated catastrophic event or unexpected accident in this location could result in production curtailments, shutdowns or periods of reduced production, which could significantly disrupt our business operations, cause us to incur additional costs and affect our ability to deliver our products to our customers as scheduled, which may adversely affect our business, financial condition and results of operations. Moreover, such events could result in severe damage to property, personal injuries, fatalities, regulatory enforcement proceedings or in our being named as a defendant in lawsuits asserting claims for large amounts of damages, which in turn could lead to significant liabilities.

 

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Occurrences of natural disasters, as well as accidents and incidents of adverse weather in or around either Chongqing or Xinjiang, China in the future may result in significant property damage, electricity shortages, disruption of our operations, work stoppages, civil unrest, personal injuries and, in severe cases, fatalities. Such incidents may result in damage to our reputation or cause us to lose all or a portion of our production capacity, and future revenue anticipated to be derived from the relevant facilities, any of which could have a material adverse effect on our business, operating results and financial condition.

 

Existing regulations and changes to these regulations may present technical, regulatory, economic and trade barriers to the purchase and use of photovoltaic products, which may significantly reduce demand for our products.

 

Photovoltaic products are subject to national and local regulations relating to building codes, safety, environmental protection, utility interconnection and metering and other aspects of the electric utility industry. In a number of countries, including China, these regulations are being modified and may continue to be modified. The purchases of, or further investment in the research and development of, alternative energy sources, including photovoltaic technology, could be deterred by unfavorable regulations, which could result in a significant reduction in the potential demand for our products. For example, without a regulatory mandated exception for solar power systems, electric utility companies are often charged interconnection or standby fees for putting distributed power generation on the electric utility grid. These fees could increase the cost to end users of using photovoltaic products and make them less desirable. In addition, trade authorities in foreign countries may apply trade sanctions against photovoltaic product imports from China, if the foreign trade authorities determine that the export sales from China are in violation of fair trade practices. Such trade sanctions can result in significant additional duties, which will adversely affect our photovoltaic product demand, thereby harming our business, prospects, results of operations and financial condition.

 

We obtain certain production equipment from a limited number of suppliers, and if such equipment is not delivered on time, is damaged in shipment or is otherwise unavailable, our ability to deliver polysilicon on time will suffer, which in turn could result in cancellation of orders and loss of revenues.

 

Our operations and expansion plans depend on our ability to obtain a sufficient amount of equipment that meets our specifications on a timely basis. Some of our equipment used in polysilicon and wafer production is not readily available from alternative vendors and would be difficult to repair or replace if it were to become damaged or cease working. If any of these suppliers were to experience financial difficulties or go out of business, or if there were any damage to or a breakdown of our production equipment, our business would incur losses. In addition, a supplier’s failure to supply our ordered equipment in a timely manner, with adequate quality and on terms acceptable to us, could delay the capacity expansion of our manufacturing facilities and otherwise disrupt our production schedule or increase our costs of production. We have experienced significant delays in the delivery of our key equipment in the past. Failure to obtain equipment meeting our specifications could have a material adverse effect on our business, financial condition and results of operations. Furthermore, demand for polysilicon and wafer production equipment may result in significant increases in prices of such equipment or shortages in related components for our intended expansion. Any unexpected price increases could materially and adversely affect our financial condition and results of operations.

 

We have sourced and will continue to source some of our production equipment from Chinese manufacturers, and we cannot assure you that the China-sourced equipment will perform at the same level as our imported equipment or will meet our quality requirements.

 

We have purchased key equipment from Chinese and international suppliers. Compared to major international suppliers, our China-based suppliers generally have shorter operating histories and less experience in providing equipment for the polysilicon industry. We cannot assure you that the locally made equipment will perform at similar levels of quality and reliability as our imported equipment. In the event the China-sourced equipment does not perform as well as the imported equipment or does not perform at all, we may encounter disruption in our manufacture or deterioration of product quality, which in turn could materially and adversely affect our business, financial condition and results of operations.

 

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Product defects could result in increased costs, decreased sales, and damage to our customer relationships and our reputation.

 

Our photovoltaic products may contain defects that are not detected until after it is shipped or processed by our customers. In the event our products are returned to us due to product defects, we would be required to replace the defective products promptly. If we deliver products with defects, or if there is a perception that our products are of substandard quality, we may incur substantially increased costs associated with termination of contracts and replacement of shipped products, and our credibility, market reputation and relationship with customers will be harmed and sales of our products may be materially and adversely affected.

 

Substantially all of our production, storage, administrative, and research and development facilities are located in either Chongqing or Xinjiang, China. Any damage or disruption at these facilities would have a material adverse effect on our financial condition and results of operations.

 

Substantially all of our production, storage, administrative, and research and development facilities are currently located in either Chongqing or Xinjiang, China. Natural disasters, such as fire, floods, typhoons, earthquakes, snow storms, or other unanticipated catastrophic events, including power interruption, telecommunications failures, equipment failures, explosions, break-ins, terrorist acts or war, could significantly disrupt our ability to manufacture our products and operate our business. If any of our production facilities or material equipment were to experience any significant damage or downtime, we would not be able to meet our production targets and our business would incur losses. Any damage or disruption at these facilities would have a material adverse effect on our business, financial condition and results of operations.

 

We rely on third party intellectual property for certain key aspects of our operations, which subjects us to the payment of license fees and potential disruption or delays in the production of our products.

 

While we continue to develop and pursue patent protection for our own technologies, we expect to continue to rely on third party license arrangements for certain key aspects of our operations. For instance, we license from third party hydrochlorination process technology for our polysilicon production. See “Item 4. Information on the Company—B. Business Overview—Intellectual Property” for details of the contractual arrangements. The fees associated with such licenses could adversely affect our financial condition and operating results. If for any reason we are unable to license necessary technology on acceptable terms or at all, it may become necessary for us to develop alternative technology internally, which could be costly and delay or disrupt our production and therefore have a material adverse effect on our business and operating results.

 

Failure to protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.

 

We rely primarily on trade secrets and other contractual restrictions to protect our intellectual property. Contractual arrangements, such as the confidentiality and non-competition agreements and terms between us and our research and development personnel, afford only limited protection and the actions we may take to protect our trade secrets and other intellectual property may not be adequate. In addition, we currently hold 21 patents and have 10 pending patent applications in China covering various aspects of the polysilicon and wafer manufacturing processes. However, we cannot assure you that our patent applications will be eventually issued with sufficiently broad coverage to protect our technology and products. Failure to protect our intellectual property and proprietary rights may undermine our competitive position. Third parties may infringe on or misappropriate our proprietary technologies or other intellectual property and proprietary rights and use them to compete against us, which could have a material adverse effect on our business, financial condition or operating results.

 

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Policing unauthorized use of proprietary technology can be difficult and expensive. In particular, the laws and enforcement procedures of China and certain other countries are uncertain or do not protect intellectual property rights to the same extent as the laws and enforcement procedures of the United States do. See “—Risks Relating to Doing Business in China—Uncertainties in the interpretation and enforcement of Chinese laws and regulations could limit the legal protection available to you and us.” We may need to resort to court proceedings to enforce our intellectual property rights in the future. Litigation relating to our intellectual property might result in substantial costs and diversion of resources and management attention away from our business. An adverse determination in any such litigation will impair our intellectual property and proprietary rights and may harm our business, prospects and reputation.

 

We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards.

 

Although we are currently strengthening our research and development capability, to date, substantially all of the intellectual property used in our production process was developed by third parties. Our success will be jeopardized if we cannot use and develop our technology and know-how without infringing the intellectual property rights of third parties. The validity and scope of claims relating to photovoltaic technology patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly uncertain. We may be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties. The defense and prosecution of intellectual property suits, patent opposition proceedings, and related legal and administrative proceedings can be both costly and time-consuming and may significantly divert the efforts and resources of our technical and management personnel. An adverse determination in any such litigation or proceedings to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, to pay ongoing royalties, or to redesign our manufacturing process or our products or subject us to injunctions prohibiting the manufacture and sale of our products or the use of our technologies. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our products until resolution of such litigation.

 

Our business depends substantially on the continuing efforts of our executive officers and key employees, and our business may be severely disrupted if we lose their services.

 

Our future success depends substantially on the continued services of our executive officers and key employees, especially Mr. Guangfu Xu, our chairman, and Dr. Gongda Yao, our chief executive officer. If one or more of our executive officers or key employees were unable or unwilling to continue in their present positions, we might not be able to replace them easily, in a timely manner, or at all. Our business may be severely disrupted, our financial conditions and results of operations may be materially and adversely affected and we may incur additional expenses to recruit, train and retain personnel. If any of our executive officers or key employees join a competitor or form a competing company, we may lose customers, suppliers, know-how and key professionals and staff members. Each of our executive officers and key employees has entered into an employment agreement with us, which contains non-competition provisions. However, if any dispute arises between our executive officers and us, these agreements may not be enforceable in China, where these executive officers reside, in light of uncertainties with China’s legal system. See “— Risks Relating to Doing Business in China—Uncertainties in the interpretation and enforcement of Chinese laws and regulations could limit the legal protection available to you and us.”

 

Certain of our principal shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other shareholders.

 

As of the date of this annual report, Messrs. Guangfu Xu, Xiang Xu and Dafeng Shi, our directors that are affiliated with Daqo Group, beneficially own an aggregate of 35.6% of our outstanding share capital. As a result of their high level of shareholding, these shareholders have substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. These shareholders may take actions that are not in the best interest of us or our other shareholders. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our other shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders. These shareholders’ interests as beneficial owners of Daqo Group and Daqo New Material may not always be aligned with their interests as our shareholders. Should any conflict of interest arise, these shareholders may take actions not in the best interest of us and our other shareholders.

 

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If we are unable to attract, train and retain qualified personnel, our business may be materially and adversely affected.

 

Our future success depends, to a significant extent, on our ability to attract, train and retain qualified personnel, particularly technical personnel with expertise in the photovoltaic industry. Since our industry is characterized by high demand and intense competition for talent, there can be no assurance that we will be able to attract or retain qualified technical staff or other highly skilled employees that we will need to achieve our strategic objectives. As we have a limited operating history and are in a stage of rapid growth, despite recent setbacks, our ability to train and integrate new employees into our operations may not meet the growing demands of our business. If we are unable to attract and retain qualified personnel, our business may be materially and adversely affected.

 

Compliance with environmental regulations can be expensive, and non-compliance with these regulations may result in adverse publicity and potentially significant monetary damages and fines.

 

As our manufacturing processes generate waste water and gas and other industrial wastes, we are required to comply with all applicable regulations regarding protection of the environment. We are in compliance with present environmental protection requirements and have all the necessary environmental permits to conduct our business in all material respects. However, if more stringent regulations are adopted in the future, the cost of compliance with these new regulations could be substantial. If we fail to comply with present or future environmental regulations, we may be required to pay substantial fines, suspend production or cease operations, which in turn would have a material adverse effect on our financial condition and results of operations.

 

The discontinuation of any of the preferential tax treatments or the financial incentives and grants currently available to us in China could adversely affect our overall results of operations.

 

Various Chinese governmental authorities have provided tax incentives to our subsidiaries in China. These incentives include income tax exemption or reduced enterprise income tax rates. For example, under the PRC Enterprise Income Tax Law, or the EIT Law, the statutory enterprise income tax rate is 25%. However, our Chinese subsidiary Chongqing Daqo New Energy Co., Ltd., or Chongqing Daqo, as a “Chongqing Municipality High and New Technology Enterprise,” is entitled to a preferential enterprise income tax rate of 15%. The status is valid until December 2014 and can be renewed for additional three-year terms upon Chongqing Daqo’s application and the government’s approval. If there are significant changes in the business operations, manufacturing technologies or other criteria that cause the enterprise to no longer meet the criteria as a “high and new technology enterprise,” such status will be terminated from the year of such change. We cannot assure you that Chongqing Daqo will continue to qualify as a “high and new technology enterprise” in future periods. In addition, Chongqing Daqo has received various financial incentives and grants from the local government since its inception. For example, it received government grants in the amount of $11.5 million, $7.7 million and $4.8 million in 2011, 2012 and 2013, respectively. Any increase in the enterprise income tax rate applicable to our Chinese subsidiaries or discontinuation or reduction of any of the preferential tax treatments or financial incentives currently enjoyed by our subsidiaries in China could adversely affect our business, operating results and financial condition. Xinjiang Daqo New Energy Co., Ltd., or Xinjiang Daqo, is currently in the process of applying for “Xinjiang Municipality High and New Technology Enterprise” status.

 

The dividends we receive from our Chinese subsidiaries and our global income may be subject to Chinese tax under the EIT Law, which would have a material adverse effect on our results of operations; our foreign ADS holders may be subject to a Chinese withholding tax upon the dividends payable by us and Chinese tax on gains realized upon the sale or other disposition of our ADSs if we are classified as a Chinese “resident enterprise.”

 

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Under the Chinese enterprise income tax laws and regulations, dividends, interests, rent, royalties and gains on transfers of property payable by a foreign-invested enterprise in China to its foreign investor who is a non-resident enterprise will be subject to a 10% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with China that provides for a reduced rate of withholding tax and such non-resident enterprise is the beneficial owner of the dividends, interests, rent, royalties and gain on transfers of property. The Cayman Islands, where Daqo Cayman is incorporated, does not have such a tax treaty with China.

 

Under the EIT Law, an enterprise established outside China with its “de facto management body” within China is considered a “resident enterprise” in China and will be subject to the Chinese enterprise income tax at the rate of 25% on its worldwide income. In April 2009, the Chinese State Administration of Taxation issued a new circular to clarify criteria for determining the “resident enterprise” status of foreign companies which are controlled by enterprises incorporated in China. Pursuant to the circular, to determine whether a company formed outside of mainland China and controlled by an enterprise incorporated in China should be treated as a Chinese resident enterprise, the tax authority will review factors such as the routine operation of the organizational body that effectively manages the enterprise’s production and business operations, locations of personnel holding decision-making power, location of finance and accounting functions and properties of the enterprise, and whether more than half of the directors or senior management personnel reside in China. Substantially all of our management members are based in China. However, it remains unclear how PRC tax authorities will treat an overseas company such as ours, which is controlled by PRC natural persons rather than PRC enterprises. If the Chinese tax authorities subsequently determine that Daqo Cayman should be classified as a resident enterprise, then our worldwide income will be subject to Chinese income tax, which may have a material adverse effect on our financial condition and results of operations. Notwithstanding the foregoing provision, the EIT Law also provides that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested enterprise are exempted from income tax, subject to certain conditions. Therefore, if Daqo Cayman is classified as resident enterprise under the EIT Law, the dividends received from our Chinese subsidiaries may be exempted from withholding tax.

 

Moreover, foreign enterprise ADS holders may be subject to a 10% withholding tax (20% in the case of foreign individual ADS holders) upon dividends payable by us and 10% tax on gains realized upon the sale or other disposition of our ADSs (20% in the case of foreign individual ADS holders) if Daqo Cayman is classified as resident enterprise under the EIT Law. Any such tax may reduce the returns on your investment in our ADSs.

 

We have limited insurance coverage. In particular, we do not have any product liability insurance or business interruption insurance.

 

As the insurance industry in China is still in an early stage of development, the product liability insurance and business interruption insurance available in China offer limited coverage compared to that offered in many other countries. We do not have any product liability insurance or business interruption insurance. Any business disruption or natural disaster could result in substantial costs and a diversion of resources, which would have a material adverse effect on our business and results of operations.

 

As with other photovoltaic product manufacturers, we are exposed to risks associated with product liability claims if the use of our photovoltaic products results in injury. Since our polysilicon products are made into electricity generating devices, it is possible that users could be injured or killed by devices that use our products as a result of product malfunctions, defects, improper installation or other causes. We only began commercial shipment of our photovoltaic products in July 2008 and, because of our limited operating history, we cannot predict whether product liability claims will be brought against us in the future or the effect of any resulting negative publicity on our business. The successful assertion of product liability claims against us could result in potentially significant monetary damages and require us to make significant payments.

 

We have granted, and may continue to grant, stock options and other share-based compensation in the future, which may materially impact our future results of operations.

 

We adopted our 2009 share incentive plan, or the 2009 Plan, in August 2009 that permits the grant of stock options, restricted shares and restricted share units to employees, directors and consultants of our company. Under the 2009 Plan, we may issue awards to purchase up to 15,000,000 ordinary shares. As of the date of this annual report, excluding expired or cancelled options, the Company has granted options to purchase a total of 13,195,816 of our ordinary shares under this plan. In addition, we modified the exercise prices for certain outstanding options in January 2012 and April 2013 in order to provide additional incentives to our employees and directors pursuant to an express authorization under our share incentive plan, allowing our board of directors to approve a downward adjustment of the option exercise prices without our shareholders’ approval. As a result of these option grants, option re-pricings and potential future grants under the plan, we have incurred, and will incur in future periods, significant share-based compensation expenses. We account for compensation costs for all stock options using a fair-value based method and recognize expenses in our consolidated statement of income in accordance with the relevant rules in accordance with U.S. GAAP, which may have a material adverse effect on our net income. Moreover, the additional expenses associated with share-based compensation may reduce the attractiveness of such incentive plan to us. However, if we limit the scope of our share incentive plan, we may not be able to attract or retain key personnel who expect to be compensated with incentive shares or options.

 

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Risks Relating to Doing Business in China

 

Changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business and operations.

 

Substantially all of our assets are located in and substantially all of our revenues are currently sourced from China. Accordingly, our business, financial condition, results of operations and prospects may be influenced to a significant degree by political, economic and social conditions in China generally and by continued economic growth in China as a whole.

 

The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures since the late 1970s emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the Chinese government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercises significant control over the Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.

 

While the Chinese economy has experienced significant growth over the past decades, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us, and by government policies or guidance aimed at curtailing the perceived over-capacity of certain industry sectors, such as steel, concrete, polysilicon and wind power equipment. See “Item 4. Information on the Company—B. Business Overview—Regulation— Renewable Energy Law and Other Government Directives.” The Chinese government has implemented certain measures, including interest rate increases, to control the pace of economic growth. These measures may cause decreased economic activity in China, which could in turn reduce the demand for our services and materially and adversely affect our operating results and financial condition.

 

Uncertainties in the global economy and the Chinese economy may adversely affect our business, results of operations and financial condition.

 

The global financial markets experienced significant disruptions in 2008 and the United States, Europe and other economies went into recession. The recovery from the lows of 2008 and 2009 was uneven and is facing new challenges, including the escalation of the European sovereign debt crisis since 2011 and the slowdown of the Chinese economy in 2012 and 2013. It is unclear whether the European sovereign debt crisis will be contained and whether the Chinese economy will resume its high growth rate. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies that have been adopted by the central banks and financial authorities of some of the world’s leading economies, including China’s. There have also been concerns over unrest in the Middle East and Africa, which have resulted in volatility in oil and other markets, and over the possibility of a war involving Iran. There have also been concerns about the economic effect of the earthquake, tsunami and nuclear crisis in Japan and increasing tensions in the relationship between China and Japan. Economic conditions in China are sensitive to global economic conditions. Any prolonged slowdown in the global or Chinese economy may have a negative impact on our business, results of operations and financial condition, and continued turbulence in the international markets may adversely affect our ability to access the capital markets to meet liquidity needs.

 

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Since we derive substantially all of our revenues from customers in China, any prolonged slowdown in the Chinese economy may have a negative impact on our business, results of operations and financial condition in a number of ways. For example, our customers may reduce or delay spending with us, while we may have difficulty expanding our customer base fast enough, or at all, to offset the impact of decreased spending by our existing customers. In addition, to the extent we offer credit to any customer and such customer experiences financial difficulties due to the economic slowdown, we could have difficulty collecting payment from such customer.

 

Uncertainties in the interpretation and enforcement of Chinese laws and regulations could limit the legal protection available to you and us.

 

The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which legal decisions have limited value as precedents. In the late 1970s, the Chinese government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation and rule-making over the past three decades has been to significantly increase the protections afforded to various forms of foreign or private-sector investment in China. Our Chinese operating subsidiary, Chongqing Daqo, is a foreign-invested enterprise and is subject to laws and regulations applicable to foreign-invested enterprises as well as various Chinese laws and regulations generally applicable to companies in China. Our business is also subject to various industry policy, safety and environmental laws and regulations that affect our operations and production facility expansion plans, including those related to investment, project construction, building, zoning, fire prevention and work safety. These laws and regulations are still evolving, and their interpretation and enforcement involve uncertainties. In addition, due to the inconsistent nature of regulatory enforcements in China, local Chinese governmental authorities have significant discretion in interpreting and implementing rules and regulations, and there is no assurance that the central government authorities will always agree with the interpretations and implementations of the local governmental authorities. Currently, we possess all necessary local governmental approvals relating to our operations and production capacity expansion plans. However, if a central government agency requires us to obtain its approval and if we fail to obtain such approval in a timely manner, or at all, we may be subject to the imposition of fines against us, or the suspension or cessation of our production capacity expansion plans. See “Item 4. Information on the Company—B. Business Overview— Regulation—Renewable Energy Law and Other Government Directives.” It may be more difficult to evaluate the outcome of any regulatory or legal proceedings and the level of legal protection we enjoy than in more developed legal systems. These uncertainties may impede our ability to continue our operations or planned capacity expansions, which, as a result, could materially and adversely affect our business and operations.

 

Chinese regulations relating to offshore investment activities by Chinese residents may increase the administrative burden we face and may subject our Chinese resident beneficial owners or employees to personal liabilities, limit our subsidiaries’ ability to increase its registered capital or distribute profits to us, limit our ability to inject capital into our Chinese subsidiaries, or may otherwise expose us to liability under Chinese law.

 

SAFE has promulgated regulations that require Chinese residents and Chinese corporate entities to register with local branches of SAFE in connection with their direct or indirect offshore investment activities. These regulations may apply to our shareholders who are Chinese residents and may apply to any offshore acquisitions that we make in the future.

 

In October 2005, SAFE issued a regulation entitled “Circular on Issues Concerning Foreign Exchange Regulation of Corporate Financing and Roundtrip Investments by Chinese Residents through Offshore Special Purpose Companies,” or SAFE Circular No. 75. SAFE Circular No. 75 requires Chinese residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of Chinese companies, referred to in the notice as an “offshore special purpose company.” In addition, any Chinese resident who is a direct or indirect shareholder of an offshore company is required to update his registration with the relevant SAFE branches, with respect to that offshore company, any material change involving increase or decrease of capital, transfer or swap of shares, merger, division, equity or debt investment or creation of any security interest. Moreover, the Chinese subsidiaries of that offshore company are required to coordinate and supervise the filing of SAFE registrations by the offshore company’s shareholders who are Chinese residents in a timely manner. If a Chinese shareholder with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the Chinese subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the Chinese subsidiaries, and the offshore parent company may also be prohibited from injecting additional capital into its Chinese subsidiaries. Furthermore, failure to comply with the various SAFE registration requirements described above may result in liability for the Chinese shareholders and the Chinese subsidiaries under Chinese law for foreign exchange registration evasion.

 

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We have, up to the present, completed SAFE Circular No. 75 registration for all current beneficial shareholders of our company who are Chinese residents. However, we may not be fully informed of the identities of the beneficial owners of our company in the future and we cannot assure you that all of our Chinese resident beneficial owners will comply with SAFE regulations. The failure of our beneficial owners who are Chinese residents to make any required registrations may subject us to fines and legal sanctions, and prevent us from being able to make distributions or pay dividends, as a result of which our business operations and our ability to distribute profits to you could be materially and adversely affected.

 

Participants of our share incentive plan who are PRC individuals are required to register with SAFE, and the failure to so comply could subject us and such participants to penalties.

 

In February 2012, SAFE promulgated the Notice on the Administration of Foreign Exchange Matters for Domestic Individuals Participating in the Stock Incentive Plans of Overseas Listed Companies, or the Stock Option Notice. According to the Stock Option Notice, a PRC domestic qualified agent or the PRC subsidiary of such overseas listed company must file an application with SAFE or its local counterpart on behalf of PRC resident individuals who participate in stock incentive plans of overseas publicly-listed companies to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with the stock holding or share option exercises. Our company is an “overseas publicly-listed company,” and therefore, we and participants of our share incentive plan who are PRC individuals are subject to these regulations.

 

We have completed registration for options granted as of December 31, 2013 and are in the process of submitting an application to register the options granted on January 28, 2014. If our application is unsuccessful or our option plan participants who are PRC individuals fail to work with us to complete the registration, we or such persons may be subject to fines and legal sanctions. Any failure to comply with such regulations may subject us and the relevant participants of our share incentive plan to fines and legal sanctions and prevent us from being able to grant share incentives to our personnel, as a result of which our business operations may be adversely affected.

 

Chinese regulation of direct investment and loans by offshore holding companies to Chinese entities may delay or limit us from making additional capital contributions or loans to our Chinese subsidiaries.

 

Any capital contributions or loans that we, as an offshore entity, make to our Chinese subsidiaries are subject to Chinese regulations. For example, for each of our Chinese subsidiaries, the aggregate amount of our loans to the Chinese subsidiary cannot exceed the difference between the amount of its total investment and its registered capital as approved by the foreign investment regulatory authorities under relevant Chinese laws, and the loans must be registered with the local branch of SAFE. For each foreign invested enterprise, such as Chongqing Daqo, when the Chinese foreign investment regulatory authorities approve the establishment of such foreign invested enterprise, the authorities approve the amounts of such enterprise’s registered capital, which represent the investors’ capital commitment in equity, and the amounts of its total investment, which represent the sum of its registered capital plus the amounts of its permitted loans. After the establishment of the foreign invested enterprise, the investors can seek regulatory approval to increase its registered capital and the total investment amounts, and upon approval, there will be increases in both amounts. There is a specific statutory guideline relating to the ratio of a foreign invested enterprise’s registered capital amount over total investment amount, and all foreign investment regulatory authorities in China must follow the ratio guideline when exercising their approval authority. However, there is no uniform statutory guideline applicable to all regulatory authorities regarding whether to approve the establishment of a new foreign invested enterprise or to approve any increase in the registered capital and total investment of an existing foreign invested enterprise. In practice, authorities consider factors such as overall governmental policies relating to the specific industry and demands in a particular industry and the approval usually takes one to three months depending on the locations of the foreign invested enterprises. The approved total investment amounts of Chongqing Daqo and Xinjiang Daqo New Energy Co., Ltd., or Xinjiang Daqo, are $286.0 million and $298.0 million, respectively. The registered capital of Chongqing Daqo is $96.0 million, of which $69.6 million was contributed by Daqo Cayman as the sole investor. The registered capital of Xinjiang Daqo is $100.0 million, of which $38.4 million was contributed by Daqo Cayman as the sole investor. As a result, the maximum permissible amounts that Chongqing Daqo and Xinjiang Daqo may borrow from Daqo Cayman are $190.0 million and $198.0 million, respectively. We may not make loans to Chongqing Daqo or Xinjiang Daqo in excess of the maximum amounts permissible unless we obtain government approval to increase their total investment amounts. In addition, any increases of our capital contributions to our Chinese subsidiaries beyond the previously authorized amount must be approved by the MOFCOM and the NDRC or their respective local counterparts. We cannot assure you that we will be able to obtain these approvals on a timely basis, or at all. If we fail to obtain such approvals, our ability to make equity contributions or provide loans to our Chinese subsidiaries or to fund their operations may be negatively affected, which could adversely affect our Chinese subsidiaries’ liquidity and their ability to fund their working capital and expansion projects and meet their obligations and commitments.

 

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We rely principally on dividends and other distributions on equity paid by our wholly owned operating subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our operating subsidiaries to pay dividends to us could have a material adverse effect on our ability to borrow money or pay dividends.

 

As a holding company, we rely principally on dividends and other distributions on equity paid by our Chinese subsidiaries for our cash requirements, including funds necessary to service any debt we may incur. If our Chinese subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us. Furthermore, relevant Chinese laws and regulations permit payments of dividends by Chinese subsidiaries only out of their retained earnings, if any, determined in accordance with Chinese accounting standards and regulations. Under Chinese laws and regulations, each of our Chinese subsidiaries is required to set aside a portion of its net income each year to fund a statutory surplus reserve until such reserve reaches 50% of its registered capital. This reserve is not distributable as dividends. As a result, our Chinese subsidiaries are restricted in their ability to transfer a portion of their net assets to us in the form of dividends, loans or advances. Limitation on the ability of our Chinese subsidiaries to pay dividends to us could materially and adversely limit our ability to borrow money outside of China or pay dividends to holders of our ADSs. Also see “—Risks Relating to Our Business—The dividends we receive from our Chinese subsidiaries and our global income may be subject to Chinese tax under the EIT Law, which would have a material adverse effect on our results of operations; our foreign ADS holders may be subject to a Chinese withholding tax upon the dividends payable by us and Chinese tax on gains realized upon the sale or other disposition of our ADSs if we are classified as a Chinese ‘resident enterprise.’”

 

Fluctuations in exchange rates could result in foreign currency exchange losses.

 

The conversion of RMB into foreign currencies, including U.S. dollars, is based on rates set by the People’s Bank of China. The PRC government allowed the RMB to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. Since June 2010, the PRC government has allowed the RMB to appreciate slowly against the U.S. dollar again, though there have been periods when the U.S. dollar has appreciated against the Renminbi as well. In March 2014, the People’s Bank of China widened the band around which the value of the Renminbi is allowed to deviate from the daily reference rate, which may allow for greater volatility in the U.S. dollar and Renminbi exchange rate. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the RMB and the U.S. dollar in the future. There remains significant international pressure on the Chinese government to adopt a substantial liberalization of its currency policy, which could result in a further and more significant appreciation in the value of the Renminbi against the U.S. dollar. Significant revaluation of the Renminbi may have a material adverse effect on your investment. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.

 

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Failure to maintain effective internal control over financial reporting could have a material and adverse effect on the trading price of our ADSs.

 

We are subject to the reporting obligations under the U.S. securities laws. In connection with the audit of our internal controls over financial reporting as of and for the year ended December 31, 2011, we and our independent registered public accounting firm identified three “material weaknesses” including (i) our lack of accounting resources and expertise necessary to comply with U.S. GAAP and the Securities and Exchange Commission, or SEC, financial reporting and disclosure requirements, (ii) our lack of sufficient resources to perform thorough reviews of consolidated financial statements and related footnote disclosures during the period-end financial reporting and disclosure process, and (iii) our lack of sufficient processes, documentation and approval of related party transactions with affiliates. In 2012, we have made enhancements to our internal controls over financial reporting. See “Part II—Item 15. Controls and Procedures—Remediation and Changes in Internal Control Over Financial Reporting.” Based on these actions taken and our testing and evaluation of the effectiveness of our internal controls, we have concluded the material weaknesses no longer existed as of December 31, 2012 and December 31, 2013. Our independent registered public accounting firm did not conduct an audit of our internal control over financial reporting for the years ended December 31, 2012 and December 31, 2013.

 

However, although our management concluded that we maintained effective internal controls over financial reporting as of December 31, 2013, we cannot assure you that we will maintain effective internal control over financial reporting on an ongoing basis. If we fail to maintain effective internal controls over financial reporting, we will not be able to conclude and our independent registered public accounting firm will not be able to report (if it is required to report) that we have effective internal controls over financial reporting in accordance with the Sarbanes-Oxley Act of 2002 in our future annual report on Form 20-F covering the fiscal year in which this failure occurs. Effective internal control over financial reporting is necessary for us to produce reliable financial reports. Any failure to maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could have a material and adverse effect on the trading price of our ADSs. Furthermore, we may need to incur additional costs and use additional management and other resources as our business and operations further expand or in an effort to remediate any significant control deficiencies that may be identified in the future.

 

Proceedings instituted by the SEC against five PRC-based accounting firms, including our independent registered public accounting firm,

could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

 

In late 2012, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese affiliates of the “big four” accounting firms, (including our auditors) and also against Dahua (the former BDO affiliate in China). The Rule 102(e) proceedings initiated by the SEC relate to these firms’ inability to produce documents, including audit work papers, in response to the request of the SEC pursuant to Section 106 of the Sarbanes-Oxley Act of 2002, as the auditors located in the PRC are not in a position lawfully to produce documents directly to the SEC because of restrictions under PRC law and specific directives issued by the China Securities Regulatory Commission. The issues raised by the proceedings are not specific to our auditors or to us, but affect equally all audit firms based in China and all China-based businesses with securities listed in the United States.

 

In January 2014, an administrative judge reached an initial decision that the “big four” accounting firms should be barred from practicing before the SEC for six months. However, it is currently impossible to determine the ultimate outcome of this matter as the accounting firms have filed a petition for review of the initial decision and pending that review the effect of the initial decision is suspended. The SEC Commissioners will review the initial decision, determine whether there has been any violation and, if so, determine the appropriate remedy to be placed on these audit firms. Once such an order was made, the accounting firms would have a further right to appeal to the US Federal courts, and the effect of the order might be further stayed pending the outcome of that appeal.

 

Depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about the proceedings against these audit firms may cause investor uncertainty regarding China-based, United States-listed companies and the market price of our ADSs may be adversely affected.

 

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While we cannot predict the outcome of the SEC’s proceedings, if the accounting firms, including our independent registered public accounting firm, were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to timely find another registered public accounting firm which can audit and issue a report on our financial statements, we will not be able to meet the reporting requirements under the Exchange Act, which may ultimately result in our deregistration by the SEC and delisting from the NYSE. Moreover, any negative publicity about the SEC’s proceedings against these accounting firms may erode investor confidence in China-based, United States listed companies in general and the trading price of our ADSs may be adversely affected.

 

Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by the Public Company Accounting Oversight Board (United States), or the PCAOB, and consequently, investors may be deprived of the benefits of such inspection.

 

The independent registered public accounting firm that issues the audit reports included in this annual report, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and with applicable professional standards. Because our auditor is located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, our auditor, like other independent registered public accounting firms operating in China, is currently not inspected by the PCAOB.

 

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, and such deficiencies may be addressed as part of the inspection process to improve future audit quality. The inability of the PCAOB to conduct inspections of independent registered public accounting firms operating in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures, and to the extent that such inspections might have facilitated improvements in our auditor’s audit procedures and quality control procedures, investors may be deprived of such benefits.

 

Restrictions on currency exchange under Chinese laws may limit our ability to convert cash derived from our operating activities into foreign currencies and may materially and adversely affect the value of your investment.

 

Substantially all of our revenues and operating expenses are denominated in Renminbi. Under the relevant foreign exchange restrictions in China, conversion of the Renminbi is permitted, without the need for SAFE approval, for “current account” transactions, which includes dividends, trade, and service-related foreign exchange transactions. Conversion of the Renminbi for “capital account” transactions, which includes foreign direct investment and loans, is still subject to significant limitations and requires approvals from and registration with SAFE and other Chinese regulatory authorities. We cannot assure you that SAFE or other Chinese governmental authorities will not further limit, or eliminate, our ability to purchase foreign currencies in the future. Any existing and future restrictions on currency exchange in China may limit our ability to convert cash derived from our operating activities into foreign currencies to fund expenditures denominated in foreign currencies. If the foreign exchange restrictions in China prevent us from obtaining U.S. dollars or other foreign currencies as required, we may not be able to pay dividends in U.S. dollars or other foreign currencies to our shareholders, including holders of our ADSs. Furthermore, foreign exchange control in respect of the capital account transactions could affect our Chinese subsidiaries’ ability to obtain foreign exchange or conversion into RMB through debt or equity financing, including by means of loans or capital contributions from us.

 

We face risks related to health epidemics and other outbreaks.

 

Our business could be adversely affected by the effects of swine flu, avian flu, Severe Acute Respiratory Syndrome, or SARS or other epidemics or outbreaks. China reported a number of cases of SARS in April 2004. In 2006, 2007 and 2008, there were reports of occurrences of avian flu in various parts of China, including a few confirmed human cases and deaths. In April 2009, an outbreak of swine flu occurred in Mexico and the United States and human cases of swine flu were discovered in China and Hong Kong. In April 2013, there were reports of occurrences of avian flu in various parts of China, including a number of confirmed human cases and deaths. Any prolonged occurrence or recurrence of swine flu, avian flu, SARS or other adverse public health developments in China or any of the major markets in which we do business may have a material adverse effect on our business and operations. These could include our ability to deliver our products within or outside of China, as well as temporary closure of our manufacturing facilities, or our customers’ facilities, leading to delayed or cancelled orders. Any severe travel or shipment restrictions and closures would severely disrupt our operations and adversely affect our business and results of operations.

 

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Risks Relating to Our ADSs

 

The trading prices of our ADSs have been and may continue to be volatile, which could result in substantial losses to investors.

 

The closing trading prices of our ADSs ranged from $4.07 to $46.55 in 2013, and are likely to remain volatile in the future and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, like the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States. A number of China-based companies, including many solar energy companies, have listed their securities on U.S. stock exchanges. The securities of some of these companies have experienced significant volatility, including price declines in connection with their initial public offerings. The trading performances of these Chinese companies’ securities after their offerings may affect the attitudes of investors toward Chinese companies listed in the United States in general and consequently may impact the trading performance of our ADSs, regardless of our actual operating performance.

 

In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

·variations in our revenues, earnings and cash flow;

 

·announcements of our new investments, acquisitions, strategic partnerships, or joint ventures;

 

·announcements of new products and expansions by us or our competitors;

 

·announcements of sale of existing business segments;

 

·fluctuations in market prices of or demand for our products;

 

·changes in financial estimates by securities analysts;

 

·changes in the ratio of ADSs vs. common shares;

 

·additions or departures of key personnel; and

 

·potential litigation or regulatory investigations.

 

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade. We cannot assure you that these factors will not occur in the future.

 

The sale or availability for sale of substantial amounts of our ADSs could adversely affect their market price.

 

Sales of substantial amounts of our ADSs in the public market or the perception that these sales could occur, could adversely affect the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future. Our ADSs are freely tradable without restriction or further registration under the U.S. Securities Act of 1933, as amended, or the Securities Act, subject to the restrictions in Rule 144 and Rule 701 under the Securities Act. In addition, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale may adversely affect the market price of our ADSs.

 

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Our Third Amended and Restated Memorandum and Articles of Association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.

 

Our Third Amended and Restated Memorandum and Articles of Association contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction.

 

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.

 

We are an exempted company incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, as amended from time to time, the Companies Law of the Cayman Islands, as amended from time to time, and the common law of the Cayman Islands. The rights of shareholders to take actions against the directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

 

The Cayman Islands courts are also unlikely:

 

·to recognize or enforce against us judgments of courts of the United States based on certain civil liability provisions of U.S. securities laws; and

 

·to impose liabilities against us, in original actions brought in the Cayman Islands, based on certain civil liability provisions of U.S. securities laws that are penal in nature.

 

There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will in certain circumstances recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.

 

As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States.

 

Certain judgments obtained against us by our shareholders may not be enforceable.

 

We are a Cayman Islands company and all of our assets are located outside of the United States. Substantially all of our current operations are conducted in the China. In addition, a majority of our current directors and officers are nationals and residents of countries other than the United States. Substantially all of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the United States federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers.

 

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The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to vote your ordinary shares.

 

As a holder of our ADSs, you will only be able to exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will vote the underlying ordinary shares in accordance with these instructions. You will not be able to directly exercise your right to vote with respect to the underlying shares unless you withdraw the shares. Under our Third Amended and Restated Memorandum and Articles of Association, the minimum notice period required for convening a general meeting is seven days. When a general meeting is convened, you may not receive sufficient advance notice to withdraw the shares underlying your ADSs to allow you to vote with respect to any specific matter. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to vote and you may have no legal remedy if the shares underlying your ADSs are not voted as you requested.

 

The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

 

Under the deposit agreement for the ADSs, if you do not vote, the depositary will give us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings unless:

 

·we have failed to timely provide the depositary with notice of meeting and related voting materials;

 

·we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

·we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;

 

·a matter to be voted on at the meeting would have a material adverse impact on shareholders; or

 

·the voting at the meeting is to be made by a show of hands.

 

The effect of this discretionary proxy is that if you do not vote at shareholders’ meetings, you cannot prevent our ordinary shares underlying your ADSs from being voted, except under the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

 

You may not receive dividends or other distributions on our ordinary shares and you may not receive any value for them, if it is illegal or impractical to make them available to you.

 

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares underlying our ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

 

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You may not be able to participate in rights offerings and may experience dilution of your holdings.

 

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

You may be subject to limitations on transfer of your ADSs.

 

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

 

We may be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes, which could subject U.S. investors in our ADSs or ordinary shares to adverse tax consequences.

 

A non-United States corporation, such as our company, will be classified as a “passive foreign investment company” (or a “PFIC”), for United States federal income tax purposes, for any taxable year if either (i) 75% or more of its gross income consists of certain types of “passive” income or (ii) 50% or more of the value of its assets (determined on the basis of a quarterly average) produce or are held for the production of passive income. We do not believe that we were a PFIC, for United States federal income tax purposes, for the taxable year ended December 31, 2013. Although we do not currently expect that our assets or activities will change in a manner that would cause us to become a PFIC for our current taxable year or the foreseeable future, there can be no assurance our business plans will not change in a manner that will affect our PFIC status. Because there are uncertainties in the application of the relevant rules and PFIC status is a fact-intensive determination made on an annual basis, no assurance can be given that we are not or will not become classified as a PFIC.

 

If we were to be classified as a PFIC in any taxable year, a U.S. Holder (as defined in “Item 10. Additional Information—E. Taxation—Material United States Federal Income Tax Considerations”) would be subject to special rules generally intended to reduce or eliminate any benefits from the deferral of United States federal income tax that a U.S. Holder could derive from investing in a non-United States corporation that does not distribute all of its earnings on a current basis. Further, if we are classified as a PFIC for any year during which a U.S. Holder holds our ADSs or ordinary shares, we generally will continue to be treated as a PFIC for all succeeding years during which such U.S. Holder holds our ADSs or ordinary shares. See “Item 10. Additional Information—E. Taxation—Material United States Federal Income Tax Considerations—Passive Foreign Investment Company Considerations.”

 

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ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

Our company was incorporated in Cayman Islands as Mega Stand International Limited in November 2007. We changed our corporate name to Daqo New Energy Corp. in August 2009.

 

We are a company limited by shares domiciled in the Cayman Islands. The corporate affairs of Daqo New Energy Corp. are governed by our Third Amended and Restated Memorandum and Articles of Association, the Companies Law (2013 Revision) of the Cayman Islands and the common law of the Cayman Islands.

 

In 2008, we established Chongqing Daqo as our wholly owned operating subsidiary in China. Through Chongqing Daqo, we focus primarily on the manufacture and sale of polysilicon and have expanded into wafer manufacturing. In addition to Chongqing Daqo, we established Nanjing Daqo New Energy Co., Ltd., or Nanjing Daqo, in 2007 in China, through which we conducted our module manufacturing business. In 2009, we established our wholly owned subsidiary Daqo Solar Energy North America, or Daqo North America, in California to promote our products in North America. In 2011, we established a wholly owned subsidiary, Daqo New Energy Holdings (Canada) Ltd., or Daqo Canada, to expand our operations in Canada. In 2011, to expand our polysilicon manufacturing capacity, we established another wholly owned subsidiary in China named Xinjiang Daqo New Energy Co., Ltd.

 

Daqo Group established Daqo New Material in 2006 in Chongqing, China. Although all of Daqo Group’s equity interest holders also beneficially own shares of Daqo Cayman, Daqo Group does not have any shareholding in our company. As of the date of this annual report, holders of equity interests in Daqo Group in aggregate beneficially own 58.5% of the outstanding ordinary shares of our company. Subsequent to the establishment of Chongqing Daqo, in July 2008, Chongqing Daqo entered into a lease agreement with Daqo New Material to rent all of Daqo New Material’s land, production infrastructure, machinery, equipment, facilities, factories, buildings and other assets for polysilicon production. This lease was terminated on December 30, 2013. Under Financial Accounting Standards Board Accounting Standards Codification 810-10-15, “Variable Interest Entities,” we were deemed to be Daqo New Material’s primary beneficiary and Daqo New Material had been consolidated from July 1, 2008 to December 30, 2013.

 

We commenced commercial production at the Phase 1 polysilicon facilities in July 2008. Production at the Phase 1 polysilicon facilities used equipment and property of both the Company and Daqo New Material.

 

Even though we do not directly or indirectly hold any equity interests in Daqo New Material, under U.S. GAAP, Daqo New Material has been deemed to be our predecessor business from November 16, 2006 through June 30, 2008.

 

Under a non-competition agreement with us, Daqo Group has agreed not to engage in the business of manufacturing, marketing or distributing polysilicon or any other solar power products anywhere in the world or compete in any manner with our businesses without our consent for an indefinite term. Such related party transactions are subject to our audit committee’s review and approval. Under the non-competition agreement, we, through Daqo Cayman and Chongqing Daqo, are entitled to seek temporary restraining orders, injunctions or other equitable relief, in addition to monetary remedies specified in the agreement, if Daqo Group breaches its non-competition obligations. With the approval of our audit committee, we gave our consent to Daqo Group to enter the photovoltaic cell manufacturing business in China. Daqo Group incorporated the wholly owned subsidiary, Zhenjiang Daqo Solar Co., Ltd., or Zhenjiang Daqo, which started commercial production of photovoltaic cells in 2011.

 

On October 7, 2010, we listed our ADSs, each representing five ordinary shares of Daqo New Energy Corp., on the New York Stock Exchange under the symbol “DQ” in connection with an initial public offering. We issued a total of 9,200,000 ADSs at $9.50 per ADS in connection with our initial public offering.

 

In February 2011, we incorporated a wholly owned subsidiary, Xinjiang Daqo, in Shihezi Economic Development Area in Xinjiang Autonomous Region, China, to build our Phase 2a polysilicon production facilities. We finished construction of our Phase 2a polysilicon facilities in September 2012 and have engaged in commercial production at these facilities since the first quarter of 2013.

 

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In April 2011, we incorporated a wholly owned subsidiary, Daqo Canada, to expand our operations in North America. Through Daqo Canada, we set up a joint venture with JNE Solar Inc., a party unrelated to us prior to this transaction, in Hamilton, Ontario. This joint venture was terminated in April 2012. We liquidated Daqo Canada in October 2013.

 

In September 2012, to focus on our core businesses of polysilicon and wafer production, we sold our 100% equity interest in our module business to Daqo Group for a consideration of $9.9 million. On December 21, 2012, we effected a change of the ADS to ordinary share ratio from one ADS representing five ordinary shares to one ADS representing 25 ordinary shares. The ratio change had the same effect as a 1-for-5 reverse ADS split.

 

In September 2012, we halted polysilicon production in order to begin maintenance and technology improvement projects at the Phase 1 polysilicon facilities with the primary objective of lowering the cost to produce polysilicon at these facilities. In conjunction with the production stoppage, a supplementary lease agreement with Daqo New Material was reached which reduced lease payments beginning in 2013 to approximately $0.

 

In the first quarter of 2013, we terminated Daqo North America, which was originally designed to promote our module products in North America. In the second quarter of 2013, we incurred fixed asset impairment charges related to the Phase 1 polysilicon facilities to reflect the market challenges that had an adverse effect on the profit-generating ability of the assets.

 

As of March 2013, we successfully reached our initial targets for both capacity and cost structure for our Xinjiang polysilicon facilities. As part of our efforts toward further improvement, we successfully completed a project to identify and reduce restrictions on our production throughput, or a “debottlenecking” project, prior to the end of 2013. We expect to fully realize capacity of 6,150 MT and lower total production costs to the level of $14 per kg when the newly added capacity is ramped up.

 

In November 2013, the Board approved our plan to further expand our capacity in Xinjiang from 6,150 MT to 12,150 MT in order to take advantage of the enormous competitive advantage in electricity price in Xinjiang compared to that of Chongqing. We also plan to upgrade our off-gas treatment process from traditional Hydrogenation technology to Hydrochlorination technology. Simultaneous with our 2014 annual maintenance, we will prepare our Xinjiang facilities for the expansion. We expect to complete construction and installation and start pilot production by the end of 2014, and we expect to fully ramp up the newly added capacity in the second quarter of 2015.

 

In November 2013, we also achieved great progress in our wafer business by increasing our annual capacity from 36 million pieces to 72 million pieces and lowering our production costs significantly. We continuously strive to improve the cost structure for wafer production. We are in the process of implementing a slurry recovery system and expect to complete the project in May 2014.

 

As a result of certain difficulties in obtaining the planned reductions in cost at the Phase 1 polysilicon facilities, combined with the plan to expand capacity at our Xinjiang plant, we concluded the best course of action was to (i) cease production at the Phase 1 polysilicon facilities, after which we incurred an impairment charge of $158.4 million in the second quarter of 2013, (ii) relocate machinery and equipment from the Phase 1 polysilicon facilities to Xinjiang and (iii) ultimately, on December 30, 2013, sign an amendment to the supplementary lease agreement to terminate the lease, which resulted in the de-consolidation of Daqo New Material. To support the wafer manufacturing at Chongqing Daqo, a new lease agreement was entered into with Daqo New Material to lease a small portion of its facilities, including, but not limited to, the dining hall, part of the office buildings and portions of the employee dormitory, on January 1, 2014.

 

As a result of our relocation, Chongqing Daqo no longer needed to lease facilities from Daqo New Material as originally planned. On December 30, 2013, Chongqing Daqo signed an amendment to the supplementary lease agreement to terminate the lease agreement. Because of the fact that Chongqing Daqo will still use a very small portion of Daqo New Material’s facilities, including, but not limited to, the dining hall, part of the office buildings and portions of the employee dormitory, on January 1, 2014, Chongqing Daqo signed a new lease agreement with Daqo New Material for the limited facilities mentioned above.

 

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Our principal executive offices are located at 666 Longdu Avenue, Wanzhou, Chongqing 404000, People’s Republic of China, and our telephone number at that location is +86-23-6486-6666. Our registered office in the Cayman Islands is located at the offices of International Corporation Services Ltd., P.O. Box 472, 2nd Floor Harbor Place, Grand Cayman KY1-1106, Cayman Islands. Our agent for service of process in the United States is Law Debenture Corporate Services Inc., located at 400 Madison Avenue, 4th Floor, New York, NY 10017.

 

See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures” for a discussion of our capital expenditures.

 

B. Business Overview

 

Photovoltaics is one of the proven and most rapidly growing renewable energy sources in the world. Energy from the sun is converted into electricity primarily through the photovoltaic effect and, to a lesser extent, through concentrated solar thermal technologies.

 

We are a leading polysilicon manufacturer based in China. We utilize the chemical vapor deposition process, or the “modified Siemens process,” to produce polysilicon, and have fully implemented the closed loop system to produce high-quality polysilicon cost-effectively. We manufacture and sell high-quality polysilicon to photovoltaic product manufacturers, who further process our polysilicon into ingots, wafers, cells and modules for solar power solutions. Currently our annual capacity for polysilicon is 6,150 MT. We plan to further increase the capacity to 12,150 MT by the end of 2014, and we expect to fully ramp up capacity in the second quarter of 2015. We also plan to upgrade our off-gas treatment process from traditional Hydrogenation technology to Hydrochlorination technology. Simultaneous with our 2014 annual maintenance, we will prepare our Xinjiang facilities for expansion. We improve our production efficiency and increase our output through technological improvements, adoption of process innovation and refinement as well as equipment enhancement. Actual production volume may exceed the production capacity due to operational improvements we may implement at our facilities in response to market conditions.

 

We have expanded to the downstream photovoltaic manufacturing businesses to establish facilities for wafer manufacturing. Our current wafer manufacturing annual capacity is 72 million pieces. We have started to report wafer shipments in units of “million pieces” instead of “MW” since the first quarter of 2013. Improvements in wafer technology can cause watts per piece to increase, resulting in larger MW shipments without increases in the amount of wafer produced, and consequently we believe that the newly adopted unit more accurately presents our operating performance. Most of our wafer product is high efficiency wafer which represents approximately 4.3 watts per piece. The following diagram illustrates the value chain for the manufacture of crystalline-silicon based photovoltaic products:

 

 

 

 

Our operations are located in Chongqing and Xinjiang, which are in southwestern and northwestern China, respectively. The cost of doing business in western China is generally lower than the coastal areas of China. Because of our strategic locations, we experience advantages in electricity and raw material costs over our competitors that are based in developed countries or in the coastal areas of China.

 

We impose rigorous quality control standards at various stages of our manufacturing process. We systematically test raw materials from our suppliers and test our inputs at each stage of our manufacturing process to ensure that they meet all technical specifications. With our strict quality control measures in our manufacturing and facility construction processes, we are able to produce high-quality polysilicon consistently at our facilities. In 2013, approximately 99.3% of our polysilicon met the solar grade quality standard, approximately 96.3% of our polysilicon met the highest specification of the solar grade quality standard, and approximately 88.0% of our polysilicon met the electronic grade quality standard in China.

 

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We have achieved substantial growth since we commenced commercial production of polysilicon in July 2008. Although we experienced a significant downturn in terms of revenue and net income in 2012, our revenue and gross margin improved in 2013 due to a recovery in the global market and our continuous cost reduction efforts. We produced 4,524 MT, 3,349 MT (1) and 4,805 MT of polysilicon and sold 3,947 MT(3), 3,262 MT(2)(3) and 4,283 MT(3) in 2011, 2012 and 2013, respectively. We generated revenues from continuing operations of $232.2 million, $86.9 million and $109.0 million in 2011, 2012 and 2013, respectively. We achieved net income attributable to Daqo New Energy Corp. shareholders of $33.3 million in 2011. We incurred net losses attributable to Daqo New Energy Corp. shareholders of $111.9 million and $70.9 million in 2012 and 2013 respectively.

 

We currently sell polysilicon to China-based photovoltaic product manufacturers. The majority of our sales are made under framework contracts, with the prices to be determined at the time when specific sales orders are made. As of December 31, 2013, our major photovoltaic product customers included operating entities of Jiangsu Meike Silicon Energy, Zhenjiang Daqo Solar, Hanwha SolarOne, JinkoSolar and EGing PV.

 

We commenced commercial production of wafers using our own polysilicon in July 2011. In November 2013, we successfully increased our annual wafer production capacity to 72 million pieces. In addition to our wafer sales, since the second quarter of 2012, we started to provide multi-crystalline ingot and block manufacturing outsourcing services to our customers. In May 2010, we commenced commercial production of modules. We sold all of our module facilities in September 2012 to focus on our core businesses of polysilicon and wafer production. The operation of our downstream photovoltaic product manufacturing business involves risks and uncertainties, such as higher cost, lack of experience, financing, construction and operational uncertainties, potential competition and regulatory risks. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business” for details.

 

Note:
(1) Excluding 617 MT polysilicon produced in Xinjiang facilities during the pilot production period.
(2) Excluding 323 MT polysilicon sold from Xinjiang facilities during the pilot production period.
(3) The polysilicon sales volume here only refers to the external sales. The internal sales to our in-house wafer facilities were 454 MT, 315 MT and 770 MT in 2011, 2012 and 2013, respectively.

 

Quarterly sales volume table for polysilicon and wafer in 2013:

 

Sales Volume First Quarter Second Quarter Third Quarter Fourth Quarter FY 2013
Polysilicon (MT) 700.91 973.13 1,313.05 1295.79 4282.88
Wafer (million pieces) 0.73 9.09 7.08 12.69 29.59
Wafer OEM (million pieces) - - - 3.45 3.45
Ingot and Block (MT) 40.45 160.68 10.16 0.30 211.59

 

Our Products

 

We manufacture and sell high-purity polysilicon to photovoltaic product manufactures, who further process the polysilicon into ingots, wafers, cells and modules for solar power solutions. We offer ready-to-use polysilicon, packaged to meet crucible stacking, pulling, and solidification needs. Our current annual capacity for polysilicon production is 6,150 MT. We are one of the best quality polysilicon makers in China. In 2013, approximately 96.3% of our polysilicon met the highest specification of the solar grade quality standard, and approximately 88.0% of our polysilicon met the electronic grade quality standard in China.

 

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Polysilicon monthly quality data in 2013:

 

In addition, we also offer high-quality wafers through our downstream photovoltaic product manufacturing business. Currently the annual capacity of our wafer facilities is 72 million pieces. To meet the prevailing market demands, we produce both standard and high efficiency multi-crystalline wafers with dimensions of 156 millimeters x 156 millimeters and thickness of 200 microns. Our high efficiency wafers are produced through an innovative casting manufacturing process.

 

See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Components of Results of Operations—Revenues” for a breakdown of our net revenues by category of activity.

 

Manufacturing Process

 

Polysilicon

 

Modified Siemens Process

 

Three main technologies are used in polysilicon production: the Siemens process, the fluidized bed reactor process and the newly developed upgraded metallurgical grade silicon process. The Siemens process is an existing and well proven process technology predominantly used in high purity silicon feedstock production in the solar industry. Three other new technologies, the fluidized bed reactor process, the upgrading metallurgical grade silicon process and the vapor-to-liquid deposition, have the potential for lower cost production but are relatively new and less proven.

 

We use the modified Siemens process to produce polysilicon. The modified Siemens process includes three distinct steps: (1) TCS production; (2) distillation; and (3) deposition. In addition, we recover and recycle exhaust gas throughout the process in our closed loop manufacturing system. The diagram below describes our current general manufacturing process:

 

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TCS production. The first step of the manufacturing process is to produce TCS from two widely available industrial raw materials: MG-Si and liquid chlorine. We generate TCS in-house through our integrated manufacturing process. TCS production includes two steps: hydrogen chloride synthesis, or HCl synthesis, and TCS synthesis. At the HCl synthesis step, liquid chlorine from a chlorine tank is vaporized to chlorine gas and sent to the HCl synthesis furnace, where it reacts with hydrogen to generate HCl. At the TCS synthesis step that follows, MG-Si powder is then sent to a TCS furnace and reacted with HCl gas. The temperature in the TCS synthesis furnace is maintained at 280–320ºC to facilitate the TCS reaction.

 

Distillation. Distillation is a method of separating mixtures based on differences in their boiling points. Raw TCS is purified through distillation to produce high purity TCS feedstock. The difference in boiling points of TCS and impurities such as boron, phosphorous, and metal halides allow for purification of TCS. It is critical to remove these impurities in this process to eliminate the possible causes of low performance in solar cells. In the distillation process, all by-product chemicals from vent gases are separated and further purified before being sent back to our production areas.

 

Deposition. The purified TCS from the distillation process is vaporized, mixed with hydrogen gas, and then fed into the deposition reactor. The mixed gas passes over heated silicon slim rods inside the deposition reactor. In the reactor, multiple pair slim rods are heated up to approximately 1,100°C and high purity silicon is deposited on the rods surface. The constant feeding of TCS and hydrogen gas allows for continuous silicon deposition until 150–200mm in diameter is achieved. At this point the deposition cycle is completed and the ultra pure silicon is harvested.

 

Closed loop manufacturing system

 

We have implemented the modified Siemens process in a completely closed loop system. The closed loop system is an advanced polysilicon manufacturing process widely used by leading international polysilicon manufacturers. Compared to the open loop system, the closed loop system uses raw materials more efficiently, requires less electricity and produces less pollution. Manufacturing polysilicon generates an exhaust gas primarily consisting of hydrogen, HCl, and chlorosilanes. Using the vent gas recovery system, which combines condensers, distillation towers, adsorption beds and compressors, we are able to separate the exhaust stream from our manufacturing process into individual components that can be reused after further purification. For instance, a by-product of the deposition step is TET, which is a toxic chemical. Through a separate hydrogenation process, we convert TET to TCS, so that we eliminate the costs related to TET disposal and reduce operational risks of TET treatment. Mixed chlorosilanes are recovered as a liquid stream suitable for separation where we can directly reuse TCS. Anhydrous HCl is recovered with high purity, suitable for use in TCS production. Recovered hydrogen typically contains contaminants of fewer than 10 parts per million and is recycled to the deposition reactors. Recycling significantly reduces costs related to waste disposal and the amount of raw materials we need to purchase for production.

 

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Although the closed loop system has lower manufacturing costs than the open loop system, manufacturing facilities based on the open loop system can be built within a shorter period time with less initial capital investment for equipment. Most of polysilicon manufacturing facilities in China were traditionally built based on the open loop system. However, as the polysilicon market may face downward pricing pressure from time to time, we believe that an increasing number of China-based manufacturers are converting their open loop system to the closed loop system and some of them have completed such conversion. The full implementation of the closed loop system by other polysilicon manufacturers has diminished our competitive advantages provided by this system. Nevertheless, in August 2011, Chongqing Daqo entered into a Technology License and Transfer Agreement with GTAT Corporation, a Delaware company, under which GTAT granted us a license to use, in both our Chongqing and Xinjiang facilities, its Hydrochlorination TCS Production Technology and Chlorosilane Recovery/Waste Neutralization Technology, which will help expand our manufacturing capacity and significantly reduce electricity consumption to reduce our production costs to reach a more competitive level.

 

To achieve high efficiency in our manufacturing process, we have also installed a distribution control system and a thermal energy recycling mechanism. The distribution control system enables tight quality control, reduces process related variations, and improves productivity. Our thermal energy recycling system allocates heat generated from our deposition reactors and hydrogenation reactors to many other production areas, such as distillation facilities for TCS purification and our refrigeration station to support a large number of condensers.

 

Moving forward, for our off-gas treatment process we plan to adopt Hydrochlorination technology, a process which has seen increasing application in polysilicon manufacturing in recent years. It converts TET (STC) to TCS by reacting with metallurgical grade silicon powder. Using Hydrochlorination technology, chemical reactions take place under much higher pressure and at lower temperatures in comparison to the traditional hydrogenation process. As a result, it consumes less electricity and offers a higher STC/TCS conversion rate. In addition, the hydrochlorination process also does not require fresh TCS production, which further reduces production costs.

 

Wafer

 

We conducted our wafer business through tolling arrangements with third party wafer manufacturers in 2009 and 2010. In July 2011, we commenced commercial production of multi-crystalline silicon wafers at our wafer production facilities, which have a current production capacity of 72 million pieces.

 

The manufacturing process of wafers typically consists of two major steps: ingot preparation and wafering. Multi-crystalline ingots are prepared by directional solidification in a casting furnace. Silicon ingots will then be shaped to the required sizes and sliced to wafers by wire saws.

 

Manufacturing Capacity

 

The following table sets forth our major installed approximate annual production capacity objectives as of the dates indicated and includes the expected date of initial commercial operation and fully ramped-up production of each expansion phase.

 

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Approximate
Annual
Production
Capacity

Construction Period

Commercial
Production
Period

Fully
Ramped-up

Production

Polysilicon:        
Phase 1a facilities (1) (2) 1,500MT June 2007—May 2008 July 2008—September 2012 March 2009
Phase 1b facilities (1) (2) 1,800MT May 2008—May 2009 December 2009—September 2012 January 2010
Capacity enhancement of Phase 1 facilities (1) (2) 1,000MT December 2010 December 2010—September 2012 December 2010
Phase 2a facilities (3) 5,000MT Second Quarter 2011—
September 2012
First Quarter 2013—Present March 2013
Capacity enhancement of Phase 2a facilities (3) 1,150MT July 2013—January 2014 January 2014—Present Second Quarter 2014 (4)
Phase 2b facilities (3) 6,000MT April 2014—December 2014 (5) December 2014 (5) Second Quarter
2015 (5)
         
Wafer:        
Phase 1a facilities (1) 36 million pieces July 2010—February 2011 July 2011—Present November 2011
Phase 1b facilities (1) 72 million pieces February 2011—September 2011 May 2013—Present November 2013

 

 

 

Notes:

 

(1)The facilities are located in Chongqing.

 

(2)We halted polysilicon production at these facilities in September 2012 and ultimately determined to cease production in the second quarter of 2013.

 

(3)The facilities are located in Xinjiang.

 

(4)Estimated and may change subject to actual conditions.

 

(5)The estimated timetable of the Phase 2b expansion project in our Xinjiang polysilicon facilities may change subject to actual conditions.

 

Our annual polysilicon production capacity reached 6,150 MT in 2013. We plan to further expand the capacity of our Xinjiang facilities to 12,150 MT in order to better take advantage of what we believe will be lower production costs in Xinjiang, and optimize utilization of the assets being relocated from the Phase 1 polysilicon facilities. We also plan to upgrade our off-gas treatment process from traditional Hydrogenation technology to Hydrochlorination technology. Simultaneous with our 2014 annual maintenance, we will prepare our Xinjiang facilities for expansion. We expect to complete construction and start a trial run by the end of 2014, and we expect to fully ramp up capacity in the second quarter of 2015. Our capacity expansion plan and technology improvement plan are preliminary and subject to risks and uncertainties that may be out of our control. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business—Our future success depends substantially on our ability to significantly expand our polysilicon production capacity and output, which exposes us to a number of risks and uncertainties” and “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business—If we are unable to manage our expansion effectively, our business and financial results may be adversely affected.”

 

Materials and Inputs Used in Production

 

Polysilicon

 

Raw materials required for our polysilicon manufacturing process primarily include metallurgical grade silicon, which is silicon of 95% to 99% purity, and liquid chlorine, two widely available industrial raw materials used in our in-house production of TCS, electricity and other utilities, and other significant inputs for production, such as argon gas, caustic soda and graphite parts. We produce liquid chlorine in our in-house facilities. This provides us with a reliable supply of liquid chlorine and also helps us to further reduce material costs.

 

The costs of electricity are significant in the production of polysilicon. The electricity costs in Chongqing are lower than those in coastal areas of China and those in developed countries due to Chongqing’s abundant hydroelectric resources. The costs of electricity in Xinjiang are over 50% lower than even those in Chongqing due to Xinjiang’s abundant coal resources. We also use other utilities, such as steam, water and natural gas, for our manufacturing process. Steam supply is important to the production of polysilicon. We use both a local supplier and our in-house capabilities to produce steam.

 

Wafer

 

Wafer manufacturing uses solar grade polysilicon as the primary raw material and consumables such as crucibles, wires and slurry. Our high quality polysilicon is a crucial factor that will enable us to provide high quality silicon wafers to customers. We intend to utilize our in-house solar grade polysilicon for high efficiency wafer production.

 

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Equipment

 

The major polysilicon production equipment includes hydroelectrolysis devices, hydrochlorination synthesis furnaces, TCS synthesis furnaces, distillation towers, polysilicon deposition reactors, hydrogenation reactors, exhaust gas recovery units and distribution control systems. The major wafer production equipment includes crystal growing furnaces, crucible coating machines, squarers, wire saws, wet benches and testing tools.

 

We have close relationships with several of the world’s leading equipment manufacturers and work closely with selected equipment manufacturers to develop and build our production lines. In addition, we developed technical specifications for the design of our power supply systems and reactors and have engaged manufacturers to construct the equipment in accordance with our specifications. Our engineers work closely with our equipment suppliers to design our production facilities. Furthermore, to lower costs, we have purchased and will continue to purchase equipment that can be appropriately designed and manufactured by China-based suppliers. Our technical team is responsible for overseeing the installation of our manufacturing lines to optimize the interaction between the various individual components of the entire production process. They work together with our equipment suppliers’ technical teams on site at the time of installation.

 

Quality Assurance

 

We apply our quality control system at each stage of our manufacturing process, from raw materials procurement to production and delivery, in order to ensure a consistent quality of our products. We systematically inspect raw materials from our suppliers, such as MG-Si, liquid chlorine and various consumables for our polysilicon business and polysilicon for our wafer business. We also test our inputs in each stage of our production process to ensure the inputs meet all technical specifications.

 

We sample each lot of polysilicon harvested from the deposition reactors and keep the samples for product quality tracking purpose. We also set up a product tracking system to trace back all shipped products to the samples we keep and to our database, which contains detailed information of each shipment. We received the ISO 9001:2008 certification for our quality assurance system for production of polysilicon, which we believe demonstrates our technological capabilities and inspires customer confidence. In addition, in 2009, Chongqing Science and Technology Commission issued a three-year certificate to recognize our polysilicon as a high and new technology product. We have successfully renewed the certificate until November 2015. We are also in the process of applying for “High and New Technology Enterprise” status for our Xinjiang polysilicon facilities in Xinjiang.

 

For our wafer production, we inspect all critical incoming materials, such as feedstock silicon, crucible, slurry and wire to ensure they meet our wafer production requirement. Through manufacturing process, technical parameters such as minority lifetime, resistivity, geometry dimension and surface appearance will be checked at various points as part of in-process quality control. As a final product, each wafer is sent to an automatic inspection machine to be inspected against our product technical specifications.

 

In order to facilitate our production of photovoltaic products and ensure the quality of the finished product, we conduct analysis for raw materials, in-process products and finished products and monitor the environmental impact and safety throughout the production process.

 

Customers and Sales

 

We currently sell polysilicon and wafers to China-based photovoltaic product manufacturers. Our major customers include operating entities of Jiangsu Meike Silicon Energy, Zhenjiang Daqo Solar, Hanwha SolarOne, JinkoSolar and EGing PV. We sell a substantial portion of our photovoltaic products to a limited number of customers. Our top three customers in aggregate accounted for 38.7%, 40.9% and 38.5% of our total revenues in 2011, 2012 and 2013, respectively.

 

The majority of our polysilicon sales are made under framework contracts. The framework contracts typically provide binding terms for the sales volumes of our polysilicon. The pricing terms are typically agreed upon between us and our customers based on the prevailing market prices when specific sales orders are made. We currently sell all of our wafer products on a spot pricing basis.

 

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We have established nationwide marketing capability through our sales team in China. Each member of our sales team is dedicated to a particular region. Our sales team attends domestic and international industrial conferences and trade fairs and organizes advertising and public relations events. Our sales and marketing team works closely with both our research and development team and our production team to coordinate our ongoing supply and demand planning.

 

Research and Development

 

We believe that the continual development of our technology will be vital to maintaining our long-term competitiveness. We have one of the leading research and development teams among polysilicon manufacturers in China. Our research and development team consists of 140 experienced researchers and engineers. Our senior management team spearheads our research and development efforts and sets strategic directions for the advancement of our products and production processes, focusing on efforts to improve product quality, reduce manufacturing costs and broaden our product markets. In 2013, we completed 48 research and technology or process improvement projects to enhance our polysilicon and wafer manufacturing processes, and successfully registered 8 patents with the State Intellectual Property Office of PRC.

 

Intellectual Property

 

Our intellectual property is an essential element of our business. We rely on patents, copyrights, trademarks, trade secrets and other intellectual property laws, as well as non-competition and confidentiality agreements with our employees, business partners and others, to protect our intellectual property rights.

 

As of the date of this annual report, we hold 21 patents and have 10 additional pending patent applications covering different aspects of the polysilicon manufacturing process. We also rely heavily on a combination of proprietary process engineering, trade secrets and employee contractual protections to establish and protect our intellectual property, as we believe that many crucial elements of our production processes involve proprietary know-how, technology or data that are not covered by patents or patent applications, including technical processes, equipment designs, algorithms and procedures. We have taken security measures to protect these elements. All of our research and development personnel have entered into confidentiality and proprietary information agreements with us. These agreements address intellectual property protection issues and require our employees to assign to us all of the inventions, designs and technologies that they develop when primarily utilizing our resources or when performing their duties during their employment.

 

While we continue to develop and pursue patent protection for our own technologies, we expect to continue implementing third party license arrangements on certain key aspects of our operation. For the risks associated with our reliance on certain third-party technologies, see “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business—We rely on third party intellectual property for certain key aspects of our operation, which subjects us to the payment of license fees and potential disruption or delays in the production of our products.” In August, 2011, Chongqing Daqo entered into a Technology License and Transfer Agreement with GTAT Corporation, a Delaware company, under which GTAT granted us a license to use its Hydrochlorination TCS Production Technology and Chlorosilane Recovery/Waste Neutralization Technology for our current polysilicon production and future polysilicon production expansions in both our Chongqing and Xinjiang facilities.

 

Most of our equipment supply contracts with international suppliers include an indemnification provision under which the supplier undertakes to indemnify us against actions, claims, demands, costs, charges, and expenses arising from or incurred by reason of any infringement or alleged infringement of patent, copyright, trade mark or trade name by the use of the equipment provided by the supplier. However, it is unclear whether we will be entitled to such indemnification in the event that we use the equipment supplied by such supplier in conjunction with other equipment not supplied by such supplier. In addition, many of our equipment supply contracts with China-based suppliers do not provide any intellectual property indemnification provisions. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business—We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards.”

 

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Competition

 

We face competition in China and in the international markets in which we have sales.

 

The photovoltaic market is dominated by a few major manufacturers with a large number of small manufacturers competing for the remaining small portion of the market. We face competition mainly from top manufacturers who have succeeded in establishing a strong brand name with solar companies. For our polysilicon and wafer businesses, our major international competitors include Hemlock, Wacker, OCI, REC, MEMC, and Green Energy Technology, and our China-based competitors include GCL-Poly, TBEA and China Silicon Corporation, among others. In addition, some solar cell and module manufacturers have or have announced the intention of establishing polysilicon production or affiliate relationships with manufacturers of polysilicon, including some of our customers and potential customers. We compete with these in-house capabilities, which could limit our ability to expand our sales. Furthermore, the demand for our polysilicon may be adversely affected by alternative technologies in cell manufacturing. The vast majority of silicon-based photovoltaic cell manufacturers currently use chunk or granular polysilicon. However, alternative technologies are being developed in cell manufacturing. For example, one such technology, thin-film cell production, uses little to no silicon in the production of solar cells. We believe that the solar cells made using thin-film technologies generally tend to have lower energy conversion efficiency than silicon-based solar cells. In addition, the manufacturing cost of silicon-based cells has been significantly reduced recently, which largely reduces or eliminates the historical cost advantage of thin-film cells. Based on our management’s industry knowledge, we believe silicon-based cells will remain the most widely used solar photovoltaic cells in the near future.

 

We believe that the key competitive factors in the market for photovoltaic products include:

 

·product quality;

 

·price and cost competitiveness;

 

·manufacturing technologies and efficiency;

 

·manufacturing reliability;

 

·economies of scale; and

 

·reputation.

 

We believe we differentiate ourselves from our competitors and capture market share in the polysilicon markets through our product quality, price and cost competitiveness, and manufacturing technologies and efficiency.

 

Regulation

 

This section sets forth a summary of the most significant regulations or requirements that affect our business activities in China.

 

Renewable Energy Law and Other Government Directives

 

China enacted the Renewable Energy Law in February 2005 and amended the law in December 2009. The amended Renewable Energy Law sets forth the national policy to encourage and support the development and use of solar and other renewable energy and its use for on-grid generation. The law also sets forth the national policy to encourage the installation and use of solar technologies in water-heating systems, heating and cooling systems, power generation systems and other energy utilization systems. In addition, the law provides financial incentives, such as national funding, preferential loans and tax preferences for the development of renewable energy projects.

 

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In January 2006, the National Development and Reform Commission, or the NDRC, issued two implementing rules relating to the Renewable Energy Law that, among other things, provide general policies regarding the pricing of on-grid power generated by solar and other renewable energy.

 

In May 2006, the Ministry of Finance issued measures providing that the Chinese government shall provide certain government subsidies and financial incentives to support the development of the renewable energy industry, including the solar energy industry.

 

In August 2006, the Ministry of Housing and Urban-Rural Development (formerly the Ministry of Construction) and the Ministry of Finance also issued guidelines which sought to expand the use of solar energy in residential buildings.

 

In August 2007, the NDRC promulgated the Medium and Long-Term Development Plan for the Renewable Energy Industry. This plan sets forth national policy to provide financial allowance and preferential tax regulations for the renewable energy industry. A similar demonstration of the PRC government’s commitment to renewable energy was also set forth in the Eleventh Five-Year Plan for Renewable Energy Development, which was promulgated by the NDRC in March 2008. The Outline of the Twelfth Five-Year Plan for National Economic and Social Development of the PRC, which was approved by the National People’s Congress in March 2011, also demonstrates a commitment to promote the development of renewable energy to enhance the competitiveness of the renewable energy industry.

 

In March 2009, the Ministry of Finance promulgated the Interim Measures for Administration of Government Subsidy Funds for Application of Solar Photovoltaic Technology in Building Construction to support the development of solar photovoltaic technology in China. Local governments are encouraged to issue and implement supporting policies. Also in March 2009, the Ministry of Finance and the Ministry of Housing and Urban-Rural Development jointly promulgated the Implementation Opinion on Acceleration in the Application of Solar Photovoltaic Technology in Building Construction. On March 8, 2011, the Ministry of Finance and Ministry of Housing and Urban-Rural Development jointly promulgated the Notice on Further Application of Renewable Energy in Building Construction, which aims to raise the percentage of renewable energy used in buildings.

 

In July 2009, the Ministry of Finance, the Ministry of Science and Technology and the National Energy Bureau jointly issued measures that provide for government subsidies to support the photovoltaic industry.

 

In September 2009, the NDRC and nine other governmental agencies jointly issued measures aimed at curtailing the perceived over-capacity in certain industry sectors, such as steel, concrete, polysilicon and wind power equipment. Pending the promulgation of more specific regulations, the measures require new projects after the date of the new measures in any of the deemed “over-capacity industries” to obtain approval from the NDRC. The measures also provide that the Chinese government shall support polysilicon manufacturers with large manufacturing capacities and advanced technologies. As a result, any entity which plans to establish a polysilicon manufacturing facility or to expand its current manufacturing facility in China after the measures were issued must seek pre-approval from the NDRC.

  

On January 24, 2011, the NDRC issued detailed regulations for the approval of new polysilicon construction projects.

 

On July 24, 2011, the NDRC issued the Circular on Improving the On-Grid Price Policy for Photovoltaic Power, which aims to stimulate the photovoltaic power industry by regulating the price of photovoltaic power.

 

On July 4, 2013, the General Office of the State Council of China issued “Several opinions on promoting healthy development of Solar PV industry” which increased the aggregated target for PV installations as of 2015 from the previously announced 21GW to 35GW.

 

On September 16, 2013, the Ministry of Industry and Information Technology issued “Regulatory Requirements to Solar PV manufacturing industry” to set up specific requirements for all sectors through the whole solar PV value chain regarding layout, scale, capacity, quality, efficiency, power consumption, environmental control and certain other elements of PV production, in order to optimize industry layout, adjust industry structure, modulate total capacity, encourage innovation and support PV applications.

 

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On January, 2014, the National Energy Administration of China announced the PV installation target for 2014 to be 14GW, which includes 8GW for distributed PV systems and 6GW for large scale PV power plants.

 

Environmental and Safety Regulations

 

We use, generate and discharge toxic, volatile or otherwise hazardous chemicals and wastes in our research and development and manufacturing activities. China enacted the Environmental Protection Law effective December 1989. In addition to the Environmental Protection Law, we are subject to a variety of specific laws and regulations in China related to the storage, use and disposal of hazardous materials, including laws and regulations governing water pollution, air pollution, solid waste pollution, noise pollution, hazardous chemicals, pollutant discharge fees and environmental impact appraisals. We are also subject to laws and regulations governing worker safety, work safety permits and occupational disease prevention. Our operation is subject to regulation and periodic monitoring by local environmental protection and work safety authorities.

 

Foreign Currency Exchange

 

Foreign currency exchange in China is primarily governed by two sets of regulations issued in 1996.

 

Under the Foreign Exchange Administration Rules, the Renminbi is freely convertible for routine current account items, including distribution of dividends, payment of interest, and trade and service-related foreign exchange transactions. However, conversion of Renminbi for most capital account items, such as direct investment, overseas loan, securities investment and repatriation of investment, is still subject to the approval of SAFE.

 

Under the Regulations of Settlement, Sale and Payment of Foreign Exchange, foreign invested enterprises may only buy, sell and remit foreign currencies at authorized banks and must comply with certain procedural requirements, such as providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from SAFE. Foreign invested enterprises are also subject to limitations on capital investments outside of China, which include requirements to obtain approvals from the Ministry of Commerce, the NDRC and SAFE.

 

Admission of Foreign Investment

 

The principal regulation governing foreign ownership of solar power businesses in the PRC is the Foreign Investment Industrial Guidance Catalogue. Under the current catalogue, which was amended in 2013 and became effective May 1, 2013, the solar power related business is classified as an “encouraged foreign investment industry.” Companies that operate in encouraged foreign investment industries and satisfy applicable statutory requirements are eligible for preferential treatment, including exemption from customs and input value added taxes, or VAT, and priority consideration in obtaining land use rights.

 

SAFE Circular No. 75

 

SAFE Circular No. 75, which became effective as of November 1, 2005, requires Chinese residents, including both legal persons and natural persons, to register with their local SAFE branch before establishing or acquiring control of any company outside of China with assets or equity interests in Chinese companies for the purpose of capital financing. Such a company outside of China is referred to as an “offshore special purpose company.” Chinese residents must also file amendments to their registrations if their offshore companies experience capital variation, such as changes in share capital, share transfers, mergers and acquisitions, long-term equity or debt investments or creation of any security interest over any assets located in China or any other material change in share capital. Failure to comply with the registration procedures may result in restrictions being imposed on the foreign exchange activities of the relevant Chinese entity. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China—Chinese regulations relating to offshore investment activities by Chinese residents may increase the administrative burden we face and may subject our Chinese resident beneficial owners or employees to personal liabilities, limit our subsidiaries’ ability to increase its registered capital or distribute profits to us, limit our ability to inject capital into our Chinese subsidiaries, or may otherwise expose us to liability under Chinese law.”

 

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Regulations on Employee Stock Options Plans

 

In February 2012, SAFE promulgated the Notice on the Administration of Foreign Exchange Matters for Domestic Individuals Participating in the Stock Incentive Plans of Overseas Listed Companies, or the Stock Option Notice. According to the Stock Option Notice, a PRC domestic qualified agent or the PRC subsidiary of such overseas listed company must file an application with SAFE or its local counterpart on behalf of PRC resident individuals who participate in stock incentive plans of overseas publicly-listed companies to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with the stock holding or share option exercises. Our company is an “overseas publicly-listed company,” and therefore, we and participants of our share incentive plan who are PRC individuals are subject to these regulations. We have completed the registration for the options granted as of year end 2013 and are in the process of submitting an application to register the options granted on 28 January, 2014.

 

Seasonality

 

Due to our limited size, we do not expect our operating results and operating cash flows to be subject to seasonal variations. This pattern may change, however, as a result of growth, new market opportunities or new product introductions.

 

C. Organizational Structure

 

The following diagram illustrates our corporate structure, including our principal subsidiaries, as of the date of this annual report.

 

 

 

 

 

Notes:

 

(1)Individual owners of Daqo Group beneficially hold equity interests in Daqo Cayman through nine personal holding companies incorporated in the British Virgin Islands. See “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”

 

(2)Indicates the respective shareholding percentage of the shareholders in Daqo Cayman.

 

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(3)Indicates jurisdiction of incorporation.

 

(4)Indicates companies within the listing group.

 

D. Property, Plants and Equipment

 

We are headquartered in Wanzhou, Chongqing, China, where we own several buildings with approximately 50,465 square meters of office and manufacturing space in total as of December 31, 2013. We have been granted land use rights to approximately 132,441 square meters of land on which our plants or offices are situated, and such land use rights are usually valid for a period of fifty years starting from the date of grant from the local government. Our Phase 2 production facilities in Xinjiang have approximately 92,340 square meters of office and manufacturing space in total as of December 31, 2013. On January 1, 2014, we signed a five-year lease agreement with Daqo New Materials for, among other things, office buildings and employee dormitories. In addition, we hold a lease for approximately 398 square meters of office space in Shanghai, expected to expire in April 2014.

 

In September 2012, we sold our 100% equity interest in Nanjing Daqo to Daqo Group for a consideration of $9.9 million in order to concentrate on our core businesses of polysilicon and wafer production.

 

We believe that our existing facilities, together with our facilities under construction, are adequate for our current and foreseeable requirements.

 

See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Capital Expenditures” for a discussion of our capital expenditures.

 

Environmental and Safety Matters

 

Our manufacturing processes generate noise, waste water, gaseous wastes and other industrial wastes. We believe we are in compliance with all present national and local environmental protection requirements in all material respects and have all the necessary environmental permits to conduct our business in China. We process all our waste water and waste gas through various treatments so that they meet the respective national discharge standard. In addition, most of our solid waste can be reused and does not contain poisonous materials. We have established a pollution control system and installed various types of anti-pollution equipment in our facilities to reduce, treat, and where feasible, recycle the waste generated in our manufacturing process.

 

We are required to undergo environmental protection and work safety acceptance inspections and obtain approval from relevant governmental authorities before our manufacturing lines are permitted to commence full production. Our production facilities are subject to various pollution control regulations with respect to noise and air pollution and the disposal of waste and other hazardous materials. We have obtained a pollutant discharge permit, a work safety permit for storage and use of hazardous chemicals and a permit for the use of atmospheric pressure containers we have installed.

 

Insurance

 

We maintain various insurance policies to safeguard against risks and unexpected events. We purchased property insurance and project construction insurance policies covering our inventory, equipment, vehicles, facilities, buildings and buildings under construction. These insurance policies cover losses due to fire, explosion and a wide range of human accidents. We also provide social security insurance including pension insurance, unemployment insurance, work-related injury insurance and medical insurance for our employees. We do not maintain business interruption insurance or general third-party liability insurance. We also do not have product liability insurance or key-man life insurance. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business—We have limited insurance coverage. In particular, we do not have any product liability insurance or business interruption insurance.” We consider our insurance coverage to be in line with that of other manufacturing companies of similar size in China.

 

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ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the historical consolidated financial statements of our company for the years ended December 31, 2011, 2012 and 2013 and related notes included elsewhere in this annual report on Form 20-F. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this annual report.

 

A. Operating Results

 

Overview

 

We are a leading polysilicon manufacturer based in China with an annual production capacity of 6,150 MT as of the date of this annual report. We believe our production cost for polysilicon is one of the lowest and our product quality is one of the best in China. We have expanded to the downstream photovoltaic manufacturing business to establish facilities for wafer manufacturing. Our current wafer manufacturing annual capacity is 72 million pieces. We had 100MW module production facilities in Nanjing, all of which we sold to Daqo Group in September 2012.

 

We strive to improve our polysilicon production efficiency and to increase our output through technological improvements, adoption of process innovation and refinement, as well as equipment enhancement. As a result of these initiatives, we produced 4,524 MT polysilicon in 2011. In 2012, our polysilicon output was 3,349 MT(1), which was less than 2011 due to the suspension of the Phase 1 polysilicon facilities and less than normal output in our Xinjiang facilities during the pilot production period in the fourth quarter of 2012. In 2013, we produced 4,805 MT polysilicon which was all contributed by our Xinjiang facilities. We conducted a “debottlenecking” project for our Xinjiang facilities and successfully completed the project and started pilot production in December 2013. We expect to fully realize capacity of 6,150 MT and lower production costs to the level of $14 per kg when the newly added capacity is fully ramped up. We plan to further increase the capacity in our Xinjiang facilities to 12,150 MT through a capacity expansion project which includes relocating machinery and equipment from the Phase 1 polysilicon facilities and is expected to be completed by the end of 2014. We also plan to upgrade our off-gas treatment process from traditional Hydrogenation technology to Hydrochlorination technology. Simultaneous with our 2014 annual maintenance, we will prepare our Xinjiang facilities for expansion. We currently sell polysilicon to China-based photovoltaic product manufacturers. The majority of our sales are made under framework contracts, with the prices to be determined at the time when specific sales orders are made. As of December 31, 2013, our major photovoltaic product customers included operating entities of Jiangsu Meike Silicon Energy, Zhenjiang Daqo Solar, Hanwha SolarOne, JinkoSolar and EGing PV.

 

We have expanded to the downstream photovoltaic manufacturing business to establish facilities for wafer manufacturing. Our Phase 1a wafer manufacturing facilities in Chongqing commenced commercial production with an annual capacity of 36 million pieces in July 2011. We gradually increased the utilization rate of our wafer facilities in 2013 and successfully expanded the capacity to 72 million pieces in November 2013. We plan to adopt several technical improvements in 2014 including a slurry recovery system which will enable further cost reductions.

 

We have achieved substantial growth since we commenced commercial production of polysilicon in July 2008, though we experienced a significant downturn in terms of revenue and net income in 2012. In 2013, with the recovery of the solar PV market, we achieved an increase of 25.5% in our revenues compared to 2012. Our gross margin also improved from negative 43.1% in 2012 to negative 23.9% in 2013. We produced 4,524 MT, 3,349 MT(1) and 4,805 MT of polysilicon and sold 3,947 MT(3), 3,262 MT(2)(3) and 4,283 MT(3) in 2011, 2012 and 2013, respectively. We generated revenues from continuing operations of $232.2 million, $86.9 million and $109.0 million in 2011, 2012 and 2013, respectively. We achieved net income attributable to Daqo New Energy Corp. shareholders of $33.3 million in 2011. We incurred net losses attributable to Daqo New Energy Corp. shareholders of $111.9 million and $70.9 million in 2012 and 2013 respectively.

 

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Note:

(1) Excluding 617 MT polysilicon produced in Xinjiang facilities during the pilot production period.
(2) Excluding 323 MT polysilicon sold from Xinjiang facilities during the pilot production period.
(3) The polysilicon sales volume here only refers to the external sales. The internal sales to our in-house wafer facilities were 454 MT, 315 MT and 770 MT in 2011, 2012 and 2013, respectively.

 

Key Factors Affecting Our Results of Operations

 

The following are key factors that affect our financial condition and results of operations and are important for understanding our business:

 

·demand for photovoltaic products, including government incentives to promote the usage of solar energy;

 

·product prices;

 

·our product mix;

 

·our production capacity and utilization; and

 

·our production costs, and in particular the cost of electricity.

 

Demand for photovoltaic products

 

Our business and revenue growth are, in part, dependent on the demand for photovoltaic products. The photovoltaic industry remains at a relatively early stage of development and it is uncertain whether solar energy will be widely adopted. Although demand for photovoltaic products has grown significantly over the past decade, the global economic slowdown and turmoil in the global financial markets, especially the European sovereign debt crisis that unfolded in 2010 and continued through 2013, coupled with rapid declines in petroleum and natural gas prices, have made solar energy less cost competitive and less attractive as an alternative source of energy.

 

Demand for photovoltaic products is driven, in part, by government incentives that make the economic cost of solar power competitive with the cost of traditional and other forms of energy. We believe that the near-term growth of the market for solar energy applications depends in large part on the availability and size of government subsidies and economic incentives. Reduction in or elimination of government subsidies and economic incentives may hinder the growth of this market or result in lower sales prices for solar energy products, which could cause our revenues to decline.

 

Global solar PV installations in 2013 totaled around 36.5 GW, which represents a 16% increase compared to 31.4 GW in 2012. Although the European markets shrank significantly due to subsidy cuts in major markets like Germany, Italy and Spain, the markets in China, Japan and the US took over the leading positions as the three biggest markets for solar PV in 2013. Currently most of the analyst reports forecast that global solar PV installations in 2014 will be in the range of 42~45 GW, which represents growth of 15%~23%. On the premise that the global market grows as expected and there will not be significant new supply being added into the market in 2014, we believe the average selling price for polysilicon will be strongly supported by demand in the range of $20 per kg to $25 per kg.

 

Product prices

 

The sales prices of our photovoltaic products are volatile and cannot always be predicted with certainty. Our sales prices declined from mid-2008 to the middle of 2010 due to industry-wide excess supply but stabilized in the third quarter of 2010 and increased marginally in the fourth quarter of 2010 due to end market demand. In 2011 our sales prices declined rapidly in the fourth quarter primarily due to excess supply in the market. The decline in sales prices continued throughout 2012. Our sales prices started to recover through 2013 due to improved demand and reduced inventory levels. The decline in the market price of polysilicon resulted in an approximately 7% decrease in the average selling price of our polysilicon from 2010 to 2011, a further 59.3% decrease from 2011 to 2012 and a further 23.3% decrease from 2012 to 2013. The market prices for polysilicon and wafer have improved significantly through 2013, albeit not sufficiently to reverse the year-on-year average decrease, into early 2014. For example, the average selling price for our polysilicon increased by 17.1% from January 2013 to December 2013. Our gross margin from continuing operations decreased from 42.8% in 2010 to 37.6% in 2011 and further decreased to negative 43.1% in 2012. In 2013, our gross margin from continuing operations improved to negative 23.9%.

 

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Company’s polysilicon average selling prices vs. average spot prices* (VAT excluded):

 

 

* Average spot prices are monthly averages based on PVinsights “PV Poly Silicon Weekly Spot Price” data.

 

Product mix

 

The proportion of our revenues that are generated from the sales of other photovoltaic products, also referred to as product mix, affects our revenues and profitability. In addition to the revenues generated from sales of polysilicon, we also generated revenues from other products. In 2010, we generated revenues from sales of modules and wafers and we processed wafers through tolling arrangements with third party wafer manufacturers. In 2011, we generated revenues from sales of wafers and modules we produced in our facilities. In 2012, we generated revenue from sales of modules for the first three quarters of the year before we sold 100% of our equity interests of Nanjing Daqo, and we also generated revenue from sales of wafers produced in our facilities. For the year ended December 31, 2013, the revenues we generated from our two segments included sales of polysilicon and wafers, which accounted for 70.4% and 29.6% of our total revenues from continuing operations, respectively.

 

Our production capacity and utilization

 

In the near future, we plan to continue to focus on our core businesses to further improve our operation efficiency, cost structure and products quality by expanding our capacity, adopting new technologies and optimizing the manufacturing processes. For our polysilicon business, we ramped up production at the Phase 1b facilities to their full annual capacity of 1,800 MT in 2010. We expanded the aggregate capacity of our Phase 1a and Phase 1b facilities to 4,300 MT through a capital enhancement project in 2011. In September 2012, we halted the production of polysilicon in our Phase 1a and 1b facilities in Chongqing and ultimately determined to cease production in the second quarter of 2013. In September 2012, we successfully completed our Xinjiang Phase 2a facilities. Currently our annual capacity in Xinjiang Phase 2a for polysilicon is 6,150 MT. We plan to further increase the capacity to 12,150 MT by the end of 2014 and fully ramp up capacity in the second quarter of 2015. For our wafer business, the Phase 1a wafer manufacturing facilities in Chongqing commenced commercial production in July 2011 and reached the current capacity of 36 million pieces in November 2011. We gradually increased the utilization rate of our wafer facilities in 2013 and successfully expanded the capacity to 72 million pieces in November 2013.

 

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Our production costs

 

Our polysilicon production costs consist primarily of the costs of electricity and other utilities, raw materials, labor and depreciation. Currently electricity is the largest component of our polysilicon production costs. In our Phase 2 facilities in Xinjiang, because of the abundant coal resources, the local electricity rate is much lower than that in most areas in China. This cost advantage, along with our operational expertise, enables us to become one of the lowest cost producers around the globe. Our wafer production costs consist primarily of the costs of polysilicon, other raw materials, labor and depreciation. We plan to implement additional measures to reduce our production costs through technology, process and equipment improvement. For example, we are conducting a capacity expansion project in our Xinjiang polysilicon facilities to increase our capacity from 6,150 MT to 12,150 MT. We also plan to upgrade our off-gas treatment process from traditional Hydrogenation technology to Hydrochlorination technology. Simultaneously with our 2014 annual maintenance, we will prepare our Xinjiang facilities for expansion. We expect to lower the production cost to the level of $12 per kg when we fully ramp up capacity. We also plan to adopt several technical improvements in 2014 including slurry recovery system which will enable us for further cost reduction. Effective cost-reduction measures will have a direct impact on our financial condition and results of operations.

 

Indicative polysilicon production cost breakdown:

 

Components of Results of Operations

 

Revenues

 

Our revenues are primarily derived from the sale of polysilicon and secondarily by the sale of wafers. In 2011, the revenues generated from sales of polysilicon and wafers accounted for 94.3% and 5.7% of our total revenues, respectively. In 2012, the revenues we generated from the sales of polysilicon and wafers accounted for 84.6% and 15.4% of our total revenues from continuing operations, respectively. In 2013, the revenues we generated from the sales of polysilicon and wafers accounted for 70.4% and 29.6% of our total revenues from continuing operations, respectively. The percentage increase of the sales of wafers reflected improvements in the utilization rate and capacity of our wafer facilities. We plan to continue to focus on our current businesses to further improve operation efficiency, cost structure and product quality. If we are successful in executing our expansion plans, we expect our polysilicon revenue to grow in relation to our total consolidated revenues.

 

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We commenced polysilicon production in 2008. We produced 4,524 MT, 3,349 MT(1) and 4,805 MT of polysilicon and sold 3,947 MT(3), 3,262 MT(2)(3) and 4,823 MT(3) of polysilicon in 2011, 2012 and 2013, respectively. We used approximately 54.9 MT of polysilicon to process cells through our tolling arrangements in 2011. We did not have such business arrangements in 2012 and 2013. Our polysilicon selling prices are directly affected by global supply and demand conditions. Due to the global oversupply of polysilicon since late 2008 and the resulting pricing pressure, the average selling price of our polysilicon decreased by 7% in 2011 as compared to 2010, further decreased by 59.3% in 2012 as compared to 2011 and further decreased by 23.3% in 2013 as compared to 2012. In the fourth quarter of 2012, the sales prices for polysilicon and wafer both started to recover from historical lows due to improved demand and reduced inventory levels, and have continued to do so through early 2014.

 

We generated revenues of $232.2 million, $86.9(2) million and $109.0 million from continuing operations in 2011, 2012 and 2013, respectively. We achieved net income attributable to our shareholders of $33.3 million in 2011. We incurred net losses attributable to our shareholders of $111.9 million and $70.9 million in 2012 and 2013 respectively. In 2011, our revenues from continuing operations included $218.9 million generated from sales of polysilicon and $13.2 million generated from sales of wafers. In 2012, our revenues from continuing operations included $73.5 million generated from sales of polysilicon and $13.4 million generated from sales of wafers. In 2013, our revenues from continuing operations included $76.7 million generated from sales of polysilicon and $32.3 million generated from sales of wafers.

 

We have entered into framework agreements with some of our customers. These contracts typically contain binding terms related to the sales volumes of our photovoltaic products during the contract term. The pricing terms are typically agreed upon between us and our customers based on the prevailing market prices when specific sales orders are placed. Such pricing determination method has caused, and is expected to continue to cause, fluctuations in our revenues and results of operations. During 2011, our top three customers, Tianwei New Energy, Hanwha SolarOne and Yingli Green Energy, accounted for approximately 14.2%, 12.3% and 12.2% of our total revenues, respectively, and the three customers in aggregate accounted for approximately 38.7% of our total revenues. In 2012, our top three customers, Yingli Green Energy, Solargiga and Jiangxi Sornid, accounted for approximately 25.0%, 8.6% and 7.3% of our total revenues, respectively, and the three customers in aggregate accounted for approximately 40.9% of our total revenues. In 2013, our top three customers, Jiangsu Meike Silicon Energy, Zhenjiang Daqo and Hanwha SolarOne , accounted for approximately 18.0%, 12.4% and 8.1% of our total revenues, respectively, and the three customers in aggregate accounted for approximately 38.5% of our total revenues.

 

Notes:
(1) Excluding 617 MT polysilicon produced in Xinjiang facilities during the pilot production period.
(2) Excluding 323 MT polysilicon sold from Xinjiang facilities during the pilot production period.
(3) The polysilicon sales volume here only refers to the external sales. The internal sales to our in-house wafer facilities were 454 MT, 315 MT and 770 MT in 2011, 2012 and 2013, respectively.

 

Cost of revenues

 

Our cost of revenues primarily consists of:

 

·depreciation of property, plant and equipment;

 

·electricity and other utilities, such as steam, water and natural gas;

 

·raw materials, including metallurgical grade silicon, liquid chlorine, nitrogen, calcium oxide and hydrogen;

 

·direct labor, including salaries and benefits for personnel directly involved in production activities; and

 

·processing fees paid to wafer and cell manufacturers pursuant to tolling arrangements.

 

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Due to our capacity expansion, depreciation in absolute terms has increased significantly. This trend will continue if we further expand our polysilicon production capacity or conduct technology improvement as we currently plan to do. We also expect that our total cost of revenues will increase as we increase our sales volume.

 

Operating expenses/income

 

Our operating expenses include selling, general and administrative expenses and research and development expenses, which are partially offset by other operating income as described below.

 

Selling, general and administrative expenses

 

Our selling, general and administrative expenses consist primarily of salaries and benefits for our administrative, finance and sales personnel, packaging and shipping costs, sales-related travel and entertainment expenses, other travel and corporate expenses, depreciation of equipment used for administrative purposes and professional expenses. All costs in connection with start-up activities, including costs incurred prior to commencement of production and corporate formation costs of Daqo Cayman, were expensed as incurred. We expect that the amount of our selling, general and administrative expenses will increase as we expand our polysilicon production capacity, increase our sales efforts, hire additional personnel, and incur professional expenses to support our operations as a listed company in the United States.

 

Research and development expenses

 

Our research and development expenses consist primarily of costs of raw materials used in research and development activities, salaries and employee benefits for research and development personnel, and equipment costs relating to the design, development, testing and enhancement of our production process. We expect our research and development expenses to increase in the future as we continue to hire additional research and development personnel and focus on improvement of process technologies for our products, and expand our polysilicon manufacturing business. In the fourth quarter of 2012, we incurred additional research and development expenses for our Xinjiang Phase 2 polysilicon facilities to achieve the targets for product quality, capacity and cost during the pilot production period, which are not expected to recur. Our research and development expenses in 2013 primarily resulted from continuous technology improvement projects for polysilicon and wafer production.

 

Other operating income

 

Our other operating income reflects government subsidies that we receive from time to time, including financial incentives from Chongqing and Xinjiang local government. We record government subsidies as other operating income when we receive them. The amount and timing of subsidies cannot be predicted with certainty.

 

Fixed asset impairment loss

 

We recognized $34.7 million and $42.8 million of impairment loss for the long-lived assets of our wafer facilities in 2011 and 2012 respectively. We recognized $158.4 million of impairment loss for the long-lived assets of our wafer facilities in 2013. The impairment loss of long-lived assets of our wafer and polysilicon facilities reflects the impact of year-on-year market challenges and in particular reductions in average selling prices of our products described above, without similar reductions in costs of production, that have had an adverse effect on the profit-generating ability of these assets.

 

Interest income and expense

 

Our interest income represents interest on our cash balances. Our interest expenses relate primarily to our short-term and long-term borrowings from banks, less capitalized interest expenses to the extent they relate to our capital expenditures.

 

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Taxation

 

Cayman Islands tax

 

We are an exempted company incorporated in the Cayman Islands and are not subject to tax in this jurisdiction.

 

PRC tax

 

Our Chinese subsidiaries are foreign invested enterprises in China. Under the EIT Law which took effect as of January 1, 2008, the Chinese enterprise income tax rate is 25%. However, qualified enterprises located in central or western China may enjoy preferential tax rate under a series of national policies adopted to encourage investment in central and western China.

 

Under the EIT Law, an enterprise established outside of China with its “de facto management bodies” within China may be considered a resident enterprise for Chinese tax purposes and be subject to the enterprise income tax at the rate of 25% on its global income. The implementation rules of the EIT Law provide that the term “de facto management bodies” refers to management bodies which have material management and control over all aspects of the business, including production, operations, personnel, finance, and assets. It is unclear whether Chinese tax authorities would determine that, notwithstanding our status as the Cayman Islands holding company of our operating business in China, we should be classified as a resident enterprise. Currently, substantially all of our income is already China-source income subject to Chinese taxes. However, a portion of the net proceeds received from our initial public offering were deposited into interest bearing bank accounts.

 

Chongqing Daqo, our wholly owned Chinese subsidiary and a foreign-invested enterprise established in the central and western region in China, is entitled to a preferential income tax rate of 15% from the date of its establishment to December 31, 2010. Chongqing Daqo is qualified as a “Chongqing Municipality High and New Technology Enterprise,” which entitles it to a preferential income tax rate of 15%. Chongqing Daqo received its first qualification in November 2009 for a three-year period. The status was renewed in November 2012 for an additional three years until November 2015 and the status can be renewed for additional three-year terms upon Chongqing Daqo’s application and the government’s approval. Xinjiang Daqo is in the process of applying for “High and New Technology Enterprise” status, which entitles it to enjoy the preferential income tax rate of 15%.

 

Daqo New Material, formerly our consolidated variable interest entity and a domestic Chinese enterprise, was, during 2013, subject to an income tax rate of 25%. Starting from December 31, 2013, Daqo New Material was de-consolidated from the balance sheet as of December 31, 2013.

 

Under the EIT Law and implementation regulations issued by the State Council of China, dividends, interests, rent, royalties and gains on transfers of property payable by a foreign-invested enterprise in China to its foreign investor who is a non-resident enterprise will be subject to a 10% withholding tax, unless such non-resident enterprise’s jurisdiction of incorporation has a tax treaty with China that provides for a reduced rate of withholding tax and such non-resident enterprise is the beneficial owner of the dividends, interests, rent, royalties and gains on transfers of property. The Cayman Islands, where Daqo Cayman is incorporated, does not have such a tax treaty with China. However, we intend to reinvest all of Chongqing Daqo’s undistributed earnings into our capacity expansion and/or technology improvement and do not plan to distribute any of the earnings as dividends in the foreseeable future and, accordingly, we have not set aside provision for Chinese dividend withholding tax. If we do distribute these earnings in the form of dividends, we will be subject to the withholding tax at a rate of 10%.

 

Pursuant to the Interim Regulations on Value Added Tax and their implementation rules, all entities and individuals that are engaged in the sale of goods, the provision of repairs and replacement services or the importation of goods in China are generally required to pay value-added tax, or VAT, at a rate of 17% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayer. When exporting certain goods, excluding polysilicon currently, the exporter is entitled to VAT refund, which amount will be a portion of or all of the VAT that it has already paid or borne. For our sales of polysilicon products, we are subject to the 17% VAT without any VAT refunds for such sales.

 

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Critical Accounting Policies

 

We prepare our consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of assets and liabilities, (2) disclosure of contingent assets and liabilities at the end of each reporting period, and (3) the reported amounts of revenues and expenses during each reporting period. We continually evaluate these estimates and assumptions based on historical experience, knowledge and assessment of current business and other conditions, and expectations regarding the future based on available information and reasonable assumptions, which together form a basis for making judgments about matters not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. When reviewing our financial statements, you should consider (1) our selection of critical accounting policies, (2) the judgment and other uncertainties affecting the application of such policies, and (3) the sensitivity of reported results to changes in conditions and assumptions. We consider the policies discussed below to be critical to an understanding of our financial statements as their application places the most significant demands on the judgment of our management.

 

Revenue recognition

 

We generate revenues primarily from the sale of polysilicon and wafer and recognize revenues when all of the following conditions are met: persuasive evidence of an arrangement exists, the sales price is fixed and determinable, delivery of the products has occurred, title and risk of loss have transferred to customers and collectability of receivable is reasonably assured. Our polysilicon sales agreements with our customers typically do not contain product warranties except for return and replacement of defective products within a period ranging from 3 to 30 days from delivery. In addition, our agreements do not contain post-shipment obligations or any other return or credit provisions.

 

A majority of our sales contracts provide that title and risk of loss related to the products are transferred to our customers upon receipt. We may extend credit terms to our customers after assessing a number of factors to determine their credit worthiness.

 

Allowance for doubtful accounts

 

We conduct credit reviews for customers to whom we extend credit terms. We estimate the amount of accounts receivable that may not be collected based on the aging of our accounts receivable and specific evidence relating to the financial condition of our customers that may affect their ability to pay their balances.

 

Impairment of long-lived assets

 

We evaluate our long-lived assets and finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Factors that we consider in deciding when to perform an impairment review include, but are not limited to significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in the use of the assets. An impairment analysis is performed at the lowest level of identifiable independent cash flows for an asset or asset group. We make subjective judgments in determining the independent cash flows that can be related to a specific asset group based on the asset usage model and manufacturing capabilities. We measure the recoverability of assets that will continue to be used in the operations by comparing the carrying value of the asset group to the estimate of the related total future undiscounted cash flows. If an asset group’s carrying value is not recoverable through the related undiscounted cash flows, the impairment loss is measured by comparing the difference between the asset group’s carrying value and its fair value. We determine the fair value of an asset or asset group utilizing estimated future discounted cash flows and incorporate assumptions that it believes marketplace participants would utilize. The impairment charges for the years ended December 31, 2011, 2012 and 2013 were $34.7 million (among which $3.8 million was included in loss from discontinued operations), $42.8 million and $158.4 million, respectively. The impairment loss incurred in fiscal year 2012 was related to the impairment of long-lived assets of the wafer business, and was triggered primarily by the significant decrease in average selling prices for wafers that was experienced in 2012. In 2013, the impairment loss was related to the impairment of long-lived assets of the polysilicon facilities in Chongqing. As a result of certain difficulties in obtaining the planned reductions in cost at the Phase 1 polysilicon facilities, combined with the plan to expand capacity at our Xinjiang plant, we concluded that the best course of action was to (i) cease production at the Phase 1 polysilicon facilities, after which we incurred an impairment charge of $158.4 million in the second quarter of 2013 and (ii) relocate machinery and equipment from the Phase 1 polysilicon facilities to Xinjiang.

 

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Share-based compensation expenses

 

On October 31, 2009, we granted options to purchase a total of 5,350,000 ordinary shares to our officers, directors, employees and consultants pursuant to our 2009 share incentive plan. The original exercise price of all of the options was $1.38 per share, which was re-priced to $0.25 per share on April 3, 2013 with the approval of our board of directors. Twenty-five percent of the ordinary shares subject to the options will vest one year following the grant date, and the remaining seventy-five percent of the ordinary shares subject to the option will vest in 36 equal monthly installments over the next three years. We did not grant any options or other equity incentives to any officer, director, employee or consultant before October 2009.

 

On October 6, 2010, we granted options to acquire 120,000 ordinary shares to independent directors pursuant to the 2009 Plan. Thirty percent (30%) of the ordinary shares subject to the 2009 Plan will vest one year following the grant date, thirty percent (30%) of the ordinary shares subject to the 2009 Plan will vest on the second year anniversary of the grant date, and the remaining forty percent (40%) of the ordinary shares subject to the 2009 Plan will vest on the third year anniversary of the grant date. These options were granted in anticipation of services to be provided during the respective service periods. The original exercise price of these options was $1.90 per share which was re-priced to $0.25 per share on April 3, 2013.

 

On December 3, 2010, we granted options to acquire 2,190,000 ordinary shares to certain officers, directors and employees pursuant to the 2009 Plan. The ordinary shares subject to the 2009 Plan will vest in four equal annual installments, with the first installment vesting one year following the grant date. These options were granted in anticipation of services to be provided during the respective service periods. The original exercise price of these options was $2.35 per share which was re-priced to $0.25 per share on April 3, 2013.

 

On January 9, 2012, we granted options to acquire 1,190,000 ordinary shares to certain independent directors, officers and employees pursuant to the 2009 Plan. For the independent directors, thirty percent (30%) of the ordinary shares subject to the 2009 Plan will vest one year following the grant date, thirty percent (30%) of the ordinary shares subject to the 2009 Plan will vest on the second year anniversary of the grant date, and the remaining forty percent (40%) of the ordinary shares subject to the 2009 Plan will vest on the third year anniversary of the grant date. For the officers and employees, twenty-five percent (25%) of the ordinary shares subject to the options will vest one year following the grant date, and the remaining seventy-five percent (75%) of the ordinary shares subject to the option will vest in 36 equal monthly installments over the next three years. These options were granted in anticipation of services to be provided during the respective service periods. The original exercise price was $0.42 per share, which was re-priced to $0.25 per share on April 3, 2013.

 

On April 3, 2013, we granted options to acquire 140,000 ordinary shares to a certain independent director pursuant to the 2009 Plan. The exercise price is $0.25 per share. Thirty percent (30%) of the ordinary shares subject to the 2009 Plan vested as of December 24, 2013, another thirty percent (30%) will vest as of 24 December 2014, and the remaining forty percent (40%) will vest as of December 24, 2015. These options were granted in anticipation of services to be provided during the respective service periods. The exercise price is $0.25 per share.

 

On January 28, 2014, we granted options to acquire 6,274,166 ordinary shares to certain officers, directors and employees pursuant to the 2009 Plan. For the independent directors, twenty five percent (25%) of the ordinary shares subject to the 2009 Plan will vest 6 months following the grant date, twenty five percent (25%) of the ordinary shares subject to the 2009 Plan will vest one year following the grant date, and the remaining fifty percent (50%) of the ordinary shares subject to the 2009 Plan will vest in 24 equal monthly installments over the next two years. For the officers and employees, twenty-five percent (25%) of the ordinary shares subject to the options will vest 6 months following the grant date, twenty five percent (25%) of the ordinary shares subject to the 2009 Plan will vest one year following the grant date, and the remaining fifty percent (50%) of the ordinary shares subject to the 2009 Plan will vest in 36 equal monthly installments over the next three years. These options were granted in anticipation of services to be provided during the respective service periods. The exercise price of these options is $1.49 per share.

 

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As of the end of 2013, a total of 1,436,663 options have been forfeited due to grantees’ departure from our company and a total of 631,687 options have expired.

 

We recognize share-based compensation in the statement of operations based on the fair value of equity awards on the date of the grant, with compensation expense recognized over the period in which the grantee is required to provide service to us in exchange for the equity award. We have made an estimate of expected forfeiture and is recognizing compensation costs only for those equity awards to vest. The share-based compensation expenses have been classified as either selling, general and administrative expenses or research and development expenses, depending on the job functions of the grantees.

 

With respect to options granted on October 6, 2010, December 3, 2010, January 9, 2012, April 3, 2013 and January 28, 2014, we estimated the fair value of share options granted using the binomial option pricing model with the assistance of the independent appraiser, which requires the input of highly subjective assumptions, including the expected life of the share options, estimated forfeitures and the price volatility of the underlying shares. The assumptions used in calculating the fair value of share options represent management’s best estimates. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future. In addition, we estimate our expected forfeiture rate and recognize the expense only for those shares expected to vest. These estimates are based on past employee-retention rates. We will prospectively revise our estimated forfeiture rates based on actual history. Our compensation expense may change based on changes to our actual forfeitures of these share options.

 

Results of Operations

 

The following table sets forth a summary of our consolidated statements of operations for the periods. Our historical results presented below are not necessarily indicative of the results that may be expected for any future period.

 

      Year Ended December 31,  
      2011       2012       2013  
Revenues                        
Polysilicon   $ 218,915,487     $ 73,450,807     $ 76,721,105  
Wafers     13,254,092       13,407,594       32,278,700  
                         
Total revenue     232,169,579       86,858,401       108,999,805  
Cost of revenues     (144,946,025 )     (124,290,384 )     (135,103,408 )
Gross profit (loss)     87,223,554       (37,431,983 )     (26,103,603 )
Operating expenses/income:                        
Selling, general and administrative expenses     (13,088,538 )     (12,930,198 )     (18,132,515 )
Research and development expenses     (744,322 )     (4,130,533 )     (3,391,012 )
Other operating income     12,029,030       8,729,301       5,420,777  
Long-lived asset impairment     (34,667,577 )     (42,754,481 )     (158,424,827 )
Total operating expenses     (36,471,407 )     (51,085,911 )     (174,527,577 )
Income (loss) from operations     50,752,147       (88,517,894 )     (200,631,180 )
Interest expense     (9,258,296 )     (15,408,023 )     (19,349,190 )
Exchange gain (loss)     148,676       (55,800 )     11,875  
Interest income     1,846,956       990,117       149,752  
Income (loss) before income taxes     43,489,483       (102,991,600 )     (219,818,743 )
Income tax expense     (2,717,561 )     (10,253,587 )     (1,271,765 )
Net income (loss) from continuing operations     40,771,922       (113,245,187 )     (221,090,508 )
Total income (loss) from discontinued operation     (5,857,810 )     (2,392,228 )     -  
Net income     34,914,112       (115,637,415 )     (221,090,508 )
Net income (loss) attributable to noncontrolling interest     1,590,160       (3,708,474 )     (150,147,024 )
Net income (loss) attributable to Daqo New Energy Corp.’s shareholders   $ 33,323,952     $ (111,928,941 )   $ (70,943,484 )

 

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Year Ended December 31, 2013 Compared to Year Ended December 31, 2012 for Continuing Operations

 

Total revenues. Our total revenues increased by 25.5% from $86.9 million in 2012 to $109.0 million in 2013. The increase in total revenues was primarily attributable to higher sales volumes in both polysilicon and wafers, partially offset by lower average selling prices primarily at the beginning of the year.

 

Revenue from Polysilicon. The revenue derived from polysilicon increased from $73.5 million in 2012 to $76.7 million in 2013. The improvement was primarily due to higher sales volumes that were partially offset by lower selling prices. In 2012, the polysilicon sold was mostly contributed by the Phase 1 polysilicon facilities, which halted production from September 2012 for maintenance and technology improvement projects. In September 2012, we started pilot production in our Xinjiang polysilicon facilities and fully ramped up capacity in March 2013. The polysilicon sold in 2013 was mostly contributed by our Xinjiang facilities. Although the average selling price for our polysilicon in 2013 was still lower than 2012, the average selling price of our polysilicon increased in the second half of the year relative to the first half, and achieved an overall increase of 17.1% from January 2013 to December 2013.

 

Revenue from Wafers. The revenues derived from the sales of wafers increased from $13.4 million in 2012 to $32.3 million in 2013, primarily due to higher sales volume partially offset by lower selling prices. Our wafer utilization rate also improved significantly in 2013 compared to 2012.

 

Total Cost of revenues. Our cost of revenues increased by 8.7% from $124.3 million in 2012 to $135.1 million in 2013.

 

Cost of revenue from Polysilicon. The cost of our polysilicon revenue was $85.5 million in 2013. Although our polysilicon production volume increased by 43.5% in 2013 compared to 2012, our cost of polysilicon decreased by 17.9% compared to $104.2 million in 2012 due to our cost reduction effort in our Xinjiang facilities.

 

Cost of revenue from Wafers. The cost of our wafers revenue increased by 146.8% from $20.1 million in 2012 to $49.6 million in 2013. The increase was primarily due to much higher production volume in 2013 combined with lower unit production cost. In November 2013, we fully ramped up our wafer facilities to a capacity of 72 million pieces per annum.

 

Gross loss. We had a gross loss of $26.1 million in 2013, compared to $37.4 million in 2012. Our gross margin was negative 23.9% in 2013, compared to negative 43.1% in 2012. The improvement in gross loss and gross margin from 2012 was primarily due to improved cost structures in polysilicon, partially offset by lower average selling prices. In 2013, our gross margin improved quarter by quarter. The gross margin was negative 89.0%, negative 36.7%, negative 13.3% and positive 2.6% in the first, second, third and fourth quarters of 2013, respectively.

 

Gross loss from Polysilicon. Our polysilicon business had a gross loss of $8.8 million in 2013, compared to $30.7 million in 2012. Our polysilicon business’s gross margin was negative 11.5% in 2013, compared to negative 41.8% in 2012. The improvement in gross loss and gross margin from 2012 was primarily due to improved cost structures, partially offset by lower average selling prices.

 

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Gross loss from Wafers. Our wafer business had a gross loss of $17.3 million in 2013, compared to $6.7 million in 2012. Our wafer business’s gross margin was negative 53.6% in 2013, compared to negative 50.0% in 2012. Although we reduced production costs in 2013 compare do 2012, our reduced costs were not sufficient to reverse the impact of the year-on-year decrease of average selling price.

 

Selling, general and administrative expenses. Our selling, general and administrative expenses were $18.1 million in 2013, compared to $12.9 million in 2012. The increase in selling, general and administrative expenses was primarily due to increased provisions for bad debts. In 2013, we only shipped polysilicon after we received payment from our customers. Therefore there was no additional bad debt related to polysilicon sales in 2013.

 

Research and development expenses. Our research and development expenses decreased from $4.1 million in 2012 to $3.4 million in 2013, and decreased as a percentage of total revenues from 4.7% in 2012 to 3.1% in 2013. In 2012, we incurred additional research and development expenses for our Xinjiang Phase 2a polysilicon facilities to achieve our targets for quality, capacity and cost during the pilot production period, which are not expected to recur. The research and development expenses in 2013 primarily resulted from continuous technology improvement projects for polysilicon and wafer production.

 

Fixed asset impairment loss. The Company recognized a $158.4 million impairment loss for the long-lived assets of its Chongqing polysilicon facilities in the second quarter of 2013. The impairment loss of long-lived assets of our polysilicon facilities was made to reflect the adverse effects market challenges had on the profit-generating ability of the assets. The Company recognized a $42.8 million impairment loss for the long-lived assets of its wafer facilities in the fourth quarter of 2012.

 

Other operating income. Other operating income decreased from $8.7 million in 2012 to $5.4 million in 2013, which mainly consisted of unrestricted cash incentives that we received from local government authorities, which fluctuates from period to period at the discretion of the government.

 

Interest expense and income. Our net interest expenses increased from $14.4 million in 2012 to $19.2 million in 2013. The increase from 2012 was primarily due to a decrease in capitalized interest expenses.

 

Income tax expense. Our income tax expenses were $1.3 million in 2013, compared to $10.3 million for 2012. In consideration of the uncertainty in the solar market, we determined it was more likely than not that our deferred tax assets would not be utilized before they expire.

 

Net income (loss) attributable to our shareholders. As a result of the factors described above, we had net loss attributable to our shareholders of $70.9 million, compared to net loss attributable to our shareholders of $111.9 million for 2012.

 

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011 for Continuing Operations

 

Total revenues. Our total revenues decreased by 62.6% from $232.2 million in 2011 to $86.9 million in 2012. The decrease in total revenues was primarily attributable to precipitous fall of the sales price of our polysilicon throughout 2012. The revenues derived from wafer sales increased from $13.3 million in 2011 to $13.4 million in 2012, which was primarily due to higher shipment offset by lower average selling price. The revenue derived from polysilicon decreased significantly from $218.9 million in 2011 to $73.5 million in 2012, which was due to the combined effect of a volume decrease from 3,947 MT in 2011 to 3,262 MT in 2012 exacerbated by a 54.5% decrease in polysilicon average selling price during 2012.

 

Cost of revenues. Our cost of revenues decreased by 14.2% from $144.9 million in 2011 to $124.3 million in 2012. The decrease in costs of revenues was primarily attributable to a decrease of $20.1 million in costs of revenues for polysilicon offset by a slight increase of $0.6 million in costs of revenues for wafers. The costs of revenues for polysilicon was primarily due to significant production volume shrinkage in 2012 as compared to 2011.

 

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Gross profit (loss). Our gross profit decreased by 142.9% from $87.2 million in 2011 to negative $37.4 million in 2012. Our gross margin decreased from 37.6% in 2011 to negative 43.1% in 2012. The decrease in profit margin was primarily due to the lower average selling price of polysilicon and wafers.

 

Selling, general and administrative expenses. Our selling, general and administrative expenses were $12.9 million in 2012 compared to $13.1 million in 2011. The decrease was primarily due to our effort on cost reduction.

 

Research and development expenses. Our research and development expenses increased from $0.7 million to $4.1 million, and increased as a percentage of total revenues from 0.3% in 2011 to 4.7% in 2012. We incurred additional research and development expenses for our Xinjiang Phase II polysilicon facilities to achieve the targets for quality, capacity and cost during the pilot production period, which are not expected to recur.

 

Fixed asset impairment loss. We recognized a $42.8 million impairment loss for the long-lived assets of our wafer business in 2012. The impairment loss of long-lived assets of wafer was to reflect the less than expected profit-generating ability of the assets. In 2011, we recognized an impairment loss for the long-lived assets of its wafer facilities of $34.7 million.

 

Other operating income. Other operating income decreased from $12.0 million in 2011 to $8.7 million in 2012, which mainly consisted of unrestricted cash incentives that we received from local government authorities, which fluctuates from period to period at the discretion of the government.

 

Interest expense and income. Our net interest expenses increased from $7.4 million in 2011 to $14.4 million in 2012. The increase from 2011 was primarily due to the increase of our loan balance related to Xinjiang project.

 

Income tax expense. Our income tax expenses were $10.3 million, compared to $2.7 million for 2011. In consideration of the uncertainty in the solar market, we determined it was more-likely-than-not that our deferred tax assets would not be utilized before they expire. Thus a valuation allowance of $37.7 million for deferred tax asset was recorded for the year ended December 31, 2012.

 

Net income (loss) attributable to our shareholders. As a result of the factors described above, we had net loss attributable to our shareholders of $111.9 million for 2012, compared to net income of $33.3 million for 2011.

 

Recent Accounting Pronouncements

 

In July 2013, the FASB issued a pronouncement which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The FASB’s objective in issuing this ASU is to eliminate diversity in practice resulting from a lack of guidance on this topic in current U.S. GAAP. The amendments in this ASU state that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted.

 

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 Inflation

 

In recent years, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2011, 2012 and 2013 were increases of 4.1%, 2.5% and 2.5%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future.

 

B.            Liquidity and Capital Resources

 

Liquidity

 

Our liquidity situation improved in 2013 as compared to 2012 and 2011, as the majority of the capital expenditures related to Xinjiang phase 2a project were incurred in 2011 and 2012. Net cash used in investing activities was $274.1 million, $102.9 million, and $30.7 million in 2011, 2012, and 2013, respectively. In addition, we received financial support in the form of loans from Daqo Group in the amount of $87.9 million in 2013. Net cash provided by financing activities was $112.8 million, $27.1 million and $48.8 million in 2011, 2012 and 2013, respectively. Overall, our cash and cash equivalents balance decreased by $110.9 million and $86.0 million in 2011 and 2012, respectively, and increased by $1.2 million in 2013.

 

As of December 31, 2013, although we had a net loss for the year, we believe that our cash, cash equivalents, cash flows from operating activities, financial support from Daqo Group and its affiliates, and continued support from financial institutions located in the PRC in the form of renewed and additional operating loans will be sufficient to meet our working capital, capital expenditure and repayment of bank borrowings needs that will arise in 2014 and beyond.

 

The following significant developments in 2013 have impacted our liquidity or are expected to impact our liquidity:

 

·In 2011 and 2012, the solar industry was negatively impacted by a number of factors including, but not limited to, excess capacity, reduction of government incentives in key solar markets and higher import tariffs, which contributed to declining average selling prices for our products. Our average sales price for polysilicon decreased by 59.3% in 2012 as compared to 2011 and further decreased by 23.3% in 2013 as compared to 2012. However, in the fourth quarter of 2012, the sales prices for polysilicon and wafer both started to increase from historical lows due to improved demand and reduced inventory levels. The average selling price for our polysilicon increased by 17.1% from January 2013 to December 2013. This upward trend in our polysilicon selling price continued through the first quarter of 2014.

 

·For the year ended December 31, 2013, we incurred an operating loss of $200.6 million, which included a non-cash fixed asset impairment charge of $158.4 million incurred in the second quarter of 2013. Our operating loss improved in the second half of 2013 compared to the first half. Our operating loss was $4.1 million, $5.0 million, $174.9 million (including fixed asset impairment of $158.4 million) and $16.6 million in the fourth, third, second and first quarters of 2013, respectively. We believe the positive trend will continue into 2014.

 

·During the year ended December 31, 2013, we experienced negative cash flow from operations of $16.5 million. Nevertheless, our operating cash flow improved significantly in the second half of 2013 compared to the first half. The third quarter of 2013 was the first time since the first quarter of 2012 that we achieved positive operating cash flow on a quarterly basis. In the fourth quarter of 2013 we continued to generate positive operating cash flow. We believe the upward trend will continue into early 2014.

 

·As of December 31, 2013, our current liabilities exceeded our current assets by $208.0 million. Amounts due to related parties of $88.5 million are included as current liabilities. As part of the financial support Daqo Group and its affiliates provides to us, Daqo Group has indicated that they will not require us to repay our debt to them before January 1, 2015. While we had cash and cash equivalents of $7.8 million, we had short-term bank borrowings of $68.8 million all due within one year and our current portion of long-term debt amounted to $50.1 million, such long-term debt being restricted to purchases of fixed assets and not expected to be renewed.

 

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·In November 2013, the Board approved the capacity expansion project in our Xinjiang polysilicon facilities which will increase our annual capacity from 6,150 MT to 12,150 MT. We expect to complete construction and start pilot production by the end of 2014. In addition to the equipment which is being relocated from the Phase 1 polysilicon facilities to Xinjiang facilities, the total expected capital expenditure for the project is around $100 million, which includes approximately $7.1 million of expected relocation costs. Of the expected capital expenditure, approximately $16.6 million had already been spent as of December 31, 2013. We expect that completion of this project will be subject to obtaining additional funding. Our expected expenditures are estimates; actual expenditures or components of expenditures may differ from our expected expenditure based on conditions that arise or that we become aware of in the future.

 

As noted above, we believe cash flow from operating activities, combined with the financial support from Daqo Group and its affiliates, our existing cash and cash equivalents, operating loans, facilities currently available, and those expected to be renewed will be sufficient to satisfy our obligations when they come due.

 

The following plans and actions are being taken to effectively manage our liquidity:

 

·Daqo Group provides us with a certain level of financial support and has indicated that it will not require us to pay debts owed to the Daqo Group and subsidiaries of Daqo Group, Daqo Solar and Xinjiang Daqo Investment before January 1, 2015.

 

·Although during 2013 our operating cash flow was negative, our operating cash flow improved in the second half of 2013 compared to the first half. We generated positive operating cash flow in the third and fourth quarter of 2013. The improvement was primarily due to the recovery of sales prices and our cost reduction efforts. We have taken or are in the process of taking a number of cost reduction initiatives. For example, we constructed our Phase 2a production facilities in Xinjiang and successfully ramped up capacity to 5,000MT by the end of March 2013. We also completed a debottlenecking project prior to the end of 2013 to increase our capacity to 6,150MT. We expect to lower our production costs to the level of $14 per kg when we fully ramp up capacity. Further, we are in the process of conducting a capacity expansion project in Xinjiang to increase our annual capacity from 6,150 MT to 12,150 MT. We expect to complete the construction and start pilot production by the end of 2014 and fully ramp up capacity in the second quarter of 2015. At that time, our total production cost for polysilicon is expected to be reduced to the level of $12 per kg. We are also in the process of implementing a slurry recovery system for our wafer facilities for further cost savings. According to our cost reduction roadmap and based on the premise that the sales prices will remain stable through 2014, management believes our liquidity situation will continue to improve.

 

·While there can be no assurance that we will be able to refinance our operating loans as they come due, historically we have renewed or rolled over some of our operating loans upon the maturity date of the loans and have assumed we will continue to be able to do so. In March 2014, we renewed a $16.6 million (RMB 100 million) facility from China Everbright Bank for 6 months, including a $11.6 million (RMB 70 million) operating loan and a $5.0 million (RMB 30 million) bank accepted notes facility.

 

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Based on the abovementioned factors, our management believes that adequate sources of liquidity will exist to fund our working capital and capital expenditures requirements, and to meet our short term debt obligations, other liabilities and commitments as they become due.

 

Cash Flows and Working Capital

 

Polysilicon production requires intensive capital investment. Due to our relatively short operating history, our financing has been primarily through sales of polysilicon, bank borrowings, financing from Daqo Group, and advances from customers. Furthermore, a substantial portion of our outstanding indebtedness is guaranteed by Daqo Group. In the future, we may rely upon Daqo Group to provide additional guarantees for our indebtedness or direct assistance if our cash on hand and cash flow from our operations are insufficient for our future capital needs. The following table sets forth a summary of our cash flows for the periods indicated:

 

      Year Ended December 31,   
      2011        2012        2013   
      (US$ in thousands)   
Net cash provided by (used in) operating activities   $ 44,858     $ (10,307 )   $ (16,526 )
Net cash used in investing activities     (274,139 )     (102,922 )     (30,696 )
Net cash provided by financing activities     112,781       27,144       48,827  
Effect of exchange rate changes     5,561       67       (453 )
Net increase (decrease) in cash and cash equivalents     (110,939 )     (86,018 )     1,152  
Cash and cash equivalents at the beginning of the year     203,636       92,697       6,679  
Cash and cash equivalents at the end of the
year
  $ 92,697       6,679       7,831  
Supplemental disclosure of cash flow information:                        
Interest paid   $ 10,991     $ 15,555     $ 3,235  
Income taxes paid     18,861       8,053        
Net cash inflow on the disposition           2,656        
Supplemental schedule of non-cash investing activities:                        
Purchases of property, plant and equipment included in accounts payable   $ 41,302     $ 46,595     $ 51,767  

 

Our cash and cash equivalents decreased by $110.9 million and $86.0 million in 2011 and 2012, respectively. In 2013, our cash and cash equivalents increased by $1.2 million. In 2013, net cash used in investing activities decreased significantly from 2011 and 2012 which was primarily related to the wrapping up of construction of our Xinjiang Phase 2a polysilicon facilities at the end of the third quarter of 2012. In 2013, net cash provided by financing activities increased by $21.7 million compared to 2012. The increase was primarily due to continuous financial support received from Daqo Group and its affiliates in 2013.

 

As of December 31, 2013, we had $8.8 million in restricted cash and $7.8 million in cash and cash equivalents. Approximately $5.2 million, $6.2 million and $5.2 million of our restricted cash and cash and cash equivalents were held by Chongqing Daqo Xinjiang Daqo and Cayman Daqo, respectively. Restricted cash was primarily comprised of cash that we placed in our bank accounts as guarantee deposits for the banks’ issuance of short-term letters of credit and bank notes. Cash and cash equivalents consisted of cash on hand and demand deposits, which were unrestricted as to withdrawal and use and had maturities of three months or less.

 

As of December 31, 2013, we had a working capital deficit (total current assets less total current liabilities) of $208.0 million. We had cash, cash equivalents and restricted cash of $16.7 million and short-term and long-term liabilities of $118.9 million and $134.9 million, respectively, as of December 31, 2013. In addition, we have a total capital commitment of $36.7 million. Although Daqo Group and its subsidiaries have provided financial support of $85 million to the Company and they will not ask us to repay any of this amount before January 1, 2015, there is substantial doubt as to our ability to continue as a going concern.

 

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Daqo Group and its affiliates have indicated that they will not require us to repay our debt to them before January 1, 2015. In addition, as of December 31, 2013, we have $56.2 million of unused committed and available bank standby credit facilities. In March 2014, we renewed a $16.6 million (RMB 100 million) facility from China Everbright Bank for 6 months, including a $11.6 million (RMB 70 million) operating loan and a $5.0 million (RMB 30 million) bank accepted notes facility. In summary, our continuation as a going concern is dependent upon continued financial support from Daqo Group, our ability to continue to obtain other sources of financing and our operating cash flow in 2014. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China—We are facing significant working capital pressure in the current challenging market environment. Daqo Group provides financial support to us to meet certain of our working capital requirements and obligations as they come due. If we are not able to generate adequate operating cash flow or obtain adequate financial support from Daqo Group or from other sources, we will face the risk of not being able to continue as a going concern.”

 

Operating Activities

 

Net cash used in operating activities for the year ended December 31, 2013 was $16.5 million, primarily resulting from $120.4 million of cash we received from the sale of our products, our payments for raw materials and utilities of $94.2 million, taxes paid of $2.8 million, employee salaries and welfare payments of $17.7 million and interest expense payments of $18.9 million.

 

Although during 2013 our overall operating cash flow was negative, our operating cash flow improved significantly in the second half of 2013 compared to the first half. We generated positive operating cash flow in the third and fourth quarters of 2013. The improvement was primarily due to the recovery of sales prices and our continuous cost reduction efforts at our Xinjiang facilities.

 

Net cash used in operating activities for the year ended December 31, 2012 was $10.3 million, primarily resulting from $92.1 million of cash we received from the sale of our products, our payments for raw materials and utilities of $69.2 million, taxes paid of $10.8 million, employee salaries and welfare payments of $19.5 million and interest expense payments of $15.4 million.

 

Net cash provided by operating activities for the year ended December 31, 2011 was $44.9 million, primarily resulting from $239.5 million of cash we received from the sale of our products, our payments for raw materials and utilities of $119.1 million, taxes paid of $39.0 million, employee salaries and welfare payments of $18.7 million and interest expense payments of $9.7 million.

 

Investing Activities

 

Net cash used in investing activities for the year ended December 31, 2013 was $30.7 million, primarily resulting from payments for the purchase of property, plant and equipment in a total amount of $32.5 million combined with the decrease of restricted cash of $1.8 million that we placed in our bank accounts as guarantee deposits for the banks’ issuance of short term letters of credit and the notes in support of our purchases of property, plant and equipment. In 2013, net cash used in investing activities decreased significantly from 2011 and 2012, which was primarily related to the completion of construction of our Xinjiang Phase 2a polysilicon facilities at the end of third quarter of 2012.

 

Net cash used in investing activities for the year ended December 31, 2012 was $102.9 million. Net cash used in investing activities for the year ended December 31, 2012 primarily resulted from payments for the purchase of property, plant and equipment in a total amount of $105.7 million combined with an increase of restricted cash of $0.08 million that we placed in our bank accounts as guarantee deposits for the banks’ issuance of short term letters of credit and notes in support of our purchases of property, plant and equipment and $2.7 million in net proceeds from the disposal of our module business.

 

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Net cash used in investing activities for the year ended December 31, 2011 was $274.1 million. Net cash was primarily the result of payments for the purchase of property, plant and equipment in a total amount of $252.7 million combined with decrease in restricted cash of $11.5 million that we placed in our bank accounts as guarantee deposits for the banks’ issuance of short term letters of credit and notes in support of our purchases of property, plant and equipment and a $9.9 million net interest free loan we extended to a related party in 2011.

 

Financing Activities

 

Net cash provided by financing activities for the year ended December 31, 2013 was $48.8 million, primarily resulting from cash received from related parties in the amount of $87.9 million and proceeds received from the bank borrowings and other borrowings in the amount of $74.6 million offset by the repayment of bank borrowing in the amount of $113.7 million. Net cash provided by financing activities for the year ended December 31, 2012 was $27.1 million, primarily resulting from the proceeds received from the bank borrowings and other borrowings in the amount of $129.5 million offset by the repayment of bank borrowing in the amount of $103.6 million. In 2013, net cash provided by financing activities increased by $21.7 million compared to 2012. The increase was primarily due to continuous financial support from Daqo Group and its affiliates in 2013. Daqo Group and its affiliates will not require us to repay our debt to them before January 1, 2015.

 

Net cash provided by financing activities for the year ended December 31, 2011 was $112.8 million, primarily resulting from the proceeds received from the bank borrowings in the amount of $186.6 million offset by the repayment of bank and other borrowings in the amount of $73.8 million.

 

Capital Expenditures

 

We incurred capital expenditures of $252.7 million and $105.7 million for the construction of our polysilicon, wafer and module production facilities and purchase of polysilicon, wafer and module production equipments in 2011 and 2012, respectively. In 2013, we made capital expenditures of $32.5 million for technical improvements and equipment enhancements for our wafer facilities in Chongqing and polysilicon facilities in Xinjiang. Our capital expenditures will increase in the future. We expect that total capital expenditures related to the capacity expansion project in our Xinjiang polysilicon facilities will be approximately $100 million. Of the $100 million in estimated expenditures, approximately $16.6 million has already been spent prior to 2014. We expect that completion of this project will be subject to obtaining additional funding. We intend to use cash generated from operating activities and take other actions to obtain alternative sources of financing, such as obtaining loan facilities from financial institutions, obtaining financial support from Daqo Group and its affiliates or entering into capital arrangements to meet our capital expenditure requirements.For additional information, see also “—Liquidity and Capital Resources” and “Item 4. Information on the Company—B. Business Overview—Manufacturing Capacity” in this annual report.

 

C.          Research and Development, Patents and Licenses, Etc.

 

See “Item 4. Information on the Company—B. Business Overview—Research and Development.” See “Item 4. Information on the Company—B. Business Overview—Intellectual Property.”

 

D.          Trend Information

 

Market Trends

 

Global solar PV installations in 2013 totaled around 36.5 GW, which represents a 16% increase compared to 31.4 GW in 2012. Although the European markets shrank significantly due to subsidy cuts in major markets like Germany, Italy and Spain, the markets in China, Japan and U.S. took over the leading positions as the three biggest markets for solar PV in 2013. Currently most analyst reports forecast that global solar PV installations in 2014 will be in the range of 42~45 GW, which represents growth of 15%~23%.

 

In 2013, annual solar PV installations in China were reported as 11 GW, almost double that in 2012. In February 2014, China National Energy Administration confirmed a 14 GW target for 2014, which represents growth of 27%. In addition, in February 2014, China’s Central Bank released guidance for financing policies to support four strategic industries including the solar PV industry. We believe the financing environment for the solar PV industry will improve in 2014.

 

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On the premise that the global market grows as expected, that the Chinese government continues to support solar PV industry and encourage domestic applications and that there will not be significant new supply entering into the market in 2014, we believe the prices for polysilicon and wafer will be strongly supported by demand at the current price level.

 

Operational Trends

 

We successfully completed the construction of our Phase 2a facilities in Xinjiang in September 2012 and fully ramped up capacity to 5,000 MT at our Phase 2a facilities prior to the end of March 2013. We also completed a “debottlenecking” project prior to the end of 2013, which increased our annual capacity to 6,150MT. We expect the project to lower production costs to the level of $14 per kg when we fully ramp up capacity. In November 2013, the Board officially approved the capacity expansion project in our Xinjiang polysilicon facilities which will increase our annual capacity from 6,150 MT to 12,150 MT. We expect to complete construction and start pilot production by the end of 2014. We expect to fully ramp up the newly added capacity in the second quarter of 2015 and lower production costs to the level of $12 per kg. In April 2014, we will conduct annual maintenance in our Xinjiang facilities, which will affect our output and costs for that month. However, we still expect to achieve 6,150 MT production capacity in 2014 despite the annual maintenance in April 2014.

 

In 2013, we gradually increased the utilization rate of our wafer facilities and successfully expanded the capacity to 72 million pieces in November 2013. We plan to adopt several technical improvements in 2014 including a slurry recovery system which will enable us to further reduce our production costs. We expect to complete the installation of the slurry recovery system in May 2014.

 

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events since the beginning of our fiscal year 2013 that are reasonably likely to have a material effect on our net revenues, income from operations, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial condition.

 

E.         Off Balance Sheet Commitments and Arrangements

 

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholders’ (deficit)/equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or that engages in leasing, hedging or research and development services with us.

 

F.         Tabular Disclosure of Contractual Obligations

 

The following table sets forth our contractual obligations and commercial commitments as of December 31, 2013:

 

   Payments due by Period 
   Total   Less than
1 Year
   1-3
Years
   3-5
Years
   More Than
5 Years
 
   (in thousands) 
Contractual obligations:                    
Long-term debt (1)(2)   184,920    50,050    134,870    -    - 
Capital commitments (3)   36,721    34,148    2,573    -    - 
Operating lease obligations (4)   3,268    1,122    2,146    -    - 
Total obligations   224,909    85,320    139,589    -    - 

  

 
 

Notes:

(1)Excludes interest payments.

 

(2)As of December 31, 2013, long-term bank loans in the amount of $184.9 million were guaranteed by Daqo Group.

  

(3)Represents commitments relating to our purchase of property, plant and equipment for our production capacity expansion, including payment commitments to our project contractors.

 

(4)Represents Chongqing Daqo’s obligation under the lease agreement for use of its Shanghai office until April 2014 and Chongqing Daqo’s obligation under the lease agreement with Daqo New Materials until January 2019.

 

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G.          Safe Harbor

 

This annual report on Form 20-F contains forward-looking statements. These statements are made under the “safe harbor” provisions of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements can be identified by terminology such as “will,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” “may,” “intend,” “it is possible,” “subject to” and similar statements. Among other things, the sections titled “Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company,” and “Item 5. Operating and Financial Review and Prospects,” as well as our strategic and operational plans, contain forward-looking statements. We may also make written or oral forward-looking statements in our filings with the Securities and Exchange Commission, in our annual report to shareholders, in press releases and other written materials and in oral statements made by our officers, directors or employees to third parties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements and are subject to change, and such change may be material and may have a material adverse effect on our financial condition and results of operations for one or more prior periods. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained, either expressly or impliedly, in any forward-looking statement in this annual report on Form 20-F, including but not limited to the following: the demand for photovoltaic products and the development of photovoltaic technologies; global supply and demand for polysilicon; alternative technologies in cell manufacturing; our ability to significantly expand our polysilicon production capacity and output; and the reduction in or elimination of government subsidies and economic incentives for solar energy applications. All information provided in this annual report on Form 20-F and in the exhibits is as of the date of this annual report on Form 20-F, and we do not undertake any obligation to update any such information, except as required under applicable law.

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. Directors and Executive Officers

 

The following table sets forth information regarding our directors and executive officers as of the date of this annual report.

 

Name

Age

Position/ Title

Guangfu Xu 71 Chairman of the board of directors
Xiang Xu 43 Director
Dafeng Shi 42 Director
Gongda Yao 55 Director and chief executive officer
Fumin Zhuo 61 Independent director
Rongling Chen 71 Independent director
Minsong Liang 45 Independent director
Shuming Zhao 61 Independent director
Arthur Wong 54 Independent director
Bing Sun 42 Chief financial officer
Tracy Tianqun Zhou 52 Chief marketing officer
Guoping Zhu 42 Chief technology officer

 

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Mr. Guangfu Xu is the chairman of our board of directors. Mr. Xu is principally responsible for formulating our strategic development objectives. Mr. Xu has been the chairman and general manager of Daqo Group since January 1984 and currently holds directorship positions with 27 subsidiaries and affiliated entities of Daqo Group. Mr. Xu has served as chairman of our board of directors since our incorporation in November 2007. Mr. Xu joined Xinba General Company, the predecessor entity of Daqo Group, in 1966 and has been instrumental in building Daqo Group from a small township and village enterprise to a leading manufacturer of electrical systems in China. Mr. Xu is a member of the Ninth People’s Congress of Jiangsu Province and the vice chairman of the Standing Committee of the Ninth Yangzhong City People’s Congress. Mr. Xu was named a National Township and Village Entrepreneur by the Ministry of Agriculture of China in 2001 and 2002. Mr. Xu graduated from secondary school in 1960.

 

Mr. Xiang Xu is one of our directors. Mr. Xu is also the vice chairman of the board and president of Daqo Group and currently holds directorship positions with 25 subsidiaries of Daqo Group. Mr. Xu has served as a director of our Company since our incorporation in November 2007. Mr. Xu served as the general manager of Jiangsu Changjiang Electric Co., Ltd., a subsidiary of Daqo Group, from January 2000 through May 2006. Mr. Xu received his EMBA degree from Nanjing University in 2004. Mr. Xiang Xu is the son of Mr. Guangfu Xu.

 

Mr. Dafeng Shi is one of our directors. Mr. Shi had served as a director of our company since its initial public offering until October 2011 and was appointed again to be our director in February 2013. Mr. Shi has been the vice president for finance of Daqo Group since January 2006 and currently holds directorship positions with four subsidiaries and affiliated entities of Daqo Group. Prior to joining Daqo Group, Mr. Shi served as the vice president of Yangzhong Tianyuan Accounting Firm from 2000 to 2001. Mr. Shi received his bachelor’s degree in economic management from the Correspondence Institute of the Central Party School in 1997 and his associate degree in accounting from Nanjing University of Finance & Economics in 1992. Mr. Shi received his master degree of professional accountancy from The Chinese University of Hong Kong. Mr. Shi is a Certified Public Accountant in China.

 

Dr. Gongda Yao is one of our directors and chief executive officer. Dr. Yao has served as our director and chief executive officer since August 2009. Dr. Yao has extensive experience in the electronic development and manufacturing industry. Prior to joining our company, Dr. Yao served as the vice president and China general manager for Applied Materials from October 2006 to July 2008. Dr. Yao was also the vice president and general manager of the Integrated Metal Business Unit of Novellus Systems from October 2005 to October 2006, and vice president of operations at Ciwest Semiconductor Company from April 2005 to October 2005. Before that, Dr. Yao worked for Applied Materials at various management positions for 11 years. Dr. Yao received his Ph.D. in materials science & engineering from the State University of New York at Stony Brook in 1992, his master’s degree in materials science from Tongji University and the Chinese Academy of Science in 1984 and his bachelor’s degree in theoretical physics from Shanghai University of Science and Technology in 1982. Dr. Yao holds more than 10 U.S. patents and has authored or co-authored more than 40 technical articles and papers.

 

Mr. Fumin Zhuo is one of our independent directors. Mr. Zhuo has served as our director since November 2009. Mr. Zhuo has also served as independent directors to SRE Group Ltd., a company listed on the Hong Kong Stock Exchange and China Enterprise Company Limited, a company listed on the Shanghai Stock Exchange. Mr. Zhuo has also served as non-executive director to Besunyen Holdings Company Limited, a company listed on the Hong Kong Stock Exchange. Mr. Zhuo has over two decades experience in investment and corporate management. Mr. Zhuo is currently a managing partner of Granite Global Ventures III L.L.C., a general partner of SIG Capital Limited and Chairman of Venture Star Investment (HK) Limited. Prior to joining SIG Capital Limited in July 2005, Mr. Zhuo served as the chairman and chief executive officer of Vertex China Investment Company, a company concentrating in investments in the Greater China region since July 2002. From 1995 to July 2002, Mr. Zhuo was the chief executive officer of Shanghai Industrial Holding Ltd. and the chairman of SIIC Medical Science & Technology (Group). Prior to that, starting in 1987 Mr. Zhuo served as chief assistant officer of the Shanghai Economic System Reform Committee. Mr. Zhuo has extensive experience in venture capital fund formation, mergers and acquisitions, and investment management. Mr. Zhuo received his master’s degree in economics from Fudan University and his bachelor’s degree in enterprise management from Shanghai Jiaotong University’s Electrical Engineering School.

 

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Mr. Rongling Chen is one of our independent directors. Mr. Chen has served as our director since October 2010. Mr. Chen has served as an independent director to Tianjin Zhonghuan Semiconductor Co., Ltd., a company listed on Shenzhen Stock Exchange. Between 2010 and 2012 Mr. Chen was a vice president of Applied Materials and chief administration officer of Applied Materials China. Mr. Chen was an executive advisor of IMEC, a leading advanced semiconductor R&D center based in Belgium, and also a senior advisor and chairman of China advisory board to SEMI, a global industry association serving the manufacturing supply chains for the microelectronic, display and photovoltaic industries. Mr. Chen started working for Applied Materials in 1984, and has served in various senior positions, including vice president, chairman of Applied Materials China and head of China marketing and corporate affairs, before retiring in 2012. Mr. Chen received his bachelor’s degree in semiconductor devices and materials from Zhe Jiang University.

 

Dr. Minsong Liang is one of our independent directors. Dr. Liang has served as our director since October 2011. Dr. Liang is currently a co-managing partner of CLA Partners, a boutique investment banking firm in China. Dr. Liang serves as an independent director to Qingdao Eastsoft Communication Technology Co. Ltd., a company listed on Shenzhen Stock Exchange and to Yunnan International Trust & Investment Co., Ltd., a financial services company in China. Prior to joining CLA Partners, Dr. Liang has held various management positions at China Securities Regulatory Commission and State-owned Assets Management Commission of Yunnan Province. Dr. Liang received his Ph.D. in economics from the University of Michigan at Ann Arbor and J.D. from New York University School of Law. He received his bachelor’s degree in economics from Beijing University.

 

Mr. Shuming Zhao is one of our independent directors. Mr. Zhao has served as our director since October 2011. Mr. Zhao is dean of the Nanjing University School of Business. In addition, Mr. Zhao is an adjunct professor at the University of Southern California Marshall School of Business, Claremont Graduate University, Macau University of Science and Technology and Nanjing University of Post and Telecommunications. Mr. Zhao serves as independent directors to Jiangsu Little Swan Ltd. in China and MFC Industrial Ltd., a NYSE-listed Canadian company. Mr. Zhao received his bachelor’s degree in English language from Nanjing University and a master’s degree in education and a Ph.D. in management, both from Claremont Graduate University.

 

Mr. Arthur Wong is one of our independent directors. Mr. Wong has served as our director since December 2012. Mr. Arthur Wong is the Chief Financial Officer of Beijing Radio Cultural Transmission Company Limited. He also currently serves as an independent director and Chairman of the Audit Committee for VisionChina Media Inc. and China Automotive Systems, Inc., both listed on the NASDAQ, and Besunyen Holdings Company Limited and Termbray Petro-King Oilfield Services Limited, both listed on the Hong Kong Stock Exchange. He also serves as an independent director and Chairman of the Audit Committee for YOU On Demand Holdings, Inc, listed on NASDAQ. From 2008 to 2012, Mr. Wong served as Chief Financial Officer for Asia New-Energy, Nobao Renewable Energy and GreenTree Inns Hotel Management Group sequentially. From 1982 to 2008, Mr. Wong worked for Deloitte Touche Tohmatsu, in Hong Kong, San Jose and Beijing over various periods of time, most recently as a partner in the Beijing office. Mr. Wong received a bachelor’s degree in applied economics from the University of San Francisco and a higher diploma of accountancy from Hong Kong Polytechnic University. He is a member of the American Institute of Certified Public Accountants and the Hong Kong Institute of Certified Public Accountants.

 

Mr. Bing Sun is our chief financial officer. Mr. Sun joined us, as our chief financial officer in February 2012, from Shunda Holdings Co, a solar photovoltaic company based in China, where he was the Chief Financial Officer since June 2008. Prior to Shunda Holdings, Mr. Sun was financial controller at BCD Semiconductor, a leading analog integrated device manufacturer in China from April 2007 to June 2008. Mr. Sun’s earlier experiences include serving as audit manager at Deloitte Touche Tohmatsu and compliance manager at The Brinks Company. Mr. Sun holds an MBA degree with a concentration in accounting from Virginia Commonwealth University and he is a U.S. Certified Public Accountant.

 

Dr. Tracy Tianqun Zhou is our chief marketing officer. Dr. Zhou has served as our chief marketing officer since October 2012. Dr. Zhou served as our chief technology officer between January 2009 and October 2012. Prior to joining us in January 2009, Dr. Zhou served as a product manager at Silicon Quest International in Santa Clara, California from January 2008. From 2004 to 2008, Dr. Zhou was the senior field applications engineer at MEMC Electronics Materials, Inc. in San Jose, California. Before that, Dr. Zhou was the silicon business unit manager at West Coast Quart from 2001 to 2004, operations director at Unisil Corp from 1998 to 2001 and senior process engineer at Mitsubishi Silicon America (now Sumco) from 1994 to 1998. Dr. Zhou received her Ph.D. in materials science and engineering from North Carolina State University in 1993 and a master’s degree from the Shanghai Institute of Ceramics in 1986. Dr. Zhou received her bachelor’s degree in chemistry from the University of Science and Technology of China in 1982.

 

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Mr. Guoping Zhu is our chief technology officer. Mr. Zhu has served as our chief technology officer since October 2012. Mr. Zhu joined our company in August 2006 and was previously the deputy general manager of Xinjiang Daqo. Prior to his tenure in Xinjiang, Mr. Zhu served as a technologist and deputy general manager at Chongqing Daqo Group. Mr. Zhu has over 18 years of experience in chemical, materials, and electric industries. He holds a bachelor’s degree from Tianjin University of Science and Technology.

 

Composition of Board of Directors

 

Our board of directors consists of nine directors. A director is not required to hold any shares in our company by way of qualification. A director may vote with respect to any contract or transaction in which he or she is materially interested provided the nature of the interest is disclosed prior to its consideration. Subject to our Third Amended and Restated Memorandum and Articles of Association, the directors may exercise all the powers of our company to borrow money, mortgage his or her undertaking, property and uncalled capital, and issue debentures or other securities whether outright or as security for any debt, liability or obligation of our company or of any third party. We have a majority independent board and fully independent audit committee, compensation committee and nominating and corporate governance committee, and are in full compliance with applicable SEC and NYSE rules regarding the board and committee composition.

 

B.           Compensation

 

In 2013, our aggregate payments of cash to directors or executive officers was approximately $0.8 million. In 2013, our directors and executive officers received options under our share incentive plan. See “—Share Incentive Plan.” Our PRC subsidiaries and former consolidated variable interest entity (which on December 31, 2013 ceased to be our consolidated variable interest entity) are and were required, as the case may be, by PRC law to make contributions equal to certain percentages of each employee’s salary for his or her pension insurance, medical insurance, housing fund, unemployment and other statutory benefits. We have accrued or set aside, in the aggregate, approximately $9 thousand for pension or similar retirement benefits for our executive officers and directors, as required under PRC laws, for the fiscal year ended December 31, 2013. Other than the aforementioned statutorily required contributions, we have not set aside or accrued any other amount to provide pension, retirement or other similar benefits to our executive officers and directors.

 

Share Incentive Plan

 

In August 2009, we adopted the 2009 share incentive plan, or the 2009 Plan, to attract and retain the best available personnel, provide additional incentives to employees, directors and consultants, and promote the success of our business. Our board of directors has authorized the issuance of up to 15,000,000 ordinary shares upon the exercise of awards granted under the 2009 Plan. As of the date of this annual report, excluding the expired and cancelled options, the Company has granted options to purchase a total of 13,195,816 of our ordinary shares among which 12,645,416 are outstanding.

 

The following paragraphs summarize the terms of the 2009 Plan.

 

Plan Administration. Our board of directors, or a committee designated by our board or directors, will administer the plan. The committee or the full board of directors, as appropriate, will determine the provisions and terms and conditions of each award grant.

 

Types of Awards. The 2009 Plan provides for the grant of stock options, restricted shares and restricted share units to a participant pursuant to the Plan.

 

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Award Agreement. Options and other stock purchase rights granted under our plan are evidenced by an award agreement, as applicable, that sets forth the terms, conditions and limitations for each grant.

 

Exercise Price. The exercise price subject to an option shall be determined by the plan administrator and set forth in the award agreement. The exercise price may be amended or adjusted in the absolute discretion of the plan administrator, the determination of which shall be final, binding and conclusive. To the extent not prohibited by applicable laws or any exchange rule, a downward adjustment of the exercise prices of options shall be effective without the approval of the shareholders or the approval of the affected participants.

 

Eligibility. We may grant awards to our employees, directors and consultants or those of any of our related entities, which include our subsidiaries or any entities in which we hold a substantial ownership interest.

 

Term of the Options. The term of each option grant shall be stated in the award agreement, provided that the term shall not exceed 10 years from the date of the grant.

 

Vesting Schedule. In general, the plan administrator determines, or the award agreement specifies, the vesting schedule.

 

Transfer Restrictions. Awards to purchase our ordinary shares may not be transferred in any manner by the participant other than by will or the laws of succession. An option award may be exercised during the lifetime of the optionee only by the optionee.

 

Termination of the Plan. Unless terminated earlier, the plan will terminate automatically in 2019. Our board of directors has the authority to amend or terminate the plan subject to shareholder approval to the extent necessary to comply with applicable law. However, no such action may (i) impair the rights of any participant unless agreed by the participant and the plan administrator or (ii) affect the plan administrator’s ability to exercise the powers granted to it under our plan.

 

The following table summarizes, as of the date of this annual report, the options granted to our senior executive officers, directors and to other individuals as a group, without giving effect to the options that were exercised or terminated, if any.

 

Name  Ordinary Shares Underlying Option Awarded   Exercise Price ($/Share)   Date of Grant  Date of Expiration
Directors and officers as a group    3,400,000   $0.25   October 31, 2009  October 30, 2019
    50,000   $0.25   October 6, 2010  October 5, 2020
    925,000   $0.25   December 3, 2010  December 2, 2020
    1,050,000   $0.25   January 9, 2012  January 8, 2022
    140,000   $0.25   April 3, 2013  April 2, 2023
    4,654,166   $1.49   January 28, 2014  January 27, 2024
Other individuals as a group    1,950,000   $0.25   October 31, 2009  October 30, 2019
    70,000   $0.25   October 6, 2010  October 5, 2020
    1,265,000   $0.25   December 3, 2010  December 2, 2020
    140,000   $0.25   January 9, 2012  January 8, 2022
    1,620,000   $1.49   January 28, 2014  January 27, 2014
                 
Total    15,264,166*           
 
 

* The number of total options awarded includes options that were exercised or terminated, if any.

 

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C. Board Practices

 

Code of Business Conduct and Ethics

 

Our code of business conduct and ethics provides that our directors and officers are expected to avoid any action, position or interest that conflicts with the interests of our company or gives the appearance of a conflict. Directors and officers have an obligation under our code of business conduct and ethics to advance our company’s interests when the opportunity to do so arises.

 

Duties of Directors

 

Under Cayman Islands law, our directors have a fiduciary duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association, as amended and restated from time to time. A shareholder has the right to seek damages if a duty owed by our directors is breached.

 

The functions and powers of our board of directors include, among other things:

 

·convening shareholders’ annual general meetings and reporting its work to shareholders at such meetings;

 

·declaring dividends and distributions;

 

·appointing officers and determining the term of office of officers;

 

·subject to our Third Amended and Restated Memorandum and Articles of Association, exercising the borrowing powers of our company and mortgaging the property of our company; and

 

·approving the transfer of shares of our company, including the registering of such shares in our share register.

 

Terms of Directors and Executive Officers

 

Our officers are elected by and serve at the discretion of the board of directors. Our directors are not subject to a term of office and hold office until such time as they are removed from office in accordance with our Third Amended and Restated Memorandum and Articles of Association. A director will be removed from office automatically if, among other things, the director (1) becomes bankrupt or makes any arrangement or composition with his creditors; or (2) dies or becomes of unsound mind.

 

Committees of the Board of Directors

 

Audit Committee

 

Our audit committee consists of Mr. Arthur Wong, Mr. Rongling Chen and Dr. Minsong Liang, and is chaired by Mr. Wong. All of our audit committee members satisfy the “independence” requirements of Section 303A of the Corporate Governance Rules of the New York Stock Exchange and meet the independence standards under Rule 10A-3 under the Securities Exchange Act of 1934, as amended. We have determined that Mr. Wong qualifies as an “audit committee financial expert.” The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:

 

·selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;

 

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·reviewing with our independent auditors any audit problems or difficulties and management’s response to such audit problems or difficulties;

 

·reviewing and approving all proposed related party transactions, as defined in Item 404 of Regulation S-K under the Securities Act;

 

·discussing the annual audited financial statements with management and our independent auditors;

 

·reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of material control deficiencies;

 

·annually reviewing and reassessing the adequacy of our audit committee charter;

 

·such other matters that are specifically delegated to our audit committee by our board of directors from time to time;

 

·meeting separately and periodically with management and our internal and independent auditors; and

 

·reporting regularly to the full board of directors.

 

In 2013, our audit committee held meetings or passed resolutions by unanimous written consent 8 times.

 

Compensation Committee

 

Our compensation committee consists of Mr. Fumin Zhuo, Mr. Arthur Wong and Mr. Rongling Chen, and is chaired by Mr. Zhuo. All of our compensation committee members satisfy the “independence” requirements of Section 303A of the Corporate Governance Rules of the New York Stock Exchange. Our compensation committee assists the board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Members of the compensation committee are not prohibited from direct involvement in determining their own compensation. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The compensation committee is responsible for, among other things:

 

·approving and overseeing the compensation package for our executive officers;

 

·reviewing and making recommendations to the board with respect to the compensation of our directors;

 

·reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and

 

·reviewing periodically and making recommendations to the board regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

 

In 2013, our compensation committee held meetings or passed resolutions by unanimous written consent twice, including passing resolutions regarding adjustments to directors’ compensation and modification of option programs of certain directors.

 

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Corporate Governance and Nominating Committee

 

Our corporate governance and nominating committee consists of Mr. Shuming Zhao, Mr. Arthur Wong and Mr. Rongling Chen, and is chaired by Mr. Zhao. All of our corporate governance and nominating committee members satisfy the “independence” requirements of Section 303A of the Corporate Governance Rules of the New York Stock Exchange. The corporate governance and nominating committee assists the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee is responsible for, among other things:

 

·identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy;

 

·reviewing annually with the board the current composition of the board in light of the characteristics of independence, age, skills, experience and availability of service to us;

 

·identifying and recommending to the board the directors to serve as members of the board’s committees;

 

·advising the board periodically with respect to significant developments in the law and practice of corporate governance as well as our compliance with applicable laws and regulations, and making recommendations to the board on all matters of corporate governance and on any corrective action to be taken; and

 

·monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.

 

In 2013, our corporate governance and nominating committee did not hold meetings or pass resolutions by unanimous written consent.

 

Interested Transactions

 

A director may vote in respect of any contract or transaction in which he or she is interested, provided that the nature of the interest of any directors in such contract or transaction is disclosed by him or her at or prior to its consideration and any vote on that matter.

 

Remuneration and Borrowing

 

The directors may determine remuneration to be paid to the directors. The compensation committee will assist the directors in reviewing and approving the compensation structure for the directors. Subject to our Third Amended and Restated Memorandum and Articles of Association, the directors may exercise all the powers of our company to borrow money and to mortgage or charge its undertaking, property and uncalled capital, and to issue debentures or other securities whether outright or as security for any debt obligations of our company or of any third party.

 

Qualification

 

There is no shareholding qualification for directors.

 

Employment Agreements

 

We have entered into an employment agreement with each of our executive officers. The terms of the employment agreements are substantially similar for each executive officer, except as noted below. We may terminate an executive officer’s employment for cause, at any time, without notice or remuneration, for certain acts of the officer including, but not limited to, a serious criminal act, willful misconduct to our detriment or a failure to perform agreed duties. We may terminate employment at any time without cause upon advance written notice to the executive. The executive may resign at any time if such resignation is approved by the board or an alternative arrangement with respect to the employment is agreed by the board.

 

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Each executive officer has agreed to hold, both during and after the termination of his or her employment agreement, in strict confidence and not to use, except as required in the performance of his or her duties in connection with the employment or as compelled by law, any of our or our customers’ confidential information or trade secrets. Each executive officer also agrees to comply with all material applicable laws and regulations related to his or her responsibilities at our company as well as all material written corporate and business policies and procedures of our company.

 

Each executive officer has agreed to be bound by non-competition restrictions during the term of his or her employment and for two years following the termination of such employment agreement. Specifically, each executive officer has agreed not to (1) assume employment with or provide services as a director for any of our competitors who operate in a restricted area; (2) solicit or seek any business orders from our customers; or (3) seek directly or indirectly, to solicit the services of any of our employees.

 

D.           Employees

 

As of December 31, 2013, we employed 1,330 employees, including 761 in manufacturing, 196 in equipment maintenance, 91 in quality assurance, 20 in purchasing, 68 in research and development, 11 in sales and marketing and 144 in general and administrative. In addition, we engaged independent contractors and temporary personnel from time to time. All of these employees and independent contractors are located at our facilities in Chongqing and Xinjiang, China. As of December 31, 2013, we employed approximately 39 temporary personnel through third-party contractors.

 

We had a total of 1,845, 1,545 and 1,330 employees as of December 31, 2011, 2012 and 2013, respectively.

 

As required by regulations in China, we participate in various employee social security plans that are administered by municipal and provincial governments, including housing, pension, medical insurance and unemployment insurance. We are required under Chinese law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowance of our employees, up to a maximum amount specified by the local government from time to time.

 

We typically enter into a standard confidentiality and employment agreement with our research and development personnel. These contracts involve a covenant that prohibits them from engaging in any activities that compete with our business within certain agreed period after the termination of their employment with us, and during such non-competition period.

 

We believe we maintain a good working relationship with our employees, and we have not experienced any labor disputes or any difficulty in recruiting staff for our operations.

 

E.           Share Ownership

 

The following table sets forth information with respect to the beneficial ownership of our ordinary shares, as of the date of this annual report, by:

 

·each of our directors and executive officers; and

 

·each person known to us to own beneficially more than 5.0% of our ordinary shares.

 

The calculations in the table below are based on 173,427,853 ordinary shares outstanding as of the date of this annual report.

 

Beneficial ownership is determined in accordance with the rules and regulations of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, we have included shares that the person has the right to acquire within 60 days of the date of this annual report, including through the exercise of any option, warrant or other right or the conversion of any other security. These shares, however, are not included in the computation of the percentage ownership of any other person.

 

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    Ordinary Shares Beneficially Owned  
      Number       %  
Directors and Executive Officers:                
Guangfu Xu(1)     40,075,000       23.0 %
Xiang Xu(2)     15,551,250       8.9 %
Dafeng Shi(3)     6,180,834       3.5 %
Fumin Zhuo (4)     14,106,667       8.1 %
Gongda Yao(5)     *       *  
Rongling Chen(6)     *       *  
Minsong Liang(7)     *       *  
Shuming Zhao(8)     *       *  
Arthur Wong(9)     *       *  
Tracy Tianqun Zhou(10)     *       *  
Guoping Zhu(11)     *       *  
Bing Sun(12)     *       *  
All directors and executive officers as a group     77,944,501       44.7 %
Principal Shareholders:                
Gold Intellect Limited(13)     39,000,000       22.5 %
Plenty China Limited(14)     14,820,000       8.5 %
Granite Global Ventures III L.P.(15)     11,885,641       6.9 %
NewMargin Growth Fund, L.P.(16)     11,615,513       6.7 %
Ruian International Limited(17)     10,890,000       6.3 %
Best Mount International Limited(18)     8,760,000       5.1 %

____________________________

* Beneficially owns less than 1% of our ordinary shares.

Notes:

(1)Consists of 39,000,000 shares held by Gold Intellect Limited, a British Virgin Islands company wholly owned and controlled by Mr. Guangfu Xu, and 1,075,000 shares issuable upon exercise of options held by Mr. Xu that are exercisable within 60 days of the date of this annual report. Mr. Guangfu Xu’s business address is c/o No. 11, Daquan Road, Xinba, Yangzhong, Jiangsu Province, PRC. Mr. Guangfu Xu is the chairman of the board of directors of our company and he is the father of Mr. Xiang Xu.

 

(2)Consists of 14,820,000 shares held by Plenty China Limited, a British Virgin Islands company wholly owned and controlled by Mr. Xiang Xu, and 731,250 shares issuable upon exercise of options held by Mr. Xu that are exercisable within 60 days of the date of this annual report. Mr. Xiang Xu’s business address is c/o No. 11, Daquan Road, Xinba, Yangzhong, Jiangsu Province, PRC. Mr. Xiang Xu is a director of our company and he is the son of Mr. Guangfu Xu.

 

(3)Consists of 5,449,584 shares held by Lucky Prosper Investments Limited, a British Virgin Islands company wholly owned and controlled by Mr. Dafeng Shi, and 731,250 shares issuable upon exercise of options held by Mr. Shi that are exercisable within 60 days of the date of this annual report. Mr. Dafeng Shi’s business address is c/o No. 11, Daquan Road, Xinba, Yangzhong, Jiangsu Province, PRC. Mr. Shi is a director of our company.

 

(4)Consists of (1) 11,695,471 ordinary shares held by Granite Global Ventures III L.P., (2) 190,170 ordinary shares held by GGV III Entrepreneurs Fund L.P., and (3) 2,161,026 ordinary shares held by Venture Star Investment (HK) Limited and (4) 60,000 shares issuable upon exercise of options held by Mr. Zhuo that are exercisable within 60 days of the date of this annual report. Mr. Zhuo is a managing director of Granite Global Ventures III L.L.C., which is the sole general partner of Granite Global Ventures III L.P. and GGV III Entrepreneurs Fund L.P. Mr. Zhuo is also the chairman of Venture Star Investment (HK) Limited. Mr. Zhuo disclaims beneficial ownership of the shares beneficially owned by Granite Global Ventures III L.P., GGV III Entrepreneurs Fund L.P. and Venture Star Investment (HK) Limited except to the extent of his pecuniary interests therein. Mr. Zhuo’s business address is c/o Granite Global Ventures III L.P., 2494 Sand Hill Road, Suite 100, Menlo Park, CA 94025, United States. Mr. Zhuo is a director of our company.

 

(5)The business address for Mr. Yao is No.666, Longdu Avenue, Wanzhou District, Chongqing City, PRC.

 

(6)The business address of Mr. Chen is No.585, Jianguoxi Road, Shanghai, PRC.

 

(7)The business address of Mr. Liang is Room 806, Tower C, Vantone Center, No. 6 Chaoyangmenwai Street, Chaoyang District, Beijing, PRC.

 

(8)The business address of Mr. Zhao is 2002 Anzhong Building, School of Business, Nanjing University, 16 Jinyin Jie, Nanjing, PRC.

 

(9)The business address for Mr. Wong is Room 906, 16th Floor, Huamao Building, No. 89 Jianguo Road, Chaoyang District, Beijing, PRC.

 

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(10)The business address of Dr. Zhou is No.666, Longdu Avenue, Wanzhou District, Chongqing City, PRC.

 

(11)The business address of Mr. Zhu is No.666, Longdu Avenue, Wanzhou District, Chongqing City, PRC.

 

(12)The business address of Mr. Sun is No.666, Longdu Avenue, Wanzhou District, Chongqing City, PRC.

 

(13)Gold Intellect Limited is a company incorporated in the British Virgin Islands wholly owned by Mr. Guangfu Xu. Its registered office is at c/o 11 Daquan Road, Xinba, Yangzheng, Jiangsu Province, PRC. Mr. Guangfu Xu has the sole voting and dispositive power over the shares of our company held by Gold Intellect Limited.

 

(14)Plenty China Limited is a company incorporated in the British Virgin Islands wholly owned by Mr. Xiang Xu. Its registered office is at c/o 11 Daquan Road, Xinba, Yangzheng, Jiangsu Province, PRC. Mr. Xiang Xu has the sole voting and dispositive power over the shares of our company held by Plenty China Limited.

 

(15)Consists of 11,695,471 ordinary shares held by Granite Global Ventures III L.P., and 190,170 ordinary shares held by GGV III Entrepreneurs Fund L.P. in the form of our ADSs. Granite Global Ventures L.L.C. is the sole general partner of Granite Global Ventures III L.P. and GGV III Entrepreneurs Fund L.P. Scott Bonham, Hany Nada, Glenn Soloman, Thomas Ng, Jixun Foo, Jenny Lee, Jessie Jin and Fumin Zhuo are managing directors of Granite Global Ventures L.L.C. and share voting and dispositive power over all such shares held by Granite Global Ventures III L.P. and GGV III Entrepreneurs Fund L.P. These individuals disclaim beneficial ownership of the shares beneficially owned by the above entities except to the extent of their pecuniary interests therein. The business address of Granite Global Ventures III L.P. and GGV III Entrepreneurs Fund L.P. is 2494 Sand Hill Road, Suite 100, Menlo Park, CA 94025, United States.

 

(16)NewMargin Growth Ventures LLC is the sole general partner of NewMargin Growth Fund, L.P. Messrs. Tao Feng, Greg W. Ye, Shuiwen Zhou, Cary Zhou and Hans Xu are members of the investment committee of NewMargin Growth Ventures LLC and share voting and dispositive power over all such shares held by NewMargin Growth Fund, L.P. These individuals disclaim beneficial ownership of the shares beneficially owned by the above entities except to the extent of their pecuniary interests therein. NewMargin Growth Fund, L.P.’s business address is Radisson Plaza (Xing Guo) Hotel, 8 Xing Guo Road, Villa 3, Shanghai, China 200052.

 

(17)Ruian International Limited is a company incorporated in the British Virgin Islands wholly owned by Mr. Fei Ge. Its registered office is at c/o 11 Daquan Road, Xinba, Yangzheng, Jiangsu Province, PRC. Mr. Fei Ge has the sole voting and dispositive power over the shares of our company held by Ruian International Limited.

 

(18)Best Mount International Limited is a company incorporated in the British Virgin Islands. Its registered office is at P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands. Best Mount International Limited’s shareholders are Yueping Liu, Shaoxian Ge, Sheng Xue, Xiaorong Hou, Benjiang Chang, Yuhua Jing, Jilin Ye, Jianrong Tang and Chaohui Chen and these shareholders share voting and dispositive power over all the shares held by Best Mount International Limited.

 

As of April 13, 2014, 173,427,853 of our ordinary shares were issued and outstanding. To our knowledge, 57,885,640 ordinary shares, representing approximately 33.4% of our total outstanding shares, were held by one record holder in the United States, which was JPMorgan Chase Bank, N.A., the depositary of our ADS program. The number of beneficial owners of our ADSs in the United States is likely to be much larger than the number of record holders of our ordinary shares in the United States. None of our directors or executive officers that are shareholders or principal shareholders has different voting rights from other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

A.          Major Shareholders

 

Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”

 

B.          Related Party Transactions

 

Related party transactions with Daqo Group

 

In 2011, the Company purchased auxiliary electricity transmission and system equipment totaling $15.8 million from Daqo Group. Daqo Group and its subsidiaries are mainly engaged in production of High-Low-Voltage Electrical System, Components, Environmental Protection, and High-speed Railway Equipment.

 

In 2011, the Company received an interest fee loan of $3,095,120 from Daqo Group, which was fully repaid during the same year.

 

In 2012, the Company sold a 100% equity interest in Nanjing Daqo to Daqo Group for consideration of $9,888,742 and Daqo Group owed the Company $5,110,085 in connection with this transaction as of December 31, 2013. In addition, the Company purchased fixed assets totaling $7,849,533 from Daqo Group and had $5,359,007 due to Daqo Group as of December 31, 2012. Separately, a further $1,330,044 was prepaid to purchase fixed assets as of December 31, 2012.

 

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In 2013, the Company received an interest free loan of $813,105 from Daqo Group, which was fully repaid during the same year.

 

Related party transactions with Zhenjiang Daqo

 

In 2011, the Company sold $6,958,317 in wafers, purchased cells in the amount of $3,314,115, and paid processing fees of $1,209,769 to Zhenjiang Daqo for tolling arrangements of cells.

 

In 2012, the Company sold $2,179,723 in wafers and $619,705 in polysilicon to Zhenjiang Daqo.

 

In 2013, the Company sold $8,871,220 in wafers and $4,600,646 in polysilicon to Zhenjiang Daqo.

 

Related party transactions with Daqo Solar

 

In 2011, the Company received loans of $72,199,600 from Daqo Solar, which were fully repaid during the same year and accrued interest of $1,552,126. As of December 31, 2011, the Company provided an interest free loan of $9,898,458 to Daqo Solar.

 

In 2012, the Company entered into a polysilicon sales contract with Daqo Solar, and $13,497,973 in advance payments was received as of December 31, 2012.

 

In 2013, the Company received interest free loans of $76,881,392 from Daqo Solar and repaid $28,379,679 during the same year.

 

Related party transactions with Xinjiang Daqo Investment

 

In 2012, the Company entered into a polysilicon sales contract with Xinjiang Daqo Investment, and $2,354,620 in advance payments was received as of December 31, 2012.

 

In 2013, the Company received interest free loans of $58,389,643 from Xinjiang Daqo Investment and repaid $40,193,785 during the same year.

 

Related party transactions with Nanjing Daqo

 

In August 2012, the Company entered into a one-year loan agreement with Nanjing Daqo, to lend Nanjing Daqo $1,584,820 (RMB10 million). The interest rate is fixed at 6%. In addition, the Company also sold $80,126 in cells to Nanjing Daqo.

 

In 2013, the Company agreed with Nanjing Daqo to extend the loan for one more year, interest free.

 

Related party transactions with other subsidiaries of Daqo Group

 

In 2011, the Company purchased auxiliary electricity transmission and system equipment of $2.0 million from Daqo Group subsidiaries. The Company also sold modules of $427,302 to, purchased raw materials of $300,574 from and paid service fees of $71,426 to other subsidiaries of Daqo Group.

 

In 2012, the Company purchased equipment and raw material from other subsidiaries of Daqo Group at the cost of $202,556 and $5,282, respectively.

 

In 2013, the Company purchased equipment from other subsidiaries of Daqo Group at the cost of $157,742.

 

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Employment Agreements

 

See “Item 6. Directors, Senior Management and Employees—C. Board Practices—Employment Agreements.”

 

Share Incentives

 

See “Item 6. Directors, Senior Management and Employees—B. Compensation—Share Incentive Plan” for a description of stock options and other stock purchase rights we have granted to our directors, officers and other individuals as a group.

 

C.          Interests of Experts and Counsel

 

Not applicable.

 

ITEM 8. FINANCIAL INFORMATION

 

A.          Consolidated Statements and Other Financial Information

 

See “Item 18. Financial Statements.”

 

Legal Proceedings

 

We are currently not a party to any material legal or administrative proceedings and we are not aware of any material legal or administrative proceedings threatened against us. We may from time to time be subject to various legal or administrative proceedings arising in the ordinary course of business.

 

Dividend Policy

 

We have not declared or paid any dividends on our ordinary shares or ADSs. We have no present plan to declare and pay any dividends on our shares or ADSs in the near future. We currently intend to retain our available funds and any future earnings to operate and expand our business.

 

We are a holding company incorporated in the Cayman Islands. We rely on dividends from our subsidiaries in China for our cash needs. Current PRC regulations restrict the ability of our subsidiaries to pay dividends to us. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Doing Business in China—We rely principally on dividends and other distributions on equity paid by our wholly owned operating subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our operating subsidiaries to pay dividends to us could have a material adverse effect on our ability to borrow money or pay dividends.”

 

Subject to our Third Amended and Restated Memorandum and Articles of Association and the applicable laws, our board of directors has complete discretion as to whether to recommend a distribution of dividends to shareholders, and any distribution is further subject to the approval of our shareholders. Even if our board of directors decides to recommend dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that our board of directors may deem relevant. If we pay dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. Cash dividends on our ADSs and ordinary shares, if any, will be paid in U.S. dollars.

 

B.          Significant Changes

 

Except as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.

 

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ITEM 9. THE OFFER AND LISTING

 

A.          Offering and Listing Details

 

Our ADSs, each representing 25 ordinary shares, have been listed on the New York Stock Exchange since October 7, 2010 and trade under the symbol “DQ.” Prior to December 21, 2012, each of our ADS represented five ordinary shares. We effected a change of the ADS to ordinary share ratio on December 21, 2012 from one ADS representing five ordinary shares to one ADS representing 25 ordinary shares. The ratio change had the same effect as a 1-for-5 reverse ADS split. The following table provides the high and low trading prices for our ADSs on the New York Stock Exchange for the periods indicated. For ease of comparison, the ADS prices before December 21, 2012 have been retroactively adjusted to reflect the ADS to ordinary share ratio change that took effect on December 21, 2012.

 

    Trading Price  
      High       Low  
Annual High and Low                
2010 (from October 7, 2010)     77.15       48.50  
2011     74.85       7.05  
2012     20.75       3.40  
2013     49.59       4.02  
                 
Quarterly Highs and Lows                
First Quarter of 2012     20.75       8.75  
Second Quarter of 2012     10.75       3.90  
Third Quarter of 2012     5.10       3.70  
Fourth Quarter of 2012     9.66       3.40  
First Quarter of 2013     16.70       6.65  
Second Quarter of 2013     10.66       4.02  
Third Quarter of 2013     34.80       7.60  
Fourth Quarter of 2013     49.59       23.10  
First Quarter of 2014     56.98       33.71  
                 
Monthly Highs and Lows                
October 2013     43.13       23.10  
November 2013     49.59       31.10  
December 2013     39.21       29.75  
January 2014     47.13       33.71  
February 2014     46.06       38.66  
March 2014     56.98       35.60  
April 2014 (through April 11, 2014)     46.75       39.43  

 

B.          Plan of Distribution

 

Not applicable.

 

C.          Markets

 

See “—A. Offering and Listing Details.”

 

D.          Selling Shareholders

 

Not applicable.

 

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E.           Dilution

 

Not applicable.

 

F.          Expenses of the Issue

 

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

 

A.          Share Capital

 

Not applicable.

 

B.           Memorandum and Articles of Association

 

We are a Cayman Islands company and our affairs are governed by our memorandum and articles of association, as amended from time to time, and the Companies Law of the Cayman Islands, as amended from time to time, which is referred to as the Companies Law below. The following are summaries of material provisions of our Third Amended and Restated Memorandum and Articles of Association in effect as of the date of this annual report insofar as they relate to the material terms of our ordinary shares.

 

Board of Directors

 

We are managed by a board of directors which shall consist of no less than five members. Our board of directors currently consists of nine members. An appointment of a director may be in terms that the director shall automatically retire at the next or a subsequent annual general meeting.

 

Meetings of the board of directors may be convened at any time deemed necessary by any members of the board of directors in accordance with our Third Amended and Restated Memorandum and Articles of Association.

 

A meeting of the board of directors shall be competent to make lawful and binding decisions if a quorum is present. Under our Third Amended and Restated Memorandum and Articles of Association, the quorum necessary for the transaction of the business of our board of directors may be fixed by the board of directors and unless so fixed shall be a majority of the directors then in office. At any meeting of the directors, each director, be it by his presence or by his alternate, is entitled to one vote.

 

Questions arising at a meeting of the board of directors are required to be decided by simple majority votes of the members of the board of directors present or represented at the meeting. In the case of a tie vote, the resolution shall fail. Our board of directors may also pass resolutions without a meeting by unanimous written consent.

 

See also “Item 6. Directors, Senior Management and Employees—C. Board Practices—Duties of Directors” and “—Terms of Directors and Executive Officers.”

 

Ordinary Shares

 

General

 

All of our outstanding ordinary shares are fully paid and non-assessable. Certificates representing the ordinary shares are issued in registered form. Our shareholders who are non-residents of the Cayman Islands may freely hold and vote their shares.

 

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Dividend Rights

 

The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors subject to the Companies Law.

 

Voting Rights

 

Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to vote. Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by the chairman of our board of directors or any other shareholder holding at least ten percent of the shares given a right to vote at the meeting, present in person or by proxy.

 

A quorum required for a meeting of shareholders consists of at least shareholders holding not less than an aggregate of one-third of all voting share capital of our company in issue present in person or by proxy and entitled to vote. Shareholders’ meetings may be held annually and may be convened by our board of directors on its own initiative or upon a request to the directors by shareholders holding in aggregate not less than one third of our share capital as at that date carries the right of voting at general meeting of our company. Advance notice of at least seven days is required for the convening of our annual general meeting and other shareholders meetings.

 

An ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-thirds of the votes cast attaching to the ordinary shares. A special resolution is required for important matters such as a change of name. Holders of the ordinary shares may effect certain changes by ordinary resolution, including alter the amount of our authorized share capital, consolidate and divide all or any of our share capital into shares of larger amount than our existing share capital, and cancel any shares.

 

Transfer of Shares

 

Subject to the restrictions of our Third Amended and Restated Memorandum and Articles of Association, as applicable, any of our shareholders may transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved by our board.

 

Our board of directors may, in its absolute discretion, decline to register any transfer of any ordinary share which is not fully paid up or on which we have a lien. Our directors may also decline to register any transfer of any ordinary share unless (a) the instrument of transfer is lodged with us, accompanied by the certificate for the ordinary shares to which it relates and such other evidence as our board of directors may reasonably require to show the right of the transferor to make the transfer; (b) the shares conceded are free of any lien in favor of us; or (c) a fee of such maximum sum as the New York Stock Exchange may determine to be payable, or such lesser sum as our board of directors may from time to time require, is paid to us in respect thereof.

 

If our directors refuse to register a transfer, they shall, within two months after the date on which the instrument of transfer was lodged, send to each of the transferor and the transferee notice of such refusal. The registration of transfers may, on 14 days’ notice being given by advertisement in such one or more newspapers or by electronic means, be suspended and the register closed at such times and for such periods as our board of directors may from time to time determine, provided, however, that the registration of transfers shall not be suspended nor the register closed for more than 30 days.

 

Liquidation

 

On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of shares), assets available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary shares on a pro rata basis. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.

 

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Redemption of Shares

 

Subject to the provisions of the Companies Law, we may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such manner as may be determined by special resolution.

 

Variations of Rights of Shares

 

All or any of the special rights attached to any class of shares may, subject to the provisions of the Companies Law, be varied either with the written consent of the holders of three-fourths of the issued shares of that class or with the sanction of a special resolution passed at a general meeting of the holders of the shares of that class.

 

Inspection of Books and Records

 

Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements. See “—H. Documents on Display.”

 

Limitations on the Right to Own Shares

 

There are no limitations on the right to own our shares.

 

Disclosure of Shareholder Ownership

 

There are no provisions in our amended and restated memorandum and articles of association governing the ownership threshold above which shareholder ownership must be disclosed.

 

Demand Registration Rights and Form F-3 Registration Rights

 

When we are eligible for registration on Form F-3, holders of at least 10% of our outstanding registrable securities have the right to request that we file registration statements under Form F-3 covering the offer and sale of their securities.

 

We, however, are not obligated to effect a demand registration or a Form F-3 registration if, among other things, (1) we notify the requesting holder of the registrable securities of our intention to make a public offering within 180 days, (2) the dollar amount of securities to be sold is of an aggregate price to the public of less than $5,000,000, or (3) we provide the requesting holders a certificate signed by our chief executive officer stating that in the good faith judgment of the board of directors the filing of such a registration statement will be materially detrimental to us and our shareholders. In the case of (3), we cannot exercise the deferral right more than once in any 12-month period.

 

No Sinking Fund

 

Our ordinary shares are not subject to sinking fund provisions.

 

C.          Material Contracts

 

We have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4. Information on the Company—B. Business Overview” or elsewhere in this annual report.

 

D.          Exchange Controls

 

See “Item 4. Information on the Company—B. Business Overview—Regulation—Foreign Currency Exchange.”

 

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E.          Taxation

 

The following discussion of the material Cayman Islands, PRC and United States federal tax consequences of an investment in the ordinary shares or ADSs is based upon laws and relevant interpretations thereof in effect as of the date of this annual report, all of which are subject to change. This discussion does not deal with all possible tax consequences relating to an investment in the shares or ADSs, such as the tax consequences under U.S. state, local and other tax laws.

 

Cayman Islands Taxation

 

The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by the Government of the Cayman Islands except for stamp duties which may be applicable on instruments executed in, or brought within the jurisdiction of the Cayman Islands. The Cayman Islands is not party to any double tax treaties. There are no exchange control regulations or currency restrictions in the Cayman Islands.

 

Chinese Taxation

 

Under the PRC tax laws effective prior to January 1, 2008, dividends paid to foreign investors by foreign-invested enterprises, such as dividends paid to us by our PRC subsidiaries, were exempt from PRC withholding tax. Under the PRC Enterprise Income Tax Law and its implementation rules effective on January 1, 2008, all domestic and foreign-invested companies in China are subject to a uniform enterprise income tax at the rate of 25% and dividends from a PRC subsidiary to its foreign parent company are subject to a withholding tax at the rate of 10%, unless such foreign parent company’s jurisdiction of incorporation has a tax treaty with China that provides for a reduced rate of withholding tax, or the tax is otherwise exempted or reduced pursuant to the PRC tax laws.

 

Under the EIT Law, enterprises organized under the laws of jurisdictions outside China with their “de facto management bodies” located within China are considered PRC resident enterprises and therefore be subject to PRC enterprise income tax at the rate of 25% on their worldwide income. Under the implementation rules of the EIT Law, “de facto management bodies” is defined as the bodies that have material and overall management and control over the business operations, personnel and human resources, finances and treasury, and acquisition and disposition of properties and other assets of an enterprise. In addition, a circular issued by the State Administration of Taxation on April 22, 2009 provides that a “foreign enterprise controlled by a PRC company or a PRC company group” will be classified as a “resident enterprise” with its “de facto management bodies” located within China if the following requirements are satisfied: (i) the senior management and core management departments in charge of its daily operations function mainly in the PRC; (ii) its financial and human resources decisions are subject to determination or approval by persons or bodies in the PRC; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and (iv) more than half of the enterprise’s directors or senior management with voting rights reside in the PRC. However, it remains unclear how PRC tax authority will treat an overseas company controlled by PRC natural persons rather than PRC enterprises like Daqo Cayman. The criteria set forth above do not apply to Daqo Cayman directly because Daqo Cayman is currently beneficially owned by Chinese individuals and is not a “foreign enterprise controlled by a PRC company or a PRC company group.” However, such criteria may be considered relevant in determining Daqo Cayman’s residence. Therefore, we cannot assure you that Daqo Cayman will not be deemed a PRC resident enterprise.

 

If Daqo Cayman were classified as a PRC resident enterprise under the EIT Law, enterprise ADS holders who are not Chinese residents may be subject to a 10% withholding tax (20% in the case of individual ADS holders who are not Chinese residents) upon dividends payable by Daqo Cayman, and 10% tax on gains realized upon the sale or other disposition of our ADSs (20% in the case of individual ADS holders who are not Chinese residents). In addition, the EIT law and regulations also provide that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested resident enterprise are exempted from income tax, subject to certain conditions. Therefore, if Daqo Cayman is classified as resident enterprise under the EIT Law, the dividends we receive from our Chinese subsidiaries may be exempted from withholding tax.

 

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Material United States Federal Income Tax Considerations

 

The following is a discussion of the material United States federal income tax considerations relating to the acquisition, ownership, and disposition of our ADSs or ordinary shares by U.S. Holders (as defined below) that will hold ADSs or ordinary shares as “capital assets” (generally, property held for investment) under the United States Internal Revenue Code of 1986, as amended (the “Code”). This discussion is based upon existing U.S. federal income tax law as in effect on the date of this annual report, which is subject to differing interpretations or change, possibly with retroactive effect. This discussion does not address all aspects of United States federal income taxation that may be important to particular investors in light of their individual investment circumstances, including investors subject to special tax rules (for example, financial institutions, insurance companies, broker-dealers, partnerships and their partners, and tax-exempt organizations (including private foundations)), investors who are not U.S. Holders, investors who own (directly, indirectly, or constructively) 10% or more of our voting stock, investors that will hold their ADSs or ordinary shares as part of a straddle, hedge, conversion, constructive sale, or other integrated transaction for United States federal income tax purposes, investors that are traders in securities that have elected the mark-to-market method of accounting, or investors that have a functional currency other than the United States dollar, all of whom may be subject to tax rules that differ significantly from those discussed below. In addition, this discussion does not address any non-United States, alternative minimum tax, state, or local tax considerations or the Medicare tax. Each U.S. Holder is urged to consult its tax advisor regarding the United States federal, state, local, and non-United States income and other tax considerations of an investment in ADSs or ordinary shares.

 

General

 

For purposes of this discussion, a “U.S. Holder” is a beneficial owner of our ADSs or ordinary shares that is, for United States federal income tax purposes, (i) an individual who is a citizen or resident of the United States, (ii) a corporation, or other entity taxable as a corporation for United States federal income tax purposes, created in, or organized under the law of the United States or any state thereof or the District of Columbia, (iii) an estate the income of which is includible in gross income for United States federal income tax purposes regardless of its source, or (iv) a trust (A) the administration of which is subject to the primary supervision of a United States court and which has one or more United States persons who have the authority to control all substantial decisions of the trust or (B) that has otherwise validly elected to be treated as a United States person under the Code.

 

If a partnership (or other entity treated as a partnership for United States federal income tax purposes) is a beneficial owner of our ADSs or ordinary shares, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. Partnerships and partners of a partnership holding our ADSs or ordinary shares are urged to consult their tax advisors regarding an investment in our ADSs or ordinary shares.

 

For United States federal income tax purposes, a U.S. Holder of ADSs will generally be treated as the beneficial owner of the underlying shares represented by the ADSs. Accordingly, deposits or withdrawals of ordinary shares for ADSs will generally not be subject to United States federal income tax. The United States Treasury has expressed concerns that parties to whom American depositary shares are released before shares are delivered to the depositary (a “pre-release transaction”), or intermediaries in the chain of ownership between holders of American depositary shares and the issuer of the security underlying the American depositary shares, may be taking actions that are inconsistent with the claiming of foreign tax credits by holders of American depositary shares. These actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate holders. Accordingly, the creditability of any PRC taxes, and the availability of the reduced tax rate for dividends received by certain non-corporate U.S. Holders, each described below, could be affected by actions taken by such parties or intermediaries in respect of a pre-release transaction.

 

Passive Foreign Investment Company Considerations

 

A non-United States corporation, such as our company, will be classified as a “passive foreign investment company” (or a “PFIC”), for United States federal income tax purposes for any taxable year, if either (i) 75% or more of its gross income for such year consists of certain types of “passive” income or (ii) 50% or more of the value of its assets (determined on the basis of a quarterly average) produce or are held for the production of passive income. For this purpose, cash and assets readily convertible into cash are categorized as passive assets and the company’s unbooked intangibles are generally taken into account for determining the value of its assets. We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, more than 25% (by value) of the stock.

 

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We do not believe that we were a PFIC, for United States federal income tax purposes, for the taxable year ended 2013. Although we do not currently expect that our assets or activities will change in a manner that would cause us to become a PFIC for our current taxable year or the foreseeable future, there can be no assurance our business plans will not change in a manner that will affect our PFIC status. Because there are uncertainties in the application of the relevant rules and PFIC status is a fact-intensive determination made on an annual basis, no assurance can be given that we are not or will not become classified as a PFIC.

 

The discussion below under “Dividends” and “Sale or Other Disposition of ADSs or Ordinary Shares” is written on the basis that we will not be classified as a PFIC for United States federal income tax purposes. The United States federal income tax rules that apply if we are classified as a PFIC for the current taxable year or any subsequent taxable year are generally discussed below under “Passive Foreign Investment Company Rules.”

 

Dividends

 

Subject to the PFIC rules discussed below, any cash distributions (including the amount of any taxes withheld) paid on ADSs or ordinary shares out of our current or accumulated earnings and profits, as determined under United States federal income tax principles, will generally be includible in the gross income of a U.S. Holder as dividend income on the day actually or constructively received by the depositary in the case of ADSs or by a U.S. Holder in the case of ordinary shares. Because we do not intend to determine our earnings and profits on the basis of United States federal income tax principles, any distribution paid will generally be reported as a “dividend” for United States federal income tax purposes. A non-corporate recipient will be subject to tax at the lower capital gain tax rate applicable to “qualified dividend income,” provided that certain conditions are satisfied, including that (1) the ADSs or ordinary shares, as applicable, are readily tradable on an established securities market in the United States, or, in the event that our company is deemed to be a PRC resident enterprise under the PRC Enterprise Income Tax Law, our company is eligible for the benefits of the United States-PRC treaty, (2) we are neither a passive foreign investment company nor treated as such with respect to you (as discussed below) for the taxable year in which the dividend was paid and the preceding taxable year, and (3) certain holding period requirements are met. United States Treasury guidance indicates that ordinary shares, or ADSs representing such shares, are considered for the purpose of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on the New York Stock Exchange, as are our ADSs (but not our ordinary shares). There can be no assurance that our ADSs will be considered readily tradable on an established securities market in the United States in later years. Since we do not expect that our ordinary shares will be listed on an established securities market in the United States, it is unclear whether the dividends that we pay on our ordinary shares that are not backed by ADSs currently meet the conditions required for the reduced tax rate. Dividends received on the ADSs or ordinary shares are not expected to be eligible for the dividends received deduction allowed to corporations.

 

Dividends will generally be treated as income from foreign sources for United States foreign tax credit purposes. In the event that we are deemed to be a PRC “resident enterprise” under the PRC Enterprise Income Tax Law, a U.S. Holder may be subject to PRC withholding taxes on dividends paid on our ADSs or ordinary shares. A U.S. Holder may be eligible, subject to a number of complex limitations, to claim a foreign tax credit in respect of any foreign withholding taxes imposed on dividends received on ADSs or ordinary shares. A U.S. Holder who does not elect to claim a foreign tax credit for foreign tax withheld may instead claim a deduction for United States federal income tax purposes, in respect of such withholdings, but only for a year in which such holder elects to do so for all creditable foreign income taxes. The rules governing the foreign tax credits are complex. Accordingly, each U.S. Holder is advised to consult with its tax advisor regarding the availability of a foreign tax credit under its particular circumstances.

 

Sale or Other Disposition of ADSs or Ordinary Shares

 

Subject to the PFIC rules discussed below, a U.S. Holder will generally recognize capital gain or loss upon the sale or other disposition of ADSs or ordinary shares in an amount equal to the difference between the amount realized upon the disposition and the holder’s adjusted tax basis in such ADSs or ordinary shares. Any capital gain or loss will be long-term if the ADSs or ordinary shares have been held for more than one year and will generally be United States source gain or loss for United States foreign tax credit purposes. Long-term capital gain of noncorporate U.S. Holders is generally eligible for a reduced rate of tax. The deductibility of a capital loss may be subject to limitations. In the even that we are treated as a PRC “resident enterprise” under the PRC Enterprise Income Tax Law and gain from the disposition of ADSs or ordinary shares is subject to the tax in the PRC, a U.S. Holder that is eligible for the benefits of the income tax treaty between the United States and the PRS may elect to treat the gain as PRC source income. U.S. Holders are urged to consult with their tax advisors regarding the tax consequences if a foreign withholding tax is imposed on a disposition of our ADSs or ordinary shares, including the availability of a foreign tax credit under their particular circumstances.

 

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Passive Foreign Investment Company

 

If we are classified as a PFIC for any taxable year during which a U.S. Holder holds our ADSs or ordinary shares, and unless the U.S. Holder makes a mark-to-market election (as described below), the U.S. Holder will generally be subject to special tax rules that have a penalizing effect, regardless of whether we remain a PFIC, on (i) any excess distribution that we make to the U.S. Holder (which generally means any distribution paid during a taxable year to a U.S. Holder that is greater than 125 percent of the average annual distributions paid in the three preceding taxable years or, if shorter, the U.S. Holder’s holding period for the ADSs) or ordinary shares and (ii) any gain realized on the sale or other disposition, including a pledge, of ADSs or ordinary shares. Under these PFIC rules:

 

 

·such excess distribution or gain will be allocated ratably over the U.S. Holder’s holding period for the ADSs or ordinary shares;

 

·the amount allocated to the current taxable year, and any taxable years in the U.S. Holder’s holding period prior to the first taxable year in which we were a PFIC (a “pre-PFIC year”), will be taxable as ordinary income;

 

·the amount allocated to each prior taxable year, other than a pre-PFIC year, will be subject to tax at the highest tax rate in effect applicable to the U.S. Holder for each such year; and

 

·an interest charge generally applicable to underpayments of tax will be imposed on the tax attributable to each prior taxable year, other than a pre-PFIC year.

 

A U.S. Holder of “marketable stock” (as defined below) in a PFIC may make a mark-to-market election for such stock to elect out of the tax treatment discussed above. If a U.S. Holder makes a mark-to-market election for the ADSs (but not our ordinary shares), such holder will include in income for each year that we are treated as a PFIC with respect to such holder an amount equal to the excess, if any, of the fair market value of the ADSs as of the close of the holder’s taxable year over the holder’s adjusted basis in such ADSs. A U.S. Holder will be allowed a deduction for the excess, if any, of the adjusted basis of the ADSs over their fair market value as of the close of the taxable year. However, deductions will be allowable only to the extent of any net mark-to-market gains on the ADSs included in a U.S. Holder’s income for prior taxable years. Amounts included in a U.S. Holder’s income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs, will be treated as ordinary income. Ordinary loss treatment will also apply to the deductible portion of any mark-to-market loss on the ADSs, as well as to any loss realized on the actual sale or disposition of the ADSs, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs. A U.S. Holder’s basis in the ADSs will be adjusted to reflect any such income or loss amounts. If a U.S. Holder makes a valid mark-to-market election, the tax rules that apply to distributions by corporations which are not PFICs would apply to distributions by us, except that the lower capital gains rate applicable to qualified dividend income (discussed above under “—Dividends”) would not apply.

 

The mark-to-market election is available only for “marketable stock,” which is stock that is traded in other than de minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market, as defined in applicable United States Treasury regulations. Our ADSs are listed on the New York Stock Exchange, which is a qualified exchange or market for these purposes. Consequently, if the ADSs continue to be listed on the New York Stock Exchange and are regularly traded, and a U.S. Holder holds ADSs, we expect that the mark-to-market election would be available to such U.S. Holder were we to be or become a PFIC. Because a mark-to-market election cannot be made for equity interests in any lower-tier PFICs that we own, a U.S. Holder may continue to be subject to the PFIC rules with respect to its indirect interest in any investments held by us that are treated as an equity interest in a PFIC for United States federal income tax purposes. In the case of a U.S. Holder who has held ADSs during any taxable year in respect of which we were classified as a PFIC and continues to hold such ADSs (or any portion thereof) and has not previously determined to make a mark-to-market election, and who is now considering making a mark-to-market election, special tax rules may apply relating to purging the PFIC taint of such ADSs.

 

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We do not intend to prepare or provide the information that would enable a U.S. Holder to make a qualified electing fund election (“QEF Election”), which, if available, would result in tax treatment different from the general tax treatment for PFICs described above. Accordingly, each U.S. Holder should assume that the QEF Election will not be available.

 

If a U.S. Holder holds ADSs or ordinary shares in any year in which we are treated as a PFIC with respect to such U.S. Holder, the U.S. Holder would generally be required to file United States Internal Revenue Service Form 8621. U.S. Holders are urged to consult their tax advisors regarding the application of the PFIC rules to their investment in ADSs or ordinary shares.

 

Information Reporting and Backup Withholding

 

U.S. Holders may be subject to information reporting to the Internal Revenue Service with respect to dividends on and proceeds from the sale or other disposition of our ADSs or ordinary shares. Dividend payments with respect to our ADS or ordinary shares and proceeds from the sale or other disposition of our ADSs or common shares are not generally subject to United States backup withholding (provided that certain certification requirements are satisfied). Each U.S. Holder is advised to consult its tax advisor regarding the application of the United States information reporting and backup withholding rules to its particular circumstances.

 

Individuals and certain others who are U.S. Holders, and who hold “specified foreign financial assets,” including stock of a non-U.S. corporation that is not held in an account maintained by a U.S. “financial institution,” whose aggregate value exceeds $50,000 during the tax year, may be required to attach to their tax return for the year certain specified information. A U.S. Holder who fails to timely furnish the required information may be subject to a penalty. Each U.S. Holder is advised to consult its tax advisor regarding its reporting obligations under this legislation.

 

F.           Dividends and Paying Agents

 

Not applicable.

 

 

G.          Statement by Experts

 

Not applicable.

 

H.          Documents on Display

 

We are subject to the periodic reporting and other informational requirements of the Securities Exchange Act of 1934 or the Exchange Act. Under the Exchange Act, we are required to file reports and other information with the SEC. Specifically, we are required to file annually a Form 20-F (1) within six months after the end of each fiscal year, which is December 31, for fiscal years ending before December 15, 2011; and (2) within four months after the end of each fiscal year for fiscal years ending on or after December 15, 2011. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system. Copies of reports and other information, when filed, may also be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the SEC at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the SEC at 1-800-SEC-0330. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.

 

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We will furnish JPMorgan Chase Bank, N.A., the depositary of our ADSs, with our annual reports, which will include a review of operations and annual audited consolidated financial statements prepared in conformity with U.S. GAAP, and all notices of shareholders’ meetings and other reports and communications that are made generally available to our shareholders. The depositary will make such notices, reports and communications available to holders of ADSs and, upon our request, will mail to all record holders of ADSs the information contained in any notice of a shareholders’ meeting received by the depositary from us.

 

I.          Subsidiary Information

 

For a listing of our subsidiaries, see “Item 4. Information on the Company—C. Organizational Structure.”

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

Our exposure to interest rate risk primarily relates to interest expense incurred on our short-term and long-term borrowings and interest income generated by excess cash which is mostly held in interest-bearing bank deposits. We have not used any derivative financial instruments to manage our interest rate risk exposure. As of December 31, 2013, we had outstanding long-term bank borrowings of $184.9 million mostly bearing floating rates which are subject to adjustment every 12 months based upon the PRC government’s standard interest rate. The weighted average interest rate as of December 31, 2013 for the long-term bank borrowings was 7.2%. We are currently not engaged in any interest rate hedging activities. A hypothetical five percentage point increase in interest rates would have resulted in an increase of approximately $9.2 million in our interest expense for the year ended December 31, 2013.

 

Foreign Exchange Risk

 

Substantially all of our revenues and most of our expenses are denominated in RMB. Our exposure to foreign exchange risk primarily relates to (1) the Euro or U.S. dollar income or that we may generate in the future for sale of our photovoltaic products in the international market, (2) the U.S. dollar proceeds of a small portion of our initial public offering in October 2010, most or substantially all of which we expect to convert into RMB over time for the uses discussed under “Item 14. Material Modifications to the Rights of Security Holders Use of Proceeds” and (3) the U.S. dollar and Euro denominated equipment purchase prices that we need to pay from time to time. We believe the impact of foreign currency risk is not material and we have not used any forward contracts, currency borrowings or derivative instruments to hedge our exposure to foreign currency exchange risk. Although in general our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and RMB because the value of our business is effectively denominated in RMB, while we use the U.S. dollar as our functional and reporting currency and the ADSs will be traded in U.S. dollars. The value of the RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies.

 

To the extent that we need to convert U.S. dollars into RMB for our operations, acquisitions or other uses within China, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. To the extent that we seek to convert RMB into U.S. dollars, depreciation of the RMB against the U.S. dollar would have an adverse effect on the U.S. dollar amount we receive from the conversion. As of December 31, 2013, we had RMB-denominated cash, cash equivalents and short-term investments of RMB69.4 million and U.S. dollar-denominated cash, cash equivalents and short-term investments of $5.3 million. Assuming we had converted the U.S. dollar-denominated cash, cash equivalents and short-term investments of $5.3 million into RMB at the exchange rate of $1.00 for RMB6.054 as of December 31, 2013, this cash, cash equivalents and short-term investments would have been RMB32.1 million. Assuming a 10% appreciation of the RMB against the U.S. dollar, this cash, cash equivalents and short-term investments would have decreased to RMB28.9 million.

 

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ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

A.          Debt Securities

 

Not applicable.

 

B.          Warrants and Rights

 

Not applicable.

 

C.          Other Securities

 

Not applicable.

 

D.          American Depositary Shares

 

Fees and Charges Our ADS Holders May Have to Pay

 

As an ADS holder, you will be required to pay the following service fees to the depositary bank:

 

The depositary may charge each person to whom ADSs are issued, including, without limitation, issuances against deposits of shares, issuances in respect of share distributions, rights and other distributions, issuances pursuant to a stock dividend or stock split declared by us or issuances pursuant to a merger, exchange of securities or any other transaction or event affecting the ADSs or deposited securities, and each person surrendering ADSs for withdrawal of deposited securities or whose ADSs are cancelled or reduced for any other reason, $5.00 for each 100 ADSs (or any portion thereof) issued, delivered, reduced, cancelled or surrendered, as the case may be. The depositary may sell (by public or private sale) sufficient securities and property received in respect of a share distribution, rights and/or other distribution prior to such deposit to pay such charge.

 

The following additional charges shall be incurred by the ADS holders, by any party depositing or withdrawing shares or by any party surrendering ADSs or to whom ADSs are issued (including, without limitation, issuance pursuant to a stock dividend or stock split declared by us or an exchange of stock regarding the ADSs or the deposited securities or a distribution of ADSs), whichever is applicable:

 

·a fee of $1.50 per ADR or ADRs for transfers of certificated or direct registration ADRs;

 

·a fee of up to $0.05 per ADS for any cash distribution made pursuant to the deposit agreement;

 

·a fee of up to $0.05 per ADS per calendar year (or portion thereof) for services performed by the depositary in administering the ADRs (which fee may be charged on a periodic basis during each calendar year and shall be assessed against holders of ADRs as of the record date or record dates set by the depositary during each calendar year and shall be payable in the manner described in the next succeeding provision);

 

·reimbursement of such fees, charges and expenses as are incurred by the depositary and/or any of the depositary’s agents (including, without limitation, the custodian and expenses incurred on behalf of holders in connection with compliance with foreign exchange control regulations or any law or regulation relating to foreign investment) in connection with the servicing of the shares, the delivery of deposited securities or otherwise in connection with the depositary’s or its custodian’s compliance with applicable law, rule or regulation (which charge shall be assessed on a proportionate basis against holders as of the record date or dates set by the depositary and shall be payable at the sole discretion of the depositary by billing such holders or by deducting such charge from one or more cash dividends or other cash distributions);

 

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·a fee for the distribution of securities (or the sale of securities in connection with a distribution), such fee being in an amount equal to the fee for the execution and delivery of ADSs which would have been charged as a result of the deposit of such securities (treating all such securities as if they were shares) but which securities or the net cash proceeds from the sale thereof are instead distributed by the depositary to those holders entitled thereto;

 

·stock transfer or other taxes and other governmental charges;

 

·cable, telex and facsimile transmission and delivery charges incurred at your request in connection with the deposit or delivery of shares;
·transfer or registration fees for the registration of transfer of deposited securities on any applicable register in connection with the deposit or withdrawal of deposited securities; and

 

·expenses of the depositary in connection with the conversion of foreign currency into U.S. dollars.

 

ADR holders must pay any tax or other governmental charge payable by the custodian or the depositary on any ADS or ADR, deposited security or distribution. If an ADR holder owes any tax or other governmental charge, the depositary may (i) deduct the amount thereof from any cash distributions, or (ii) sell deposited securities (by public or private sale) and deduct the amount owing from the net proceeds of such sale. In either case the ADR holder remains liable for any shortfall. Additionally, if any tax or governmental charge is unpaid, the depositary may also refuse to effect any registration, registration of transfer, split-up or combination of deposited securities or withdrawal of deposited securities until such payment is made. If any tax or governmental charge is required to be withheld on any cash distribution, the depositary may deduct the amount required to be withheld from any cash distribution or, in the case of a non-cash distribution, sell the distributed property or securities (by public or private sale) to pay such taxes and distribute any remaining net proceeds to the ADR holders entitled thereto.

 

We will pay all other charges and expenses of the depositary and any agent of the depositary (except the custodian) pursuant to agreements from time to time between us and the depositary. The depositary collects its fees for issuance and cancellation of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deduction from cash distributions, or by directly billing investors, or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide services to any holder until the fees and expenses owing by such holder for those services or otherwise are paid. The charges described above may be amended from time to time by agreement between us and the depositary.

 

Fees and Other Payments Made by the Depositary to Us

 

The depositary bank may reimburse us for certain expenses incurred by us in respect of the ADR program established pursuant to the deposit agreement, by making available a set amount or a portion of the depositary fees charged in respect of the ADR program or otherwise, upon such terms and conditions as we and the depositary bank may agree from time to time. For the year ended December 31, 2013, we have received US$496,132.84 from the depository as reimbursement for our expenses incurred in connection with the establishment and maintenance of the ADS program. In December 2012, we instructed the depositary bank to change the ratio of shares of our company by each ADS from five shares to twenty five shares per ADS. In accordance with the agreement between our company and the depositary bank, the latter ceased any reimbursement and waives, and charged “Termination/Revision Fees” of $1 million to our company.

 

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PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

 

Not applicable.

 

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

 

The following “Use of Proceeds” information relates to the registration statement on Form F-1, as amended (File Number 333-164307) for our initial public offering of 9,200,000 ADSs, representing 46,000,000 ordinary shares, which registration statement was declared effective by the SEC on October 6, 2010.

 

As of December 31, 2013, we have used all of the net proceeds received from our initial public offering. We estimate that we used approximately $69.5 million to expand our polysilicon manufacturing facilities; and approximately $10.0 million to finance capital expenditures for our wafer manufacturing business. None of the payments described in this Item were direct or indirect payments to our directors, officers, general partners or their associates, or any persons owning 10% or more of our ordinary shares, or our affiliates.

 

ITEM 15. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) or 15d-15(e) promulgated under the Exchange Act, at December 31, 2013. Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of that date, our disclosure controls and procedures required by Rules 13a-15(b) or 15d-15(b) were effective as of December 31, 2013.

 

Management’s Report On Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements in accordance with U.S. GAAP. Because of its inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

 

Our management conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, it used the criteria established within the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, our management has concluded that, as of December 31, 2013, our internal control over financial reporting was effective.

 

Changes in Internal Control over Financial Reporting

 

There have not been any changes in our internal control over financial reporting in the year ended December 31, 2013, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

88
 

 

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

 

Our board of directors has determined that Mr. Arthur Wong, an independent director (under the standards set forth in Section 303A of the Corporate Governance Rules of the New York Stock Exchange and Rule 10A-3 under the Exchange Act), and the chairman of our audit committee, is our audit committee financial expert.

 

ITEM 16B. CODE OF ETHICS

 

Our board of directors has adopted a code of ethics that applies to our directors, officers, employees and agents, including certain provisions that specifically apply to our chief executive officer, chief financial officer, chief marketing officer, chief operating officer, chief technology officer, vice presidents and any other persons who perform similar functions for us. We have posted a copy of our code of business conduct and ethics on our website at http://dqsolar.investorroom.com/.

 

 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by Deloitte Touche Tohmatsu Certified Public Accountants LLP, our independent registered public accounting firm, for the periods indicated. We did not pay any other fees to our independent registered public accounting firm during the periods indicated below.

 

   Year Ended December 31, 
   2011   2012   2013 
   (in US$ thousands) 
Audit fees(1)    900    700    700 
Tax fees(2)        8     
                
 
(1)“Audit fees” means the aggregate fees billed for professional services rendered by our independent registered public accounting firm for the audit of our annual financial statements and the review of our comparative interim financial statements.

 

(2)“Tax fees” represents the aggregate fees billed for professional services rendered by our independent registered public accounting firm for tax compliance, tax advice, and tax planning.

 

The policy of our audit committee is to pre-approve all audit and non-audit services provided by Deloitte Touche Tohmatsu Certified Public Accountants LLP, including audit services, audit-related services, tax services and other services as described above, other than those for de minimis services which are approved by the audit committee prior to the completion of the audit.

 

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

 

Not applicable.

 

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

 

On July 23, 2013, our board of directors authorized a share repurchase program, whereby our company may repurchase of up to US$3 million of our ordinary shares or ADSs from July 23, 2013 to July 22, 2014. The share repurchase program was publicly announced on July 23, 2013. The following table sets forth some additional information about our repurchases made under this program as of the date of this annual report.

 

89
 

 

   Total Number of ADSs Purchased   Average Price Paid per ADS ($)   Total Number of ADSs Purchased as Part of Publicly Announced Plans or Programs   Maximum Dollar Value of ADSs that May Yet be Purchased Under the Plans or Programs ($) 
July 23, 2013 — July 31, 2013    0    -    -    - 
August 1, 2013 — August 31, 2013    0    -    -    - 
September 1, 2013 — September 30, 2013    0    -    -    - 
October 1, 2013 — October 31, 2013    0    -    -    - 
November 1, 2013 — November 30, 2013    0    -    -    - 
December 1, 2013 — December 31, 2013    0    -    -    - 
Total    0    -    -    - 

 

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

 

Not applicable.

 

ITEM 16G. CORPORATE GOVERNANCE

 

Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from the New York Stock Exchange corporate governance listing standards. For example, neither the Companies Law of the Cayman Islands nor our memorandum and articles of association requires a majority of our directors to be independent and we could include non-independent directors as members of our compensation committee and nominating committee, and our independent directors would not necessarily hold regularly scheduled meetings at which only independent directors are present. Currently, we do not plan to rely on home country practice with respect to our corporate governance. However, if we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would under the New York Stock Exchange corporate governance listing standards applicable to U.S. domestic issuers.

 

ITEM 16H. MINE SAFETY DISCLOSURE

 

Not applicable.

 

PART III

 

ITEM 17. FINANCIAL STATEMENTS

 

We have elected to provide financial statements pursuant to “Item 18. Financial Statements.”

 

ITEM 18. FINANCIAL STATEMENTS

 

The consolidated financial statements of Daqo New Energy Corp. are included at the end of this annual report.

 

ITEM 19. EXHIBITS

 

Exhibit Number

Description of Document

1.1 Third Amended and Restated Memorandum and Articles of Association of the Registrant (incorporated herein by reference to Exhibit 4.2 to the registration statement on Form F-1, as amended (File No. 333-164307))
2.1* Deposit Agreement among the Registrant, JPMorgan Chase Bank, N.A. as depositary, and holders and beneficial owners of American Depositary Shares evidenced by American Depositary Receipts issued thereunder
2.2* Amendment No. 1 to Deposit Agreement among Daqo New Energy Corp. and JPMorgan Chase Bank, N.A. as depositary, and holders of American Depositary Receipts

 

90
 

 

Exhibit Number   Description of Document
4.1   2009 Share Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.2   Form of Indemnification Agreement with the Registrant’s directors and officers (incorporated herein by reference to Exhibit 10.2 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.3   Form of Employment Agreement between the Registrant and an Executive Officer of the Registrant (incorporated herein by reference to Exhibit 10.3 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.4   English translation of the Loan Agreement between Daqo New Material and China Construction Bank, Wanzhou Branch dated as of September 30, 2007 (incorporated herein by reference to Exhibit 10.19 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.5   English translation of the Loan Agreement between Daqo New Material and China Construction Bank, Wanzhou Branch dated as of February 28, 2008 (incorporated herein by reference to Exhibit 10.20 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.6   English translation of the Loan Agreement between Chongqing Daqo and China Construction Bank, Wanzhou Branch dated as of January 21, 2009 (incorporated herein by reference to Exhibit 10.22 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.7   English translation of the Syndicated Loan Agreement among Chongqing Daqo, China Construction Bank, Chongqing Branch, China Construction Bank, Wanzhou Branch, and China Merchants Bank, Chongqing Jiangbei Sub-branch dated as of August 28, 2009 (incorporated herein by reference to Exhibit 10.25 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.8   English translation of the Supplemental Agreement to the Syndicated Loan Agreement among Chongqing Daqo, China Construction Bank, Chongqing Branch, China Construction Bank, Wanzhou Branch, China Merchants Bank, Chongqing Jiangbei Sub-branch, China CITIC Bank, Chongqing Branch, Daqo Group, Guangfu Xu and Xiang Xu dated as of December 10, 2009, pursuant to which China CITIC Bank joined the bank syndicate as a lender (incorporated herein by reference to Exhibit 10.26 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.9   English translation of the Trademark License Agreement among Daqo Group, Chongqing Daqo and Nanjing Daqo dated as of May 8, 2009 (incorporated herein by reference to Exhibit 10.27 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.10   Non-Competition Agreement among Daqo Group, Daqo Cayman (formerly known as Mega Stand International Limited) and Chongqing Daqo dated as of July 1, 2008 (incorporated herein by reference to Exhibit 10.28 to the registration statement on Form F-1, as amended (File No. 333-164307))
4.13   English translation of Construction Contract Between Xinjiang Daqo New Energy Co., Ltd. and China National Chemical Engineering Third Construction Co., Ltd. dated as of January 2011 (Incorporated herein by reference to Exhibit 4.40 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission April 25, 2011 (File No. 001-34602))
4.14   English translation of Construction Contract Between Xinjiang Daqo New Energy Co., Ltd. and China National Chemical Engineering Third Construction Co., Ltd. dated as of March 2011 (Incorporated herein by reference to Exhibit 4.41 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission April 25, 2011 (File No. 001-34602))
4.15   English translation of the Loan Agreement between Xinjiang Daqo and Bank of China, Shihezi Branch dated as of September 30, 2011 (incorporated herein by reference to Exhibit 4.22 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 30, 2012 (File No. 001-34602))
4.16   English translation of the Loan Agreement between Chongqing Daqo and Chongqing Rural Commercial Bank dated as of October 26, 2011 (incorporated herein by reference to Exhibit 4.23 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 30, 2012 (File No. 001-34602))
4.17   English translation of the short-term Syndicated Loan Agreement among Chongqing Daqo, China Construction Bank, Wanzhou Branch and China Everbright Bank, Chongqing Branch dated March 1, 2011 (incorporated herein by reference to Exhibit 4.24 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 30, 2012 (File No. 001-34602))
4.18   English translation of the Loan Agreement between Chongqing Daqo and Huaxia Bank, Wanzhou Branch dated October 20, 2011 (incorporated herein by reference to Exhibit 4.25 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 30, 2012 (File No. 001-34602))
4.19   English translation of the Loan Agreement between Chongqing Daqo and Huaxia Bank, Wanzhou Branch dated October 26, 2011 (incorporated herein by reference to Exhibit 4.26 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 30, 2012 (File No. 001-34602))
4.20   English translation of the Supplemental Agreement between Chongqing Daqo and Daqo New Material entered into in December 2012 with respect to the Amended and Restated Lease Agreement (incorporated herein by reference to Exhibit 4.20 of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 23, 2013 (File No. 001-34602))

 

91
 

  

Exhibit
Number
   Description of Document
4.21*   English summary of Comprehensive credit agreement with Everbright Bank dated as of March 20, 2013
4.22*   English summary of Loan agreement with Everbright Bank dated as of March 20, 2013
4.23*   English summary of Loan agreement with China Construction Bank dated as of April 17, 2013
4.24*   English summary of Loan agreement with China Construction Bank dated as of November 6, 2013
4.25*   English summary of Loan agreement with Chongqing Three Gorges Bank dated as of December 18, 2013
4.26*   English translation of Lease Contract (Revised Edition) between Daqo New Material and Chongqing Daqo effective as of January 1, 2009
4.27*   English translation of Lease Contract between Daqo New Material and Chongqing Daqo effective as of January 1, 2012
4.28*   English translation of Supplemental Agreement to the Lease Contract between Daqo New Material and Chongqing Daqo effective as of October 1, 2012
4.29*   English translation of Supplemental Agreement to the Lease Contract between Daqo New Material and Chongqing Daqo effective as of January 1, 2014

8.1*   Subsidiaries of the Registrant
11.1   Code of Business Conduct and Ethics of the Registrant (incorporated herein by reference to Exhibit 99.1 to the registration statement on Form F-1, as amended (File No. 333-164307))
12.1*   CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
12.2*   CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
13.1**   CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
13.2**   CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
15.1*   Consent of Deloitte Touche Tohmatsu Certified Public Accountants LLP
101.INS**   XBRL Instance Document
101.SCH**   XBRL Taxonomy Extension Schema Document
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document
     

  

 

* Filed with this annual report on Form 20-F

** Furnished with this annual report on Form 20-F

92
 

 

SIGNATURES

 

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

 

DAQO NEW ENERGY CORP.
   
By: /s/ Gongda Yao
Name:   Gongda Yao
Title: Chief Executive Officer

  

Date: April 14, 2014

  

93
 

 

DAQO NEW ENERGY CORP.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets as of December 31, 2012 and 2013 F-3 – F-4
Consolidated Statements of Operations for the Years Ended December 31, 2011, 2012 and 2013 F-5
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2011, 2012 and 2013 F-6
Consolidated Statements of Changes in Equity for the Years Ended December 31, 2011, 2012 and 2013 F-7
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2012 and 2013 F-8 – F-9
Notes to Consolidated Financial Statements for the Years Ended December 31, 2011, 2012 and 2013 F-10 – F-38
Financial Statement Schedule I F-39 – F-43

 

F-1
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF

DAQO NEW ENERGY CORP.:

 

We have audited the accompanying consolidated balance sheets of Daqo New Energy Corp. and its subsidiaries and variable interest entity (the “Company”) as of December 31, 2012, and 2013, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for each of the three years in the period ended December 31, 2013 and the related financial statement schedule included in Schedule I. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing the audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Daqo New Energy Corp. and its subsidiaries and variable interest entity as of December 31, 2012, and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

/s/ DELOITTE TOUCHE TOHMATSU CERTIFIED PUBLIC ACCOUNTANTS LLP
Shanghai, China
 
April 14, 2014

 

F-2
 

 

DAQO NEW ENERGY CORP.

 

CONSOLIDATED BALANCE SHEETS

 

DECEMBER 31, 2012 AND 2013 

(In U.S. dollars, except share data)

 

   December 31, 
   2012   2013 
ASSETS:          
Current assets:          
Cash and cash equivalents  $6,679,024   $7,831,084 
Restricted cash   10,649,745    8,826,110 
Accounts receivable, net of allowance for doubtful accounts of $1,592,467 and $7,160,782 as of December 31, 2012 and 2013   27,822,799    9,909,662 
Notes receivables   4,631,370    15,929,627 
Prepaid expenses and other current assets   23,933,967    23,870,690 
Advances to suppliers   737,794    860,546 
Inventories   15,135,522    10,500,256 
Amount due from related parties   6,562,487    13,416,452 
Deferred tax assets - current   358,435     
           
Total current assets   96,511,143    91,144,427 
Property, plant and equipment, net   677,895,274    488,504,183 
Prepaid land use rights   36,157,610    30,377,493 
Deferred tax assets   1,057,066     
Other non-current assets   4,686,711    173,440 
           
TOTAL ASSETS  $816,307,804   $610,199,543 
           
LIABILITIES:          
Current liabilities:          
Short-term borrowings, including current portion of long-term borrowings  $120,279,760   $118,870,857 
Accounts payable   12,346,063    17,695,490 
Notes payable   21,334,082    1,573,646 
Advances from customers   29,396,238    13,217,775 
Payables for purchases of property, plant and equipment   45,468,680    51,766,695 
Accrued expenses and other current liabilities   7,617,455    7,461,621 
Amount due to related parties   23,708,363    88,537,790 
Income tax payable   160,480     
           
Total current liabilities   260,311,121    299,123,874 
Long-term borrowings   187,520,880    134,870,287 
Long-term payables for purchase of property, plant and equipment   1,126,255     
Advance from customers       11,924,121 
Deferred government subsidies   26,472,135    26,954,700 
           
Total liabilities   475,430,391    472,872,982 

 

Commitments (Note 17)

 

F-3
 

 

DAQO NEW ENERGY CORP.

 

CONSOLIDATED BALANCE SHEETS—(Continued)

 

DECEMBER 31, 2012 AND 2013

(In U.S. dollars, except share data)

   December 31, 
   2012   2013 
EQUITY:          
Daqo New Energy Corp. shareholders’ equity:          
Ordinary shares;          
$0.0001 per value 500,000,000 shares authorized as of December 31, 2012 and 2013; 175,714,103 and 175,714,103 shares issued as of December 31, 2012 and 2013, respectively and 172,877,433 and 173,427,853 shares outstanding as of December 31, 2012 and 2013, respectively   17,288    17,343 
Additional paid in capital   144,755,902    146,676,163 
Retained earnings (accumulated losses)   38,276,015    (32,667,469)
Accumulated other comprehensive income   19,551,006    23,699,196 
           
Treasury Stock, at cost (2,836,670 and 2,286,250 shares as of December 31, 2012 and 2013, respectively)   (494,928)   (398,672)
Total Daqo New Energy Corp. shareholders’ equity   202,105,283    137,326,561 
Noncontrolling interest   138,772,130     
Total equity   340,877,413    137,326,561 
TOTAL LIABILITIES AND EQUITY  $816,307,804   $610,199,543 

 

See notes to consolidated financial statements.

 

F-4
 

 

DAQO NEW ENERGY CORP.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

FOR THE YEARS ENDED DECEMBER 31, 2011, 2012 AND 2013

(In U.S. dollars, except share data)

 

   Year ended December 31, 
   2011   2012   2013 
Revenues               
- Sales to third parties  $224,781,989   $81,929,050   $74,903,630 
- Sales to related parties   7,387,590    2,799,427    32,278,700 
- Service fee       2,129,924    1,817,475 
Total revenues   232,169,579    86,858,401    108,999,805 
Cost of revenues               
- Sales to third parties   (138,037,240)   (121,222,871)   (123,974,774)
- Sales to related parties   (6,908,785)   (3,067,513)   (11,128,634)
Total cost of revenues   (144,946,025)   (124,290,384)   (135,103,408)
Gross profit (loss)   87,223,554    (37,431,983)   (26,103,603)
Operating (expenses) income:               
Selling, general and administrative expenses   (13,088,538)   (12,930,198)   (18,132,515)
Research and development expenses   (744,322)   (4,130,533)   (3,391,012)
Other operating income   12,029,030    8,729,301    5,420,777 
Long-lived asset impairment   (34,667,577)   (42,754,481)   (158,424,827)
Total operating expenses   (36,471,407)   (51,085,911)   (174,527,577)
Income (loss) from operations   50,752,147    (88,517,894)   (200,631,180)
Interest expense   (9,258,296)   (15,408,023)   (19,349,190)
Interest income   1,846,956    990,117    149,752 
Exchange gain (loss)   148,676    (55,800)   11,875 
Income (loss) before income taxes   43,489,483    (102,991,600)   (219,818,743)
Income tax expense   (2,717,561)   (10,253,587)   (1,271,765)
Net income (loss) from continuing operations   40,771,922    (113,245,187)   (221,090,508)
Total loss from discontinued operations   (5,857,810)   (2,392,228)    
Net Income (loss)   34,914,112    (115,637,415)   (221,090,508)
Net income (loss) attributable to non-controlling interest   1,590,160    (3,708,474)   (150,147,024)
Net income (loss) attributable to Daqo New Energy Corp. ordinary shareholders  $33,323,952   $(111,928,941)  $(70,943,484)
NET EARNINGS (LOSS) PER ORDINARY SHARE               
—Continuing operations  $0.22   $(0.63)  $(0.41)
—Discontinued operations  $(0.03)  $(0.01)  $ 
Basic—ordinary shares   $0.19   $(0.64)  $(0.41)
—Continuing operations  $0.22   $(0.63)  $(0.41)
—Discontinued operations  $(0.03)  $(0.01)  $ 
Diluted—ordinary shares  $0.19   $(0.64)  $(0.41)
ORDINARY SHARES USED IN CALCULATING EARNINGS PER ORDINARY SHARE               
Basic—ordinary shares   175,714,103    175,067,343    173,068,420 
Diluted—diluted shares   175,714,103    175,067,343    173,068,420 

 

See notes to consolidated financial statements.

 

F-5
 

 

DAQO NEW ENERGY CORP.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

FOR THE YEARS ENDED DECEMBER 31, 2011, 2012 AND 2013

(In U.S. dollars, except share data)

 

   Year ended December 31, 
   2011   2012   2013 
Net income (loss)  $34,914,112   $(115,637,415)  $(221,090,508)
Other comprehensive income:               
Foreign currency translation adjustments   18,483,256    3,838,790    5,543,033 
Total other comprehensive income   18,483,256    3,838,790    5,543,033 
Comprehensive income (loss)   53,397,368    (111,798,625)   (215,547,475)
Comprehensive income (loss) attributable to noncontrolling interest   7,906,161    (2,075,866)   (148,752,181)
Comprehensive income (loss) attributable to Daqo New Energy Corp. shareholders  $45,491,207   $(109,722,759)  $(66,795,294)

 

See notes to consolidated financial statements.

 

F-6
 

 

DAQO NEW ENERGY CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

 

FOR THE YEARS ENDED DECEMBER 31, 2011, 2012 AND 2013

(In U.S. dollars, except share data)

 

   Ordinary shares   Treasury
Stock
   Additional
paid in
capital
  

 

Retained
earnings

  

Accumulated

other
comprehensive
income

   Noncontrolling
interest
   Total 
   Number   $                         
Balance at January 1, 2011   175,714,103   $17,571   $   $140,305,556   $116,881,004   $6,276,868   $132,941,835   $396,422,834 
                                         
Net income                   33,323,952        1,590,160    34,914,112 
Other comprehensive income                       12,167,255    6,316,001    18,483,256 
Share-based compensation               2,206,025                2,206,025 
                                         
Balance at December 31, 2011   175,714,103    17,571        142,511,581    150,204,956    18,444,123    140,847,996    452,026,227 
                                         
Net loss                   (111,928,941)       (3,708,474)   (115,637,415)
Other comprehensive income                       2,206,182    1,632,608    3,838,790 
Share-based compensation               2,249,834                2,249,834 
Stock Repurchases   (2,836,670)   (283)   (494,928)   (5,513)               (500,724)
Disposal of Nanjing Daqo New Energy Co., Ltd.                       (1,099,299)       (1,099,299)
                                         
Balance at December 31, 2012   172,877,433    17,288    (494,928)   144,755,902    38,276,015    19,551,006    138,772,130    340,877,413 
                                         
Net loss                   (70,943,484)       (150,147,024)   (221,090,508)
Other comprehensive income                       4,148,190    1,394,843    5,543,033 
Share-based compensation               1,881,401                1,881,401 
Deconsolidation of Daqo New Material Co., Ltd.                           9,980,051    9,980,051 
Options Exercise   550,420    55    96,256    38,860                135,171 
                                         
Balance at December 31, 2013   173,427,853   $17,343   $(398,672)  $146,676,163   $(32,667,469)  $23,699,196   $   $137,326,561 

 

See notes to consolidated financial statements.

 

F-7
 

 

DAQO NEW ENERGY CORP.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

FOR THE YEARS ENDED DECEMBER 31, 2011, 2012 AND 2013

(In U.S. dollars, except share data) 

 

   Year ended December 31, 
   2011   2012   2013 
Operating activities:               
Net income (loss)  $34,914,112   $(115,637,415)  $(221,090,508)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:               
Long-lived assets impairment   38,512,376    42,754,481    158,424,827 
Share-based compensation   2,206,025    2,249,834    1,881,401 
Inventory write-down   14,252,701    14,821,620    

29,905,734

 
Allowance for doubtful accounts   1,202,940    359,733    5,482,019 
Depreciation of property, plant and equipment   35,479,645    37,371,791    52,250,595 
Gain on disposition of Nanjing Daqo       (1,099,299)    
                
Changes in operating assets and liabilities:               
Accounts receivable   (5,985,616)   (10,295,169)   12,431,119 
Notes receivable   (1,868,419)   (2,633,764)   (11,496,473)
Prepaid expenses and other current assets   (5,723,463)   (15,042,913)   29,616 
Advances to suppliers   2,279,347    2,098,761    (122,753)
Inventories   (26,579,763)   (6,745,803)   

(25,270,470

)
  Amount due from related parties   (7,390,878)   8,418,601    (6,853,965)
Prepaid land use rights   (26,718,866)   (841,195)   264,549
Other non-current assets   (7,197,546)   4,645,277    4,513,271 
Accounts payable   5,716,493    3,249,172    5,349,428 
Notes payable   4,557,116    16,776,966    (19,760,436)
  Accrued expenses and other current liabilities   (10,947,970)   (150,005)   468,946 
Accrued warranty cost   297,244         
Income tax payable   1,431,902    (8,052,589)   (160,480)
  Advances from customers   (8,967,939)   (8,794,585)   (4,254,342)
  Amount due to related party   1,993,223    14,047,531    (415,960)
Deferred government subsidies   25,127,831    618,958    482,563 
Deferred tax assets   (21,732,585)   11,572,778    1,415,502 
                
Net cash provided by (used in) operating activities   44,857,910    (10,307,234)   (16,525,817)
                
Investing activities:               
Purchases of property, plant and equipment   (252,704,147)   (105,659,395)   (32,504,507)
Increase/(decrease) in restricted cash   (11,536,224)   80,435    1,823,635 
Interest free loan to related parities   (9,898,458)        
Proceeds from disposition of Nanjing Daqo       2,656,490     
Decrease in cash on deconsolidation of Daqo New Material           (15,241)
                
Net cash used in investing activities   (274,138,829)   (102,922,470)   (30,696,113)
                
Financing activities:               
Proceeds from related parties loans   75,294,720    1,645,923    157,271,287 
Repayment of related parities loans   (75,294,720)       (69,386,568)
Proceeds from bank borrowings   186,558,358    128,047,530    39,200,480 
Proceeds from other borrowings       1,524,560    35,351,511 
Repayment of bank borrowings   (71,079,431)   (103,573,459)   (113,745,197)
Repayment of other borrowings   (2,697,397)        
Purchase and retirement of treasury shares       (500,724)    
Options exercised           135,171 
                
Net cash provided by financing activities   112,781,530    27,143,830    48,826,684 
Effect of exchange rate changes   5,560,689    67,800    (452,694)
                
Net increase (decrease) in cash and cash equivalents   (110,938,700)   (86,018,074)   1,152,060
Cash and cash equivalents at th