F-1/A 1 df1a.htm AMENDMENT NO.9 TO FORM F-1 Amendment No.9 to Form F-1
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As filed with the Securities and Exchange Commission on October 6, 2010

Registration No. 333-164307

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

AMENDMENT NO. 9

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

DAQO NEW ENERGY CORP.

(Exact name of registrant as specified in its charter)

 

 

 

Cayman Islands   3674   Not Applicable
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

 

666 Longdu Avenue

Wanzhou, Chongqing 404000

People’s Republic of China

(86-23) 6486-6666

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

Law Debenture Corporate Services Inc.

400 Madison Avenue, 4th Floor

New York, New York 10017

(212) 750-6474

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Copies to:

 

Z. Julie Gao, Esq.

Skadden, Arps, Slate, Meagher & Flom LLP

c/o 42/F, Edinburgh Tower, The Landmark

15 Queen’s Road Central

Hong Kong

(852) 3740-4700

 

Leiming Chen, Esq.

Simpson Thacher & Bartlett LLP

35th Floor, ICBC Tower

3 Garden Road

Central, Hong Kong

(852) 2514-7600

 

 

 

Approximate date of commencement of proposed sale to the public:     As soon as practicable after this registration statement becomes effective.

 

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

 

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earliest effective registration statement for the same offering.  ¨

 

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of securities to be registered    Amount to be
registered(1)(2)
  

Proposed maximum
offering price

per share(1)

   Proposed maximum
offering price(1)(2)
   Amount of
registration fee

Ordinary Shares, par value $0.0001 per share(3)

   46,000,000    $2.50    $115,000,000    $8,199.50(4)

 

(1)

Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933.

(2)

Includes ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and also includes ordinary shares that may be purchased by the underwriters pursuant to an over-allotment option. These ordinary shares are not being registered for the purpose of sales outside the United States.

(3)

American depositary shares issuable upon deposit of the ordinary shares registered hereby have been registered under a separate registration statement on Form F-6 (Registration No.333-164310). Each American depositary share represents five ordinary shares.

(4)

Previously paid.

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Issued September 28, 2010

 

8,000,000 American Depositary Shares

 

LOGO

 

DAQO NEW ENERGY CORP.

 

Representing 40,000,000 Ordinary Shares

 

Daqo New Energy Corp. is offering American depository shares, or ADSs, each representing five of our ordinary shares, par value $0.0001 per share. This is our initial public offering and no public market exists for our ADSs or our ordinary shares. We anticipate that the initial public offering price will be between $10.50 and $12.50 per ADS.

 

 

 

We have been approved to list the ADSs on the New York Stock Exchange under the symbol “DQ.”

 

 

 

Investing in the ADSs involves risks. See “Risk Factors” beginning on page 13.

 

 

 

PRICE $             PER ADS

 

 

 

     Price to Public    Underwriting
Discounts and
Commissions
   Proceeds to
the Company

Per ADS

   $      $      $  

Total

   $      $      $  

 

We have granted the underwriters the right to purchase up to an aggregate of 1,200,000 additional ADSs.

 

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the ADSs to purchasers on or about             , 2010.

 

 

 

MORGAN STANLEY

 

 

 

PIPER JAFFRAY

 

            , 2010


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LOGO


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You should rely only on the information contained in this prospectus or any related free writing prospectus filed with the Securities and Exchange Commission, or the SEC, in connection with this offering. We have not authorized anyone to provide you with information that is different from that contained in this prospectus or in any filed free writing prospectus. We are offering to sell, and seeking offers to buy, the ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus or in any filed free writing prospectus is current only as of its date, regardless of the time of its delivery or of any sale of the ADSs.

 

Until             , 2010 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

 

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in the ADSs discussed under “Risk Factors,” before deciding whether to buy our ADSs.

 

Overview

 

We are a leading polysilicon manufacturer based in China and we aim to become a vertically integrated photovoltaic product manufacturer. With an installed annual polysilicon production capacity of 3,300 metric tonnes, or MT, as of June 30, 2010, we believe we are one of the largest polysilicon manufacturers in China. We have started expanding downstream into the wafer manufacturing business and are ramping up our module manufacturing business. We also intend to enter into the cell manufacturing business in the future.

 

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. We strive to improve our 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 1,826 MT of polysilicon in the first half of 2010, which, on an annualized basis, exceeded our installed annual production capacity. We plan to increase our annual production capacity to 7,300 MT by the end of 2012 by adding a Phase 2 production line and improving our production efficiency.

 

We believe that we have a competitive cost structure in polysilicon manufacturing primarily due to our strategic location in China and our manufacturing process. As our operations are based in Chongqing, which is in the western area of China where the cost of doing business is generally lower than in the coastal areas in China, we have significant advantages in electricity, raw material and labor costs over our competitors that are based in developed countries or in the coastal areas of China. In addition, we utilize the chemical vapor deposition process, or the “modified Siemens process,” to produce polysilicon, as do the vast majority of polysilicon manufacturers in the world. We have fully implemented the closed loop system to produce high-quality polysilicon cost-effectively. Our fully implemented closed loop system differentiates us from manufacturers that only implement the closed loop system in some, but not all, of their manufacturing lines, and from manufacturers that are in the process of converting their open loop system to the closed loop system. Compared to the open loop system that many of our China-based competitors use, our closed loop system uses raw materials more efficiently, requires less electricity and causes less pollution even though manufacturing facilities based on the open loop system can be built within a shorter period of time with less initial capital expenditures on equipment. The average unit cost of polysilicon we sold in the second quarter of 2010 was $32.0 per kilogram. We define the average unit cost of polysilicon we sold in a given period as the result of our polysilicon cost of revenues divided by the polysilicon sales volume for the period.

 

We believe that our focus on producing high quality polysilicon in a cost-efficient manner has contributed to our market position. 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 both our existing Phase 1 facilities in Chongqing. In the second quarter of 2010, approximately 99% of our polysilicon met the solar grade quality standard, approximately 82% of our polysilicon met the highest specification of the solar grade quality standard and approximately 46% of our polysilicon met the electronic grade quality standard in China.

 

 

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We currently sell polysilicon to China-based photovoltaic product manufacturers. The majority of our sales are made under framework contracts. We also sell a significant portion of our polysilicon on a spot pricing basis. As of June 30, 2010, our major photovoltaic product customers included operating entities of China Sunergy (Nanjing) Co., Ltd., Jiangsu Linyang Solarfun Co., Ltd., Jinzhou Solargiga Energy Co., Ltd., Tianwei New Energy Holding Ltd. and Yingli Green Energy Holding Company Limited.

 

We aim to become a vertically integrated photovoltaic product manufacturer. We have started expanding downstream into the wafer manufacturing business. We have placed initial orders for equipment to construct our Phase 1 wafer manufacturing facilities in Chongqing with an annual installed capacity of 250 megawatts, or MW, and expect to complete the construction of these facilities in December 2010. We plan to commence commercial production of wafers in the first quarter of 2011 and ramp up to the full capacity by the end of 2011. We will use our own polysilicon to produce wafers. In addition, we are ramping up our module manufacturing business. We plan to sell our modules to photovoltaic system integrators and distributors in China and internationally, leveraging our well-recognized “Daqo” brand. We expect the downstream module market to grow rapidly. We source cells for our module production through direct purchases and tolling arrangements, and we assemble modules at our own facilities. As of June 30, 2010, we had an annual module production capacity of 50 MW at our facilities in Nanjing and plan to increase our production capacity to 200 MW in the first quarter of 2011. We commenced commercial production of modules in May 2010 and shipment to Europe in July 2010. We also intend to enter into the cell manufacturing business in the future. Our expansion into downstream businesses involves risks and uncertainties, such as limited supply of cells for our module business, our lack of experience, financing, construction and operational uncertainties, potential competition and regulatory risks. See “Risk Factors—Risks Relating to Our Business” for details. Other than the risks and uncertainties highlighted in the Risk Factors section, we do not currently expect to encounter material hurdles for expanding downstream into the wafer manufacturing business and ramping up our module manufacturing business.

 

We have achieved substantial growth since we commenced commercial production of polysilicon in July 2008. In 2009, we produced 1,523 MT of polysilicon and sold 1,498 MT, compared to 291 MT of polysilicon produced and 237 MT sold in 2008. In the six months ended June 30, 2010, we produced 1,826 MT of polysilicon and sold 1,710 MT. We generated revenues of $111.2 million and $97.6 million and achieved net income of $30.8 million and $18.0 million in 2009 and the first six months of 2010, respectively.

 

Our Strengths

 

We believe that the following strengths enable us to compete effectively and further increase our revenues and profitability:

 

   

Competitive cost structure;

 

   

Consistently high-quality products;

 

   

China-based manufacturing capacity with abundant growth opportunities;

 

   

Proven execution capabilities;

 

   

Strong focus on technologies and research and development; and

 

   

Experienced management team.

 

Our Strategies

 

Our goal is to become a leading global supplier of polysilicon for the photovoltaic industry and a vertically integrated photovoltaic product manufacturer. We intend to achieve this goal by pursuing the following strategies:

 

   

Reduce our production costs;

 

 

 

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Expand polysilicon production capacity;

 

   

Establish and expand downstream capabilities;

 

   

Further expansion of module manufacturing business; and

 

   

Deepen and broaden customer relationships.

 

Industry Background

 

Photovoltaics are one of the proven and most rapidly growing renewable energy sources in the world. Solarbuzz, a solar energy research and consulting firm, reports that the global photovoltaic market reached 7.3 gigawatts, or GW, in 2009, an increase from 1.7 GW in 2006, representing a three-year compound annual growth rate of 62.5%. Solarbuzz forecasts the market to grow from 7.3 GW in 2009 to 37.1 GW in 2014, representing a compound annual growth rate of 38.4%.

 

Despite the decrease in demand for solar power products during the second half of 2008 and the first half of 2009 resulting from the global recession and credit market crisis, we believe that demand for solar power products has recovered significantly in response to a number of factors, including the gradual recovery of the global economy and increasing availability of financing for solar power projects. Although selling prices for solar power products have generally stabilized at levels substantially below pre-crisis levels, selling prices may fluctuate again in the future.

 

We believe that demand for solar power products will continue to grow rapidly in the long term as solar power becomes an increasingly important source of renewable energy. We believe several factors will drive demand in the global photovoltaic industry, including advantages of solar power, government incentives and decreasing costs of solar energy.

 

We believe the key challenges presently facing the photovoltaic industry include the need to improve cost competitiveness against other energy sources, possible additional reduction or elimination of government subsidies and economic incentives and the ability to obtain financing.

 

The photovoltaic market in China is at an initial stage of development. According to Solarbuzz, the photovoltaic market in China was 208 MW in 2009, compared to just 35 MW in 2008. However, Solarbuzz expects that China’s photovoltaic market will undergo a significant transformation from a market dominated by off-grid rural and industrial projects to one marked by a significant increase in large on-grid, ground mounted systems as the result of changing project economics and increasing governmental support.

 

Our Relationship with Daqo Group

 

Our existing shareholders hold equity interests in Daqo Group Co., Ltd., or Daqo Group. Since our inception, we have substantially benefited from the financial support of Daqo Group, one of the largest electrical equipment manufacturers in China. As of June 30, 2010, we had outstanding payable to Daqo Group in the amount of $0.6 million and Daqo Group guaranteed substantially all of our outstanding bank borrowings. 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. If Daqo Group ceases to support us, our business, results of operations and prospects may be materially and adversely affected. See “Risk Factors—Risks Relating to Our Business—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.”

 

 

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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. Under the agreement, we, through Daqo New Energy Corp., or Daqo Cayman, and Chongqing Daqo New Energy Co., Ltd., or 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.

 

Our Risks and Challenges

 

The successful execution of our strategies is subject to certain risks and uncertainties, including:

 

   

Our future growth and profitability depend on the demand for photovoltaic products and the development of photovoltaic technologies;

 

   

Global supply for polysilicon has exceeded and may continue to exceed demand, which could cause polysilicon prices to continue to decline;

 

   

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

 

   

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

 

   

Alternative technologies in cell manufacturing may replace the need to use polysilicon;

 

   

Our future success depends substantially on our ability to significantly expand our polysilicon production capacity and output;

 

   

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;

 

   

Our ability to successfully implement our vertical integration strategy;

 

   

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

 

   

We depend on a limited number of customers and sales contracts for a significant portion of our revenues; and

 

   

We may not be able to manage our growth effectively.

 

See “Risk Factors” and other information included in this prospectus for a more detailed discussion of these and other risks, uncertainties and challenges that we face.

 

Corporate Information

 

Our principal executive offices are located at 666 Longdu Avenue, Wanzhou, Chongqing 404000, The 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 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.

 

Our website is www.dqsolar.com. Information contained on our website does not constitute a part of this prospectus.

 

 

 

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Corporate History and Structure

 

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

 

In January 2008, we established Chongqing Daqo New Energy Co., Ltd., or Chongqing Daqo, our wholly owned operating subsidiary in China. Through Chongqing Daqo, we focus primarily on the manufacture and sale of polysilicon and have recently expanded into the wafer manufacturing business. In addition to Chongqing Daqo, we established Nanjing Daqo New Energy Co., Ltd., or Nanjing Daqo, in December 2007 in China, through which we conduct our module manufacturing business. In January 2009, we established Daqo Solar Energy North America, or Daqo North America, in California as our wholly owned subsidiary to serve as our marketing office to promote our products in North America.

 

Daqo Group established Daqo New Material Co., Ltd., or Daqo New Material, on November 16, 2006 in China. Daqo Group is one of the largest electrical equipment manufacturers in 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. Immediately after the completion of this offering, holders of equity interests in Daqo Group in aggregate will beneficially own 58.9% of the outstanding ordinary shares of our company. Daqo New Material’s business activities included acquiring land use rights and constructing certain production infrastructure prior to the incorporation of our company and Chongqing Daqo. Subsequent to its establishment, Chongqing Daqo entered into a lease agreement with Daqo New Material to rent Daqo New Material’s land, production infrastructure, machinery and equipment for its polysilicon production. The initial lease agreement has a five-year term starting from July 1, 2008, with monthly lease payment at a fixed amount. The lease agreement was amended and restated in August 2009, with retrospective effect from January 1, 2009. Under the amended and restated lease agreement, the lease period is from January 1, 2009 to December 31, 2013, with monthly lease payment at a fixed amount. One month before the expiry of the lease period, Chongqing Daqo has the option to renew the lease on the same terms and conditions for additional five-year periods. Furthermore, the amended and restated lease agreement provides that Chongqing Daqo has the option to purchase, or to designate any person to purchase, the leased assets at the then fair value at any time during the lease period or within one year following the lease period, if permitted by the PRC laws and regulations. Under current PRC laws and regulations, Chongqing Daqo needs to obtain governmental approval in China to proceed with the purchase, and given the application requirements we do not think it is currently practical for us to obtain such approval. If Daqo New Material desires to transfer the ownership of the leased assets to a third party, Chongqing Daqo has the right of first refusal to acquire the leased assets under the same conditions, and if the leased assets are transferred to a third party, the lease agreement will remain effective and enforceable against the new owner. Under Financial Accounting Standards Board Accounting Standards Codification 810-10-15, “Variable Interest Entities,” we are deemed to be Daqo New Material’s primary beneficiary for accounting purposes and Daqo New Material is considered a “variable interest entity” of ours starting from July 1, 2008. Therefore, we have consolidated the financial results of Daqo New Material into our financial statements since July 1, 2008. As of June 30, 2010, Daqo Group’s equity interest in Daqo New Material amounted to $129.0 million, which was consolidated and reflected as a noncontrolling interest in the balance sheet of our company pursuant to accounting principles generally accepted in the United States, or U.S. GAAP. 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.

 

In November 2009, Daqo Cayman issued and sold 29,714,103 shares of Series A convertible preferred shares in a private placement at a price of $1.851 per share to a group of investment funds. For details of the private placement, please see “Description of Share Capital—History of Securities Issuances.”

 

 

 

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The following diagram illustrates our corporate structure immediately upon the completion of this offering, assuming no exercise of the over-allotment option granted to the underwriters:

 

LOGO

 

Notes:    (1)   The holders of our Series A preferred shares consist of investment funds affiliated with Granite Global Ventures III L.P., NewMargin Growth Fund, L.P., investment funds affiliated with Siguler Guff Advisers, LLC and Venture Star Investment (HK) Limited. The Series A preferred shares will be automatically converted into our ordinary shares upon the completion of a qualified initial public offering.
  (2)   Individual owners of Daqo Group beneficially hold equity interests in Daqo Cayman through seven personal holding companies incorporated in the British Virgin Islands. See “Principal Shareholders.”
  (3)   Indicates the respective shareholding percentage of the shareholders in Daqo Cayman.
  (4)   Indicates companies within the listing group.
  (5)   Indicates jurisdiction of incorporation.
  (6)   Daqo Group’s major shareholders include Messrs. Guangfu Xu, Xiang Xu, Fei Ge, Dafeng Shi, Bin Cai, Jianrong Tang and Wanlin Gao.
  (7)   Represents a variable interest entity.

 

 

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Conventions Which Apply to This Prospectus

 

Except where the context otherwise requires and for purposes of this prospectus only:

 

   

“we,” “us,” “our company,” “our” and “Daqo Cayman” refer to Daqo New Energy Corp., its subsidiaries and its variable interest entity;

 

   

“ADSs” refers to our American depositary shares, each of which represents five ordinary shares;

 

   

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

 

   

“shares” or “ordinary shares” refers to our ordinary shares, par value $0.0001 per share and “Series A preferred shares” refers to our Series A convertible redeemable preferred 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 “Euro” refers to the legal currency of the European Union.

 

Unless otherwise mentioned, information is presented in this prospectus:

 

   

assuming no exercise by the underwriters of their option to purchase additional ADSs to cover over-allotments;

 

   

assuming conversion of all outstanding Series A preferred shares on a one-for-one basis into 29,714,103 ordinary shares immediately prior to the completion of this offering; and

 

   

for all share and per share data, giving effect to the 10,000-for-1 share split that became effective on August 5, 2009.

 

 

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The Offering

 

Offering price

We currently expect that the initial public offering price will be between $10.50 and $12.50 per ADS.

 

ADSs offered by us

8,000,000 ADSs

 

ADSs outstanding immediately after this offering

8,000,000 ADSs (9,200,000 ADSs if the over-allotment option is exercised in full).

 

Ordinary shares outstanding immediately after this offering

169,714,103 ordinary shares, par value $0.0001 per share (175,714,103 ordinary shares if the over-allotment option is exercised in full).

 

The ADSs

Each ADS represents five of our ordinary shares.

 

The depositary will hold the ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement.

 

If we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares, after deducting its fees and expenses.

 

You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange.

 

We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

 

To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

 

Over-allotment option

We have granted to the underwriters an option, which is exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of 1,200,000 additional ADSs at the initial public offering price, less underwriting discounts and commissions.

 

Use of proceeds

Our net proceeds from this offering are expected to be approximately $83.9 million (assuming an initial public offering price of $11.50 per ADS, the midpoint of the estimated range of the initial public offering price shown on the front cover of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us). We plan to use approximately $65.0 million

 

 

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of the net proceeds to expand our polysilicon manufacturing facilities and the remainder to finance capital expenditures for our wafer manufacturing business. See “Business—Manufacturing Capacity” for additional information about our production capacity expansion plan.

 

Lock-up

We have agreed for a period of 180 days after the date of this prospectus not to sell, transfer or otherwise dispose of any of our ordinary shares, ADSs or similar securities. Furthermore, each of our directors, executive officers, shareholders and option holders has agreed to a similar 180-day lock-up. See “Underwriters.”

 

Listing

We have been approved to list our ADSs on the New York Stock Exchange under the symbol “DQ.” Our ADSs and ordinary shares will not be listed on any other stock exchange or traded on any automated quotation system.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in our ADSs.

 

Depositary

JPMorgan Chase Bank, N.A.

 

The number of ordinary shares that will be outstanding immediately after this offering:

 

   

assumes that the underwriters do not exercise their over-allotment option to purchase additional ADSs;

 

   

reflects the conversion of all outstanding Series A preferred shares into 29,714,103 ordinary shares immediately upon the completion of this offering;

 

   

excludes 5,350,000 ordinary shares issuable upon the exercise of stock options issued under our 2009 share incentive plan that are outstanding as of the date of this prospectus, at an exercise price of $1.38 per ordinary share; and

 

   

excludes ordinary shares reserved for future grants under our 2009 share incentive plan.

 

 

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Summary Consolidated Financial and Operating Data

 

You should read the following information concerning us in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

The following summary consolidated statements of operations for the period from November 22, 2007 (inception) to December 31, 2007, the years ended December 31, 2008 and 2009 and the summary consolidated balance sheet as of December 31, 2007, 2008 and 2009 are derived from our audited consolidated financial statements included elsewhere in this prospectus. We have consolidated Daqo New Material’s financial statements in ours since July 1, 2008 because under FASB Accounting Standards Codification 810-10-15, “Variable Interest Entities,” we are deemed to be Daqo New Material’s primary beneficiary for accounting purposes and Daqo New Material is considered our “variable interest entity” starting from July 1, 2008.

 

The following summary consolidated statements of operations for the six months ended June 30, 2009 and 2010 have been derived from our unaudited condensed financial statements included elsewhere in this prospectus and have been prepared on the same basis as our audited consolidated financial data. The unaudited condensed financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented.

 

The summary 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. 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.

 

     Daqo Cayman  
     Period from
November 22,
2007
(Inception) to
December 31,
    Year Ended
December 31,
    Six Months Ended
June 30,
 
     2007     2008     2009     2009     2010  
    

(in thousands, except per share data)

 

Consolidated Statement of Operations Data:

    

Revenues

   $      $ 56,368      $ 111,193      $ 49,153      $ 97,582   

Cost of revenues

            (19,392     (69,252     (24,872     (64,044
                                        

Gross profit

            36,976        41,942        24,281        33,538   

Operating expenses(1)

     (48     (9,764     (5,518     (4,555     (6,331
                                        

(Loss) income from operations

     (48     27,212        36,424        19,727        27,207   

(Loss) income before income taxes

     (48     23,454        30,176        16,646        22,008   

Income tax expense

            (1,602     (240     (2,475     (3,859
                                        

Net (loss) income

     (48     21,852        29,936        14,170        18,149   
                                        

Less: income (loss) attributable to noncontrolling interest

            327        (899     (936     117   
                                        

Net (loss) income attributable to Daqo New Energy Corp. shareholders

   $ (48   $ 21,525      $ 30,835      $ 15,107      $ 18,032   
                                        

Earnings (loss) per share, basic and diluted

   $ (0.00   $ 0.22      $ 0.29      $ 0.15      $ 0.12   

 

Note:

(1)   Includes share-based compensation expenses in the amount of $0.3 million and $0.8 million for the year ended December 31, 2009 and the six months ended June 30, 2010.

 

 

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    Daqo Cayman  
    Period from
November 22,  2007
(Inception) to
December 31,
  Year Ended
December 31,
    Six Months Ended
June 30,
 
    2007   2008   2009     2009     2010  
    (in thousands, except unit cost)  

Other Financial and Operating Data:

         

Polysilicon production volume (in MT)

        291     1,523        500        1,826   

Polysilicon sales volume (in MT)

        237     1,498 (1)      443 (1)      1,710 (2) 

Unit cost of polysilicon sold (in $/kg)

        81.7     43.9        48.4        33.5   

EBITDA (in thousands)(3)

  $   $ 35,029   $ 52,512      $ 27,167      $ 42,618   

 

 

Notes:

(1)   In addition, we used approximately 16 MT of our polysilicon to process cells through our tolling arrangements with third party cell manufacturers in the six months ended June 30, 2009.
  (2)   In addition, we used approximately 69 MT of our polysilicon to process wafers through our tolling arrangements with third party wafer manufacturers in the six months ended June 30, 2010.
  (3)   EBITDA is defined as net income plus interest expenses, taxes and depreciation and amortization less interest income. EBITDA is used by management to evaluate our financial performance and determine the allocation of resources and provides the management with the ability to determine our return on capital expenditures relating to capacity expansion of our business. In addition, we believe that EBITDA will be a key metric analyzed in determining the amount of new debt financing that may be available to us and, therefore, we believe this measure provides investors with additional information about our ability to fund our growth through debt financing, if needed. Furthermore, EBITDA eliminates the impact of items that we do not consider indicative of the performance of our business. For example, depreciation and amortization expenses relating to capacity expansion are capital expenditures that are not indicative of the operating performance of our business during the periods presented. We believe investors will similarly use EBITDA as one of the key metrics to evaluate our financial performance and to compare our current operating results with corresponding historical periods and with other companies in the photovoltaic manufacturing industry. The presentation of EBITDA should not be construed as an indication that our future results will be unaffected by other charges and gains we consider to be outside the ordinary course of our business.

 

The use of EBITDA has certain limitations. Items excluded from EBITDA are significant components in understanding and assessing our operating and financial performance. Depreciation and amortization expense, income tax expense, interest expense and interest income have been and will be incurred in our business and are not reflected in the presentation of EBITDA. Each of these items should also be considered in the overall evaluation of our results. Additionally, EBITDA does not consider capital expenditures and other investing activities and should not be considered as a measure of our liquidity. We compensate for these limitations by providing the relevant disclosure of our depreciation and amortization expense, interest expense and interest income and income tax expense both in our reconciliations to the U.S. GAAP financial measures and in our consolidated financial statements, all of which should be considered when evaluating our performance. The term EBITDA is not defined under U.S. GAAP, and EBITDA is not a measure of net income, operating income, operating performance or liquidity presented in accordance with U.S. GAAP. When assessing our operating and financial performance, you should not consider this data in isolation or as a substitute for our net income, operating income or any other operating performance measure that is calculated in accordance with U.S. GAAP. In addition, our EBITDA may not be comparable to EBITDA or similarly titled measures utilized by other companies since such other companies may not calculate EBITDA in the same manner as we do.

 

A reconciliation of EBITDA to net income, which is the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, is provided below:

 

     Year Ended
December 31,
    Six Months
Ended June 30,
     2008    2009     2009     2010
     (in thousands)

Net income attributable to Daqo New Energy Corp.’s shareholders

   $ 21,525    $ 30,835      $ 15,107      $ 18,032

Add: net loss (income) attributable to noncontrolling interest

     327      (899     (937     117
                             

Net income

     21,852      29,936        14,170        18,149

Plus: interest expenses

     3,873      6,462        3,248        5,359

Less: interest income

     115      214        167        160

Plus: income tax expenses

     1,602      240        2,475        3,859

Plus: depreciation expenses

     7,817      16,088        7,441        15,411
                             

EBITDA

   $ 35,029    $ 52,512      $ 27,167      $ 42,618

 

 

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The following table represents a summary of our consolidated balance sheet data as of December 31, 2007, 2008 and 2009 and June 30, 2010:

 

   

on an actual basis; and

 

   

on a pro forma as adjusted basis to reflect (1) the automatic conversion of all of our outstanding Series A preferred shares into 29,714,103 ordinary shares immediately upon the completion of this offering, and (2) the issuance and sale of ADSs we are offering at an assumed initial public offering price of $11.50 per ADS, the midpoint of the estimated initial public offering price range set forth on the front cover of this prospectus, after deducting underwriting discounts, commissions and estimated offering expenses payable by us.

 

     Daqo Cayman
     As of
December 31,
   As of
June 30,
       2007       2008    2009    2010    2010
     Actual     Actual    Actual    Actual    Pro Forma
As Adjusted
                          (unaudited)
     (in thousands)

Consolidated Balance Sheet Data:

             

Cash and cash equivalents

   $      $ 3,304    $ 81,414    $ 63,384    $ 147,294

Restricted cash

            20,430      8,810      1,999      1,999

Property, plant and equipment, net

            314,507      399,985      378,483      378,483

Total assets

            350,105      523,923      516,412      600,323

Short-term borrowings, including current portion of long-term borrowings

            10,389      43,826      48,972      48,972

Long-term borrowings

            84,299      144,936      128,534      128,534

Total liabilities

     48        279,052      287,829      259,664      259,664

Mezzanine equity

                 55,603      57,803     
                                   

Total Daqo New Energy Corp. shareholders’ equity (deficit)

     (48     22,042      52,496      69,982      211,695

Noncontrolling interest

            49,011      127,996      128,964      128,964
                                   

Total equity (deficit)

     (48     71,053      180,492      198,946      340,659
                                   

Total liabilities and equity

   $      $ 350,105    $ 523,923    $ 516,412    $ 600,323
                                   

 

Recent Developments

 

In July and August 2010, we produced approximately 671 MT of polysilicon, sold approximately 643 MT to customers and used approximately 17 MT of our polysilicon to process wafers through tolling arrangements with third party wafer manufacturers. The average unit cost of polysilicon we produced in July and August 2010 was $30.2 per kilogram. We define the average unit cost of polysilicon we produced in a given period as the result of our polysilicon production cost divided by the polysilicon production volume for the period. During July and August 2010, substantially all of our polysilicon met the solar grade quality standard, approximately 92% of our polysilicon met the highest specification of the solar grade quality standard and approximately 58% of our polysilicon met the electronic grade quality standard in China.

 

In September 2010, we entered into a polysilicon supply agreement with an affiliate of MEMC Electronic Materials, Inc., or MEMC, whereby we agree to sell and the customer agrees to purchase 600 MT of polysilicon for 2011. The customer also has an option to purchase 600 MT of polysilicon in 2012, subject to our mutual agreement on the applicable polysilicon sales prices.

 

 

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RISK FACTORS

 

An investment in our ADSs involves significant risks. You should carefully consider all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. The following is a description of what we consider our material risks. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

 

Risks Relating to Our Business

 

Our future growth and profitability depend on the demand for photovoltaic products and the development of photovoltaic technologies.

 

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;

 

   

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;

 

   

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, our future growth and profitability will be materially and adversely affected.

 

Global supply for polysilicon has exceeded and may continue to exceed demand, which could cause polysilicon prices to continue 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 current global economic slowdown, the crisis in the global financial markets and the significant decrease in global petroleum prices since their peak in mid-2008 have reduced or delayed the general demand for photovoltaic products. If the demand continues to decline or if our customers delay their orders, we may not be able to sell our polysilicon at desirable prices, or at all. 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

 

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in polysilicon prices. According to Solarbuzz, spot price for solar grade polysilicon in May 2008 was $450-$475 per kilogram. In January and February 2010, the spot price declined to $50-$55 per kilogram. The declining polysilicon prices had a negative impact on our revenues starting in the quarter ended June 30, 2009. As the result of the significant decline of market price for polysilicon, we had to significantly lower the selling price of our polysilicon in 2009. The market price and price of our products may further decline in the future. If we are unable to reduce costs, our profitability will be affected. If we experience further decline in demand, or if the price continues to decrease and we are unable to lower our costs in line with the price decline, our operating margins will be reduced and our financial condition and results of operations may be materially and adversely affected.

 

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 July 2008. Several of our senior management and key employees have worked together at our company for only a relatively short period of time. 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 2009 and the first six months in 2010, we cannot assure you that our results of operations will not be adversely affected in the future. Our limited operating history makes the prediction of future results of operations difficult, and therefore, past results of operations achieved by us should not be taken as indicative of the rate of growth, if any, that can be expected 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 prices of our electricity, raw material or labor costs. For example, our profits may decline in the upcoming quarters if one or more of these factors occur. Furthermore, wafers, cells and modules traditionally had lower profit margins than polysilicon and we may need to price aggressively to gain market share or remain competitive in these new businesses, which may further reduce our profit margins and cause our financial results to fluctuate from time to time.

 

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.

 

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

 

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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, 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. 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 meet our obligations under supply agreements, to maintain our competitive position or to improve our profitability. Our ability to establish additional production capacity and increase output is subject to significant risks and uncertainties, including:

 

   

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.

 

We plan to expand downstream to become a vertically integrated photovoltaic manufacturer and we may not be successful in this new endeavor, which could adversely affect our results of operations and financial condition.

 

We plan to become a vertically integrated photovoltaic manufacturer by entering into the wafer manufacturing business, ramping up our module manufacturing business and potentially entering into the cell manufacturing business in the future. Our ability to successfully implement our expansion strategy is subject to various risks and uncertainties, including:

 

   

our lack of experience in these new businesses and inability to recruit experienced personnel;

 

   

the need to raise additional funds to finance our new business operation which we may be unable to obtain on reasonable terms or at all;

 

   

cost overruns, potential delays, equipment problems or other execution difficulties in our manufacturing facility construction;

 

   

our possible lack of ability to compete in these new businesses; and

 

   

potential competition with our downstream customers as a result of our entrance into these new businesses.

 

If we are unable to manage these risks and successfully implement our expansion plans, our future results of operations may be material and adversely affected.

 

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

 

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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 2008, Spain set a cap of 500 megawatts for feed-in tariffs for solar power in 2009, and, in 2010, Spain announced its plan to cut the subsidized electricity prices paid to new photovoltaic solar power plants by up to 45%, both of which are expected to significantly reduce installations of new solar energy projects in the country. In 2009, the German government reduced solar feed-in tariffs by 9%. In July 2010, Germany implemented a further reduction in solar feed-in tariffs of 16% for rooftop systems, 15% for farmland and 11% for spaces such as former military or industrial sites. 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 as being unconstitutional or otherwise unlawful in certain other countries. 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.

 

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, M.Setek, Green Energy Technology and Sino-American Silicon and Chinese domestic polysilicon and wafer manufacturers, such as GCL-Poly, China Silicon Corporation, Sichuan Xinguang Silicon Science and Technology, LDK Solar, ReneSola, JinkoSolar and Comtec Solar Systems. In addition, many 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. As we execute our vertical integration strategy, we expect to face competition from local and international manufacturers, such as SunPower, Suntech Power, Solarfun and Canadian Solar and integrated photovoltaic product manufacturers such as Yingli Green Energy, SolarWorld, and Trina Solar. 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. In addition, before we fully ramp up our wafer and module manufacturing facilities, the production cost of our wafers and modules will not be competitive to those of our competitors due to our relatively small production scale. 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 2009 and in the six months ended June 30, 2010, our top three customers in aggregate accounted for approximately 53.6% and 41.9% of our total revenues, respectively. We anticipate that our dependence on a

 

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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, thus having a material and adverse effect on our results of operations and financial condition;

 

   

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 have experienced a period of rapid growth and expansion that has placed, and continues to place, significant strain on our management and resources. 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 skills 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 and module businesses 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, wafer and module manufacturing businesses to achieve operational efficiency, which could adversely affect our business and results of operations.

 

We expect to experience increased costs as a result of the planned capacity expansion of our Phase 1 facilities, the construction of our Phase 2 facilities and the adoption of hydrochlorination technology in our Phase 2 facilities. See “Business—Manufacturing Capacity.” Before our production facilities become fully operational, we will need to make substantial payments for the installation of machinery and equipment, the training of personnel and other related expenses. A significant portion of these payments will be made prior to any revenues being realized from the expansion project. If we cannot complete our expansion plans on a timely basis or increase production yields in our facilities in accordance with our plan, we may not be able to achieve lower costs per unit of production, which would decrease our margins and lower our profitability.

 

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 uncommon cold weather in China in the winter of 2009 resulted in a surging natural gas demand, which in turn caused severe gas shortage in many regions, including Chongqing, where substantially all our polysilicon manufacturing facilities are 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 the shortage 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 outage,

 

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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.

 

The full implementation of the closed loop system by other polysilicon manufacturers has diminished and may continue to diminish our competitive advantages provided by this system.

 

We have implemented the modified Siemens process in a completely closed loop system. We believe we are one of the few China-based polysilicon manufacturers that have fully implemented the closed loop system in the polysilicon production process. Compared to the open loop system, the closed loop system uses raw materials more efficiently, requires less electricity and produces less pollution. 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 and may continue to diminish our competitive advantages provided by this system.

 

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 of polysilicon and module production capacities, our establishment of wafer business and our working capital requirements and to repay any short-term or long-term bank borrowings when due. We will also need cash resources to fund our research and development activities in order to remain competitive on cost and technology. 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 become increasingly competitive. 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 and financial market crisis.

 

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

 

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

 

As of June 30, 2010, we had outstanding bank borrowings of $168.2 million with a weighted average floating interest rate of 5.80%, and we expect to incur additional debt in the future. We borrowed the majority of these bank loans from China Construction Bank, Wanzhou Branch with guarantees from Daqo Group, an affiliated company 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 the terms satisfactory to us or at all to satisfy the substantial capital expenditure requirements associated with our planned capacity expansion, whether on our own or with the continuing support from Daqo Group. In addition, this level of 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 plan to enter into the downstream wafer manufacturing business and we may not be successful in this new endeavor, which may adversely affect our business expansion strategies and harm our financial condition and results of operations.

 

We plan to expand into the wafer production business, which we believe will enable us to capture greater revenue opportunities and diversify business risks. Our ability to successfully implement our wafer business strategy is subject to various risks and uncertainties, including:

 

   

our possible lack of ability to compete in the wafer production business; and

 

   

potential competition with our downstream customers.

 

We will use a portion of the offering proceeds to finance capital expenditures for our wafer manufacturing business and if we cannot generate revenues or achieve profitability in this business within a reasonable period of time after this offering, our financial condition will be adversely affected. In addition, our current management team has limited experience in this area and we will need to recruit additional skilled employees, including technicians and managers at different levels for our successful expansion into the wafer manufacturing business. All these factors and uncertainties may adversely affect our business expansion strategy and our financial condition and results of operations.

 

We have recently entered into the downstream module manufacturing business, and we may not be successful in this new endeavor, which may adversely affect our business expansion strategies.

 

We commenced commercial production of modules at our Nanjing facilities and shipped modules to customers in Europe in July 2010. To expand our module business, we plan to increase our production capacity from 50 MW as of June 30, 2010 to 200 MW in the first quarter of 2011. We have obtained the requisite permits for our module manufacturing business in Nanjing and are in the process of obtaining governmental approvals for our module capacity expansion plan. We expect to receive governmental approvals in the near future. However, if such approvals cannot be obtained in a timely manner, we may be required to suspend our module manufacturing expansion plan until such approvals are obtained, which could adversely affect our expansion strategies.

 

We currently source wafers and cells for our module production through direct purchases and tolling arrangements. If we cannot secure a stable supply of cells for our module production at reasonable prices, our ability to execute our expansion plan will be adversely and materially affected. Currently, due to the supply and

 

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demand imbalance in China’s photovoltaic cell market, there is a limited supply of high quality photovoltaic cells. We cannot assure you that such supply and demand imbalance will not continue or recur or we will be able to obtain sufficient cells in pace with the expansion of our module manufacturing capacity in the future.

 

We provide customers with a five-year limited product warranty against defective materials and workmanship and a 25-year limited power output warranty against loss in power for our module products. As a result, we bear the risk of extensive warranty claims long after we sell our products. If we experience a large amount of warranty claims in the future, we may incur significant repair and replacement costs associated with such claims. Furthermore, widespread product failures could harm our reputation and customer relationships and may cause our sales to decline, which in turn could have a material adverse effect on our financial condition and results of operations.

 

We may expand our business through alliances, joint ventures or acquisitions in the future.

 

If we are presented with appropriate opportunities, we may 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. 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.

 

We will face risks associated with the marketing, distribution and sale of our photovoltaic products internationally, and if we are unable to effectively manage these risks, they could impair our ability to expand our business and operate profitably.

 

With our increased production, we intend to sell a portion of our products outside of China in the future. The marketing, distribution and sale of our polysilicon, wafers and modules in the international market would expose us to a number of risks, including:

 

   

fluctuations in currency exchange rates;

 

   

increased costs associated with maintaining marketing efforts in various countries;

 

   

difficulty and costs relating to compliance with the different commercial and legal requirements of the overseas markets in which we offer our products; and

 

   

trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses, which could increase the prices of our products and make us less competitive in some countries.

 

If we are unable to effectively manage these risks, we may not be able to successfully expand our business abroad, operate profitably, fully utilize our existing and expanded capacity and grow our business as we have planned.

 

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If we are unable to operate effectively or natural disasters 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 our Phase 1 facilities in November 2009 for quality check purposes and in April 2010 for periodical maintenance and plan to do so for our Phase 1 facilities in December 2010 for periodical maintenance and capacity enhancement, which has 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 and module manufacturing processes. Such equipment requires skills and experience for safe operation. We could experience events such as equipment failures, explosions or fires due to employee errors, equipment malfunctions, accidents, 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.

 

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 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.

 

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

 

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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, REC and Wacker 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.

 

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.

 

Existing regulations and changes to these regulations may present technical, regulatory and economic 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 the photovoltaic products and make them less desirable, thereby harming our business, prospects, results of operations and financial condition.

 

A global financial and economic crisis, particularly a slowdown in the Chinese economy, may adversely affect our business, results of operations and financial condition.

 

The global financial crisis and economic downturn that unfolded in 2008 and continued in 2009 have adversely affected economies and businesses around the world, including those in China. Since we currently derive substantially all of our revenues from customers in China, any prolonged slowdown in the Chinese economy may have an adverse effect on our business, operating results and financial condition in a number of ways. For example, our customers may decrease 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.

 

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 suffer. In addition, a supplier’s failure to supply our ordered equipment in a timely manner, with adequate quality and on

 

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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.

 

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.

 

Most of our production, storage, administrative, and research and development facilities are located in close proximity to one another in Chongqing, 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 close proximity to one another in Chongqing, China. A natural disaster, 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 suffer. Any damage or disruption at these facilities would have a material adverse effect on our business, financial condition and results of operations.

 

On May 12, 2008, an earthquake of a magnitude of 8.0 on the Richter scale hit the Sichuan Province, which is located adjacent to Chongqing. Businesses and production operations in the affected areas of Sichuan Province were shut down temporarily due to safety concerns. There can be no assurance that we may not be directly or indirectly affected by similar natural disasters in the future.

 

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, Poly

 

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Engineering S.r.l., or Poly Engineering, granted a license to our company for the exclusive rights in China, Taiwan, Hong Kong and Macau to utilize its modified Siemens process to produce polysilicon in our facilities. See “Business—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 have seven pending patent applications in China covering various aspects of the polysilicon manufacturing process. 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 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.

 

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.

 

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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 June 30, 2010, we had outstanding payable to Daqo Group in the amount of $0.6 million and Daqo Group guaranteed substantially all of our outstanding bank borrowings. 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. 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 outcome.

 

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.”

 

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

 

Currently, four of our directors, Messrs. Guangfu Xu, Xiang Xu, Fei Ge and Dafeng Shi, beneficially own an aggregate of 58.0% of our outstanding share capital on an as-converted, fully diluted basis. Upon the completion of this offering, these four shareholders will beneficially own an aggregate of 44.4% of our outstanding share capital assuming no exercise of the over-allotment option granted to the underwriters. These four shareholders are also directors of Daqo Group or Daqo Group’s material subsidiaries. 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 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, including those who purchase ADSs in this offering. Our existing

 

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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, our existing shareholders may take actions not in the best interest of us and the investors who purchase ADSs in this offering.

 

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, including our initiatives to expand downstream into the wafer and cell manufacturing businesses and to ramp up our module manufacturing capacity. As we are still a relatively young company and our business has grown rapidly, 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. In addition, to commence construction of our Phase 2 facilities, we will need to complete compulsory environmental impact evaluation process and obtain new environmental permits. 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, which became effective on January 1, 2008, the statutory enterprise income tax rate is 25%. However, our Chinese subsidiary Chongqing Daqo, as a foreign-invested enterprise established in the central and western regions of in China, is entitled to a preferential enterprise income tax rate of 15% through 2010. In December 2009, Chongqing Daqo was qualified as a “Chongqing Municipality High and New Technology Enterprise.” This will entitle it to a preferential enterprise income tax rate of 15% for three years from the grant date of the certificate 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 $2.4 million for the six months ended June 30, 2010. 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.

 

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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 will be subject to a Chinese withholding tax upon the dividends payable by us, if we are classified as a Chinese “resident enterprise.”

 

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. 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 more than half of the directors or senior management personnel residing in China. Substantially all of our management members are based in China. However, it remains unclear how PRC tax authority will treat an overseas company controlled by PRC natural persons rather than PRC enterprises like our case. 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, under the EIT Law, foreign ADS holders will be subject to a 10% withholding tax upon dividends payable by us 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 rely on a lease agreement with Daqo New Material for material property, plant and equipment necessary for our production, and if Daqo New Material fails to perform, or terminates the lease agreement for any reason, our business could be disrupted.

 

Chongqing Daqo leases certain property, plant and equipment from Daqo New Material for its polysilicon production under a lease agreement effective from July 1, 2008, which was subsequently amended. When the initial term expires, Chongqing Daqo has an option to renew the lease agreement on the same conditions for additional terms. If Daqo New Material fails to perform or terminates the lease agreement for any reason, including, for example, due to its breach of the agreement or the unavailability of any required governmental approvals, or if it refuses to extend or renew the lease agreement when the agreement expires, and we cannot find an immediately available alternative source for leasing similar property, plant and equipment, then our ability to carry on our operations will be impaired. If Daqo New Material fails to perform its obligations, we may need to initiate legal procedures in courts to enforce the agreement. Such procedures can be lengthy and the result may not be favorable to us.

 

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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.

 

In the course of the preparation and audit of our financial statements as of and for the years ended December 31, 2009, we and our independent auditors, respectively, noted one material weakness and one significant deficiency in our internal control over financial reporting. We may incur extra costs in implementing measures to address such weakness and deficiency. If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately report our results of operations or prevent fraud, and investor confidence and the market price of our ADSs may be materially and adversely affected.

 

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls over financial reporting. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in connection with the audits of our consolidated financial statements as of and for the years ended December 31, 2009, we and our independent registered public accounting firm identified one “material weakness” and one “significant deficiency” in our internal control over financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board of the United States. The material weakness identified related to our lack of sufficient accounting resources and expertise necessary to comply with U.S. GAAP and the Securities and Exchange Commission, or the SEC, reporting and compliance requirements. The significant deficiency identified related to our lack of sufficient and formally documented procedures for the financial closing and reporting process. To address the weakness and the deficiency that have been identified, we are in the process of implementing a number of measures, including: (1) hiring an outside consulting firm to review our internal control processes, policies and procedures in order to assist us in identifying any weaknesses or deficiencies in our internal control over financial reporting, (2) providing further training to our financial and accounting staff to enhance their knowledge of U.S. GAAP, and (3) adopting and implementing additional policies and procedures, including an enterprise resource planning system, to strengthen our internal control over financial reporting. We are working to implement these measures during 2010, although we cannot assure you that we will complete such implementation in a timely manner.

 

Upon the completion of this offering, we will become a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, will require that we include a report of management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2011. In addition, our independent registered public accounting firm must report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is

 

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effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is adverse if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, after we become a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

 

During the course of documenting and testing our internal control procedures in order to satisfy the requirements of Section 404, we may identify other deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could harm our operating results and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions.

 

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 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 share incentive plan, we may issue options to purchase up to 15,000,000 ordinary shares. As of the date of this prospectus, options to purchase 5,350,000 ordinary shares have been granted under this plan. As a result of these option grants and potential future grants under the plan, we have incurred, and will incur significant share-based compensation expenses in future periods. 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 are expected to be compensated by incentive shares or options.

 

Implementation of the new labor laws in China may adversely affect our business operations.

 

On June 29, 2007, the Chinese government promulgated a new labor contract law which became effective on January 1, 2008. Subsequent to this, the Chinese government promulgated the implementation rules of the new labor contract law. Pursuant to the new labor contract law, employers are subject to stricter requirements in terms of signing labor contracts, paying remuneration, determining the term of employees’ probation and unilaterally terminating labor contracts. These newly enacted labor laws and regulations impose greater liabilities on employers and may significantly increase the costs to an employer if it decides to reduce its workforce. In the event we decide to significantly change or cut down our workforce, the new labor contract law could adversely affect our ability to make such changes in a manner that is most favorable to our business or in a timely and cost effective manner, which in turn may materially and adversely affect our financial condition and results of operations.

 

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

 

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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 a 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 “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 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 over the past three decades has significantly increased the protections afforded to various forms of foreign or private-sector investment in China. Our Chinese operating subsidiaries, Chongqing Daqo and Nanjing Daqo, are foreign-invested enterprises and are 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, all governmental approvals relating to our operations and production capacity expansion plans have been issued by the relevant competent local government authorities. 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. In addition, under the measures jointly issued by the National Development and Reform Commission, or NDRC, and nine other governmental agencies in September 2009, we will need to seek pre-approval from NDRC if we plan to further expand our production capacity beyond Phase 2. As the detailed guidelines for approval criteria or timeline under these measures have yet to be promulgated, we cannot assure you that we will obtain the required NDRC approval in time or at all if we plan to further expand our production capacity beyond

 

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Phase 2. See “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.

 

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering; any requirement to obtain prior CSRC approval could delay this offering and failure to obtain this approval, if required, could have a material adverse effect on our business, operating results and reputation as well as the trading price of our ADSs, and could also create uncertainties for this offering.

 

On August 8, 2006, six Chinese regulatory agencies, including the Ministry of Commerce, or MOFCOM, the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration for Taxation, the State Administration for Industry and Commerce, or the SAIC, the CSRC and the State Administration of Foreign Exchange, or SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, which became effective on September 8, 2006. The M&A Rules, among other things, include provisions that purport to require that an offshore special purpose vehicle formed for the purpose of an overseas listing of interest in a Chinese company obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures require the filing of an application and supporting documents with the CSRC.

 

The application of the M&A Rules with respect to this offering remains unclear. Our Chinese counsel, Jun He Law Offices, has advised us that, as Daqo Cayman set up Chongqing Daqo and Nanjing Daqo as newly established wholly foreign owned subsidiaries in China, Daqo Cayman is not a special purpose vehicle formed for the purpose of acquiring a Chinese domestic company, and therefore we are not required to apply to the CSRC for approval for this offering. However, the CSRC may disagree with this conclusion and if prior CSRC approval is required but not obtained, we may face regulatory actions or other sanctions from the CSRC or other Chinese regulatory agencies. In such event, these regulatory agencies may impose fines and penalties on our operations in China, limit our operating privileges in China, delay or restrict the repatriation of the proceeds from this offering into China, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, and prospects, as well as the trading price of our ADSs. The CSRC or other Chinese regulatory agencies may also take actions requiring us to postpone or cancel this offering before settlement and delivery of the ADSs offered by this prospectus.

 

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

 

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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.

 

We have, up to the present, completed the 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 the 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.

 

On March 28, 2007, SAFE issued the Operating Procedures on Administration of Foreign Exchange Regarding Chinese Individuals’ Participation in Employee Share Ownership Plans and Employee Stock Option Plans of Overseas Listed Companies, or the Stock Option Rule. Under the Stock Option Rule, Chinese citizens who are granted stock options by an overseas publicly listed company are required, through a Chinese agent or Chinese subsidiary of such overseas publicly listed company, to register with SAFE and complete certain other procedures. We and our Chinese employees who have been granted stock options will be subject to the Stock Option Rule when our company becomes an overseas publicly listed company. If we or our Chinese employees fail to comply with such regulation, we or our employees may be subject to fines and legal sanctions.

 

Chinese regulation of direct investment and loans by offshore holding companies to Chinese entities may delay or limit us from using the proceeds of this offering to make 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, including from the proceeds of this offering, are subject to Chinese regulations. For example, for each of our Chinese subsidiary, 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 the SAFE. For each foreign invested enterprise, such as Chongqing Daqo and Nanjing 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

 

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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 amounts of the approved total investments of Chongqing Daqo and Nanjing Daqo are $188.0 million and $48.9 million, respectively. The amount of the registered capital Chongqing Daqo is $63.0 million, $17.5 million of which is to be contributed by Daqo Cayman as the sole investor. The amount of the registered capital of Nanjing Daqo is $20.0 million, $9.1 million of which is to be contributed by Daqo Cayman as the sole investor. As of June 30, 2010, the amount of loans that Chongqing Daqo was permitted to borrow from Daqo Cayman cannot exceed $125.0 million and that for Nanjing Daqo cannot exceed $28.9 million. We may not make loans to Chongqing Daqo and Nanjing 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 National Development and Reform Commission 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.

 

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 will be subject to a Chinese withholding tax upon the dividends payable by us, if we are classified as a Chinese ‘resident enterprise.’”

 

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

 

The change in value of the Renminbi against the U.S. dollar is affected by, among other things, changes in China’s political and economic conditions. From 1995 until July 2005, the People’s Bank of China intervened in the foreign exchange market to maintain an exchange rate of approximately RMB8.3 per U.S. dollar. On July 21, 2005, the Chinese government changed this policy and began allowing modest appreciation of the Renminbi versus the U.S. dollar. Under the new policy, the Renminbi was permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy caused the Renminbi to appreciate approximately 21.5% against the U.S. dollar over the following three years. Since July 2008, however, the Renminbi has traded within a narrow band against the U.S. dollar, remaining within 1% of its July 2008 high. As a consequence, the Renminbi has fluctuated sharply since July 2008 against other freely traded currencies, in tandem with the U.S. dollar. For example, the Renminbi appreciated approximately 27% against the Euro between July 2008 and November 2008. In June 2010, the PRC government announced that it would increase

 

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Renminbi exchange rate flexibility. However, it remains unclear how this policy will be implemented. 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. In addition, appreciation of the Renminbi against the U.S. dollar would increase our production costs, and, to the extent that we need to convert U.S. dollars we receive from this initial public offering into Renminbi for our operations, have an adverse effect on the Renminbi amount we would receive from the conversion. 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.

 

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 have been reports on the 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. 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.

 

Risks Relating to Our ADSs and This Offering

 

An active trading market for our ordinary shares or our ADSs may not develop and the trading price for our ADSs may fluctuate significantly.

 

We have been approved to list our ADSs on the New York Stock Exchange. Prior to the completion of this offering, there has been no public market for our ADSs or our ordinary shares underlying the ADSs, and we cannot assure you that a liquid public market for our ADSs will develop. If an active public market for our ADSs

 

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does not develop following the completion of this offering, the market price and liquidity of our ADSs may be materially and adversely affected. The initial public offering price for our ADSs will be determined by negotiation between us and the underwriters based upon several factors, and we can provide no assurance that the trading price of our ADSs after this offering will not decline below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

 

The trading prices of our ADSs are likely to be volatile, which could result in substantial losses to investors.

 

The trading prices of our ADSs are likely to be volatile 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 or are in the process of listing their securities on U.S. stock market. 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 services and expansions by us or our competitors;

 

   

changes in financial estimates by securities analysts;

 

   

additions or departures of key personnel;

 

   

release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities;

 

   

potential litigation or regulatory investigations; and

 

   

fluctuations in market prices of our products.

 

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 after the completion of this offering, 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. The ADSs sold in this offering will be freely tradable without restriction or further registration under the U.S. Securities Act of 1933, as amended, or the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. There will be 8,000,000 ADSs (representing 40,000,000 ordinary shares) outstanding immediately after this offering, or 9,200,000 ADSs (representing 46,000,000 ordinary shares) if the underwriters exercise their option to purchase additional ADSs in full. In connection with this offering, we and all of our officers, directors and shareholders have agreed not to sell any ordinary shares or ADSs for 180 days after the date of this

 

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prospectus without the prior written consent of the underwriters. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of our ADSs. See “Underwriters” and “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our securities after this offering.

 

Because the initial public offering price is substantially higher than the pro forma net tangible book value per share, you will experience immediate and substantial dilution.

 

If you purchase ADSs in this offering, you will pay more for each ADS than the corresponding amount paid by existing shareholders for their ordinary shares. As a result, you will experience immediate and substantial dilution of approximately $5.26 per ADS (assuming that no outstanding options to acquire ordinary shares are exercised). This number represents the difference between our pro forma net tangible book value per ADS of $6.24 as of June 30, 2010, after giving effect to this offering and the assumed initial public offering price of $11.50 per ADS, the midpoint of the estimated initial public offering price range set forth on the front cover of this prospectus. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon the completion of this offering.

 

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.

 

We will adopt a third amended and restated memorandum and articles of association, or the Third Amended and Restated Memorandum and Article of Association, that will become effective immediately upon completion of this offering. 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 (2010 Revision) 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

 

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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. For a discussion of significant differences between the provisions of the Companies Law of the Cayman Islands (2010 Revision) and the laws applicable to companies incorporated in the United States and their shareholders, see “Description of Share Capital—Differences in Corporate Law.”

 

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. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

 

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;

 

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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.

 

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 parities, 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

 

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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 will incur increased costs as a result of being a public company.

 

Upon completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, impose various requirements on the corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. For example, as a result of becoming a public company, we will need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

 

In the past, shareholders of a public company often brought securities class action suits against the company following periods of instability in the market price of that company’s securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations, which could harm our results of operations and require us to incur significant expenses to defend the suit. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

 

The Company 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.

 

Based on our current income assets, we presently do not expect to be classified as a PFIC (as defined for U.S. federal income tax purposes and as described below) for the current taxable year and we do not anticipate becoming a PFIC in future taxable years. A non-U.S. corporation will be considered as a PFIC for U.S. federal income tax purposes for any taxable year if either (1) 75% or more of its gross income for such year consists of certain types of “passive” income, or (2) 50% or more of the value of its assets is attributable to assets that produce or are held for the production of passive income. Because 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 “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. For more information, see the section titled “Taxation—Material United States Federal Income Tax Considerations—Passive Foreign Investment Company Considerations.”

 

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FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements that reflect our current expectations and views of future events. The forward looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Recent Developments,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” 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 planned use of proceeds;

 

   

our financial condition and results of operations;

 

   

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

 

   

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

 

   

government subsidies and economic incentives for solar energy application.

 

This prospectus also contains estimates, projections and statistical data related to the polysilicon markets and photovoltaic industry in several countries, including China. This market data, including data from Solarbuzz, 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 prospectus relate only to events or information as of the date on which the statements are made in this prospectus. 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 prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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USE OF PROCEEDS

 

We estimate we will receive net proceeds from this offering of approximately $83.9 million, or approximately $96.7 million if the underwriters exercise their option to purchase additional ADSs in full, after deducting the underwriting discounts and estimated offering expenses payable by us in this offering. These estimates are based upon an assumed initial offering price of $11.50 per ADS, the midpoint of the range shown on the cover page of this prospectus. A $1.00 change in the initial public offering price would, in the case of an increase, increase, and, in the case of a decrease, decrease the net proceeds of this offering by $7.4 million, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us.

 

We plan to use these net proceeds for the following purposes:

 

   

approximately $65.0 million to expand our polysilicon manufacturing facilities; and

 

   

approximately $18.9 million to finance capital expenditures for our wafer manufacturing business.

 

The foregoing represents our current intentions to use and allocate the net proceeds of this offering based upon our present plans and business conditions. For additional information about our production capacity expansion plan in 2010 and 2011, see “Business—Manufacturing Capacity.” Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus.

 

To the extent that the net proceeds of this offering are not immediately applied for the above purposes, we intend to deposit the proceeds into interest bearing bank accounts withdrawable on demand or to invest in short-term investment grade debt securities.

 

Since we are an offshore holding company, we will need to make capital contributions and loans to our PRC subsidiaries such that the net proceeds of the offering can be used in the manner described above. Such capital contributions and loans are subject to a number of limitations and approval processes under Chinese laws and regulations. We cannot assure you that we can obtain the approvals from the relevant governmental authorities, or complete the registration and filing procedures required to use our net proceeds as described above, in each case on a timely basis, or at all. See “Risk Factors—Risks Relating to Doing Business in China—Chinese regulation of direct investment and loans by offshore holding companies to Chinese entities may delay or limit us from using the proceeds of this offering to make additional capital contributions or loans to our Chinese subsidiaries.”

 

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DIVIDEND POLICY

 

We have never declared or paid any dividends on our ordinary shares. 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 “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. See “Description of American Depositary Shares.” Cash dividends on our ADSs and ordinary shares, if any, will be paid in U.S. dollars.

 

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CAPITALIZATION

 

The following table sets forth our capitalization as of June 30, 2010:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect the automatic conversion of all of our outstanding Series A preferred shares into 29,714,103 ordinary shares immediately upon the completion of this offering; and

 

   

on a pro forma as adjusted basis to reflect (1) the automatic conversion of all of our outstanding Series A preferred shares into 29,714,103 ordinary shares immediately upon the completion of this offering, and (2) the issuance and sale of 8,000,000 ADSs in this offering at an assumed initial public offering price of $11.50 per ADS, the midpoint of the estimated initial public offering price range set forth on the front cover of this prospectus, after deducting underwriting discounts, commissions and estimated offering expenses payable by us.

 

You should read this table in conjunction with “Selected Consolidated Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of June 30, 2010
     Actual    Pro  Forma(1)    Pro
Forma As
Adjusted
     (in thousands)

Long-term liabilities

   $ 129,124    $ 129,124    $ 129,124

Mezzanine equity

        

Series A preferred shares, par value $0.0001 per share, 40,000,000 shares authorized, 29,714,103 shares issued and outstanding

     57,803          

Shareholders’ equity

        

Ordinary shares, par value $0.0001 per share, 460,000,000 shares authorized, 100,000,000 shares issued and outstanding

     10      13      17

Additional paid-in capital(2)

     1,034      58,834      142,740

Accumulated other comprehensive income

     1,496      1,496      1,496

Retained earnings(3)

     67,442      67,442      67,442
                    

Total shareholders’ equity(2)

     69,982      127,785      211,695

Noncontrolling interest

     128,964      128,964      128,964
                    

Total equity

     198,946      256,749      340,659
                    

Total capitalization(2)

   $ 385,873    $ 385,873    $ 469,783
                    

 

Notes:

(1)   Assuming that the conversion of the Series A preferred shares took place on June 30, 2010.
  (2)   A $1.00 increase/decrease in the assumed initial public offering price of $11.50 per ADS would increase/decrease paid-in capital, total shareholders’ equity and total capitalization by $7.4 million.
  (3)   Including $5.5 million in statutory reserves that are not available for distribution pursuant to PRC law.

 

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DILUTION

 

If you invest in our ADSs, your interest will be diluted for each ADS you purchase to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS immediately after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the net tangible book value per share attributable to the existing shareholders for our presently outstanding ordinary shares.

 

Our net tangible book value as of June 30, 2010 was approximately $70.0 million, or $0.70 per ordinary share and $3.50 per ADS as of that date. Net tangible book value represents the amount of our total assets, minus the amount of our total liabilities, intangible assets, Series A preferred shares and noncontrolling interest. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the proceeds we will receive from this offering after deducting underwriting discounts and commissions and estimated offering expenses payable by us, assuming an initial public offering price per ordinary share represented by the midpoint of the estimated initial public offering price range set forth on the cover of this prospectus, from such assumed initial public offering price per ordinary share.

 

Without taking into account any other changes in net tangible book value after June 30, 2010, other than giving effect to (1) the conversion of all of our outstanding Series A preferred shares into 29,714,103 ordinary shares, and (2) our sale of the ADSs offered in this offering at the initial public offering price of $11.50 per ADS, the midpoint of the estimated initial public offering price range set forth on the cover of this prospectus after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value as of June 30, 2010 would have been $211.7 million, or $1.25 per ordinary share and $6.24 per ADS. This represents an immediate increase in net tangible book value of $0.55 per ordinary share and $2.74 per ADS, to the existing shareholders and an immediate dilution in net tangible book value of $1.05 per ordinary share and $5.26 per ADS, to investors purchasing ADSs in this offering. The following table illustrates such dilution:

 

     Per
Ordinary
Share
   Per ADS

Assumed initial public offering price per ADS

   $ 2.30    $ 11.50

Net tangible book value as of June 30, 2010

     0.70      3.50

Pro forma net tangible book value after giving effect to this offering

     1.25      6.24

Amount of dilution in net tangible book value to new investors in the offering

     1.05      5.26

 

The following table summarizes, on a pro forma basis as of June 30, 2010, the differences between existing shareholders and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share/ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.

 

     Ordinary Shares
Purchased
    Total Consideration     Average Price Per
     Number    Percent     Amount    Percent     Ordinary
Share
   ADS
     (in thousands, except per share and per ADS data and percentages)

Existing shareholders

   129,714.1    76.43   $ 55,010.0    37.42   $ 0.42    $ 2.12

New investors

   40,000.0    23.57        92,000.0    62.58        2.30      11.50
                             

Total

   169,714.1    100     147,010.0    100     
                             

 

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A $1.00 increase/decrease in the assumed public offering price of $11.50 per ADS would increase/decrease our pro forma net tangible book value after giving effect to the offering by $7.4 million, the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by $0.55 per ordinary share and $2.74 per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by $0.16 per ordinary share and $0.78 per ADS, assuming no charge to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

 

The pro forma information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

 

The discussion and tables above also assume no exercise of any outstanding share options. As of the date of this prospectus, there were 5,350,000 ordinary shares issuable upon exercise of outstanding share options at an exercise price of $1.38 per share, and there were 9,650,000 ordinary shares available for future issuance upon the exercise of future grants under our 2009 share incentive plan. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

 

Our business is primarily conducted in China and substantially all of our revenues, costs of revenues and operating expenses are denominated in Renminbi. We use U.S. dollars as reporting currency in our financial statements and in this prospectus. Monetary assets and liabilities denominated in Renminbi are translated into U.S. dollars at the rates of exchange as of the balance sheet date, equity accounts are translated at historical exchange rates and revenues, expenses, gains and losses are translated using the average rate for the year as published by the People’s Bank of China. Translation adjustments are reported as cumulative translation adjustments and are shown as a separate component of other comprehensive income in the statement of changes in equity. In other parts of this prospectus, any Renminbi denominated amounts are accompanied by translations. Transactions in Renminbi are recorded at the rates of exchange prevailing when the transactions occur. With respect to amounts not recorded in our consolidated financial statements included elsewhere in this prospectus, all translations from Renminbi to U.S. dollars were made at RMB6.7815 to $1.00, the noon buying rate set forth in the H.10 statistical release of the Federal Reserve Board on June 30, 2010. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. The PRC government restricts or prohibits the conversion of Renminbi into foreign currency and foreign currency into Renminbi for certain types of transactions. On September 17, 2010, the noon buying rate set forth in the H.10 statistical release of the Federal Reserve Board was RMB6.7230 to $1.00.

 

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

     Noon Buying Rate

Period

   Period End    Average(1)    Low    High
     (RMB Per $1.00)

2005

   8.0702    8.1826    8.2765    8.0702

2006

   7.8041    7.9579    8.0702    7.8041

2007

   7.2946    7.5806    7.8127    7.2946

2008

   6.8225    6.9193    7.2946    6.7800

2009

   6.8259    6.8295    6.8470    6.8176

2010

           

March

   6.8258    6.8262    6.8270    6.8254

April

   6.8247    6.8256    6.8275    6.8229

May

   6.8305    6.8275    6.8310    6.8245

June

   6.7815    6.8184    6.8323    6.7815

July

   6.7735    6.7762    6.7807    6.7709

August

   6.8069    6.7873    6.8069    6.7670

September (through September 17)

   6.7230    6.7702    6.8102    6.7230

 

Source: Federal Reserve Statistical Release

Note:

(1)   Annual averages are calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages are calculated by using the average of the daily rates during the relevant month.

 

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ENFORCEABILITY OF CIVIL LIABILITIES

 

We were incorporated in the Cayman Islands in order to enjoy certain benefits, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of exchange control or currency restrictions, and the availability of professional and support services. However, certain disadvantages accompany incorporation in the Cayman Islands, such as a less-developed body of securities laws as compared to the United States, significantly less legal protection for investors as compared to the United States, and the potential lack of standing by Cayman Islands companies to sue before the federal courts of the United States.

 

Our organizational documents do not contain provisions requiring arbitration of disputes between us and our officers, directors and shareholders, including disputes arising under the securities laws of the United States.

 

Substantially all of our operations are conducted in China, and substantially all of our assets are located there. In addition, a majority of our officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

 

We have appointed Law Debenture Corporate Services Inc. as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

 

Thorp Alberga, our counsel as to Cayman Islands law, and Jun He Law Offices, our counsel as to PRC law, have advised us that there is uncertainty as to whether the courts of the Cayman Islands and China would:

 

   

recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

   

entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

 

Thorp Alberga has further advised us that a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, fines, penalties or similar fiscal or revenue obligations and which was neither obtained in a manner nor is of a kind enforcement of which is contrary to natural justice or the public policy of the Cayman Islands, will be subject to enforcement proceedings as a debt in the courts of the Cayman Islands under the common law.

 

Jun He Law Offices has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other agreements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in China will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. Therefore, at present, a judgment rendered by a court in the United States is not likely to be enforced by a PRC court.

 

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CORPORATE HISTORY AND STRUCTURE

 

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., or Daqo Cayman, in August 2009.

 

In January 2008, we established Chongqing Daqo New Energy Co., Ltd., or Chongqing Daqo, our wholly owned operating subsidiary in China. Through Chongqing Daqo, we focus primarily on the manufacture and sale of polysilicon and have recently expanded into the wafer manufacturing. In addition to Chongqing Daqo, we established Nanjing Daqo New Energy Co., Ltd., or Nanjing Daqo, in December 2007 in China, through which we conduct our module manufacturing business. In January 2009, we established Daqo Solar Energy North America, or Daqo North America, in California as our wholly own subsidiary to serve as our marketing office to promote our products in North America.

 

Daqo Group Co. established Daqo New Material on November 16, 2006 in China. Daqo Group is one of the largest electrical equipment manufacturers in 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. Immediately after the completion of this offering, holders of equity interests in Daqo Group in aggregate will beneficially own 58.9% of the outstanding ordinary shares of our company, assuming no exercise of the over-allotment option granted to the underwriters. Daqo New Material’s activities included acquiring land use rights and constructing certain production infrastructure prior to the incorporation of our company and Chongqing Daqo. Subsequent to the establishment of Chongqing Daqo, Chongqing Daqo entered into a lease agreement with Daqo New Material to rent Daqo New Material’s land, production infrastructure, machinery and equipment for its polysilicon production. The initial lease agreement has a five-year term starting from July 1, 2008, with monthly lease payment at a fixed amount. The lease agreement was amended and restated in August 2009, with retrospective effect from January 1, 2009. Under the amended and restated lease agreement, the lease period is from January 1, 2009 to December 31, 2013, with monthly lease payment at a fixed amount. One month before the expiry of the lease period, Chongqing Daqo has the option to renew the lease on the same terms and conditions for additional five-year periods. Furthermore, the amended and restated lease agreement provides that Chongqing Daqo has the option to purchase, or to designate any person to purchase, the leased assets at the then fair value at any time during the lease period or within one year following the lease period, if permitted by the PRC laws and regulations. Under current PRC laws and regulations, Chongqing Daqo needs to obtain governmental approval in China to proceed with the purchase, and given the application requirements we do not think it is currently practical for us to obtain such approval. If Daqo New Material desires to transfer the ownership of the leased assets to a third party, Chongqing Daqo has the right of first refusal to acquire the leased assets under the same conditions, and if the leased assets are transferred to a third party, the lease agreement will remain effective and enforceable against the new owner until its expiry. Under Financial Accounting Standards Board Accounting Standards Codification 810-10-15, “Variable Interest Entities,” we are deemed to be Daqo New Material’s primary beneficiary for accounting purposes and Daqo New Material is considered a “variable interest entity” of ours starting from July 1, 2008. Therefore, we have consolidated the financial results of Daqo New Material into our financial statements since July 1, 2008. As of June 30, 2010, Daqo Group’s equity interest in Daqo New Material amounted to $129.0 million, which was consolidated and reflected as a noncontrolling interest in the balance sheet of our company pursuant to U.S. GAAP. 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.

 

On November 9, 2009, Chongqing Daqo signed a supplemental lease agreement with Daqo New Material to lease the production facilities of Phase 1b from November 9, 2009 until December 31, 2013 at a fixed amount. The other terms of the supplemental lease agreement are the same as those of the amended and restated lease agreement of Phase 1a.

 

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

 

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compete in any manner with our businesses without our consent for an indefinite term. Under the 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.

 

In November 2009, Daqo Cayman issued and sold 29,714,103 shares of Series A convertible preferred shares in a private placement at a price of $1.851 per share to a group of investment funds. For details of the private placement, please see “Description of Share Capital—History of Securities Issuances.”

 

The following diagram illustrates our corporate structure immediately upon the completion of this offering, assuming no exercise of the over-allotment option granted to the underwriters.

 

LOGO

 

 

Notes:

(1)   The holders of our Series A preferred shares consist of investment funds affiliated with Granite Global Ventures III L.P., NewMargin Growth Fund, L.P., investment funds affiliated with Siguler Guff Advisers, LLC and Venture Star Investment (HK) Limited. The Series A preferred shares will be automatically converted into our ordinary shares upon the completion of a qualified initial public offering.
  (2)   Individual owners of Daqo Group beneficially hold equity interests in Daqo Cayman through seven personal holding companies incorporated in the British Virgin Islands. See “Principal Shareholders.”
  (3)   Indicates the respective shareholding percentage of the shareholders in Daqo Cayman.
  (4)   Indicates companies within the listing group.
  (5)   Indicates jurisdiction of incorporation.
  (6)   Daqo Group’s major shareholders include Messrs. Guangfu Xu, Xiang Xu, Fei Ge, Dafeng Shi, Bin Cai, Jianrong Tang and Wanlin Gao.
  (7)   Represents a variable interest entity.

 

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

 

You should read the following information concerning us and our predecessor business, Daqo New Material, in conjunction with our consolidated financial statements and predecessor business financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

The following selected consolidated statements of operations for our company for the period from November 22, 2007, the date of our inception, to December 31, 2007 and for the years ended December 31, 2008 and 2009 and the selected consolidated balance sheet as of December 31, 2007, 2008 and 2009 are derived from our audited consolidated financial statements included elsewhere in this prospectus. We have consolidated Daqo New Material’s financial statements in ours since July 1, 2008 because under Financial Accounting Standards Board Accounting Standards Codification 810-10-15, “Variable Interest Entities,” we are deemed to be Daqo New Material’s primary beneficiary for accounting purposes and Daqo New Material is considered our “variable interest entity” starting from July 1, 2008.

 

The following selected consolidated statements of operations for the six months ended June 30, 2009 and 2010 have been derived from our unaudited condensed financial statements included elsewhere in this prospectus and have been prepared on the same basis as our audited consolidated financial data. The unaudited condensed financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented.

 

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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. 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.

 

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The following tables also present the selected consolidated statements of operations for Daqo New Material (our predecessor business) for the period from November 16, 2006, the date of its inception, to December 31, 2006, for the year ended December 31, 2007 and for the period from January 1, 2008 to June 30, 2008, and the selected consolidated balance sheet data as of December 31, 2006 and 2007, and June 30, 2008, which are derived from Daqo New Material’s audited financial statements included in this prospectus. Our predecessor business’s financial statements are prepared and presented in accordance with U.S. GAAP.

 

    Predecessor Business     Daqo Cayman  
    Period from
November 16,

2006 to
December 31,
    Year Ended
December 31,
    Period from
January 1, 2008 to
June 30,
    Period from
November 22, 2007
(inception) to
December 31,
    Year Ended
December 31,
    Six Months Ended
June 30,
 
    2006     2007     2008     2007     2008     2009     2009     2010  
   

(in thousands, except per share data)

 

Consolidated Statement of Operations Data:

               

Revenues

  $      $      $      $      $ 56,368      $ 111,193      $ 49,153      $ 97,582   

Cost of revenues

                                (19,392     (69,252     (24,872     (64,044
                                                               

Gross profit

                                36,976        41,942        24,281        33,538   

Operating expenses(1)

   
(490

    (1,053     (1,902     (48     (9,764     (5,518    
(4,555

    (6,331
                                                               

(Loss) income from operations

    (490     (1,053     (1,902     (48     27,212        36,424        19,727        27,207   

(Loss) income before income taxes

    (486     (978     (1,717  

 

(48

    23,454        30,176        16,646        22,008   

Income tax expense

    160        207        428               (1,602     (240     (2,475     (3,859
                                                               

Net (loss) income

    (326     (771     (1,289     (48     21,852        29,936        14,170        18,149   

Less: income (loss) attributable to noncontrolling interest

    (326     (771     (1,289            327        (899     (936     117   
                                                               

Net (loss) income attributable to Daqo New Energy Corp. shareholders

  $      $      $      $ (48   $ 21,525      $ 30,835      $ 15,107      $ 18,032   
                                                               

Earnings (loss) per share, basic and diluted

  $      $      $      $ (0.00   $ 0.22      $ 0.29      $ 0.15      $ 0.12   

 

Note:     (1)   Includes share-based compensation expenses in the amount of $0.3 million and $0.8 million for the year ended December 31, 2009 and the six months ended June 30, 2010.

 

    Daqo Cayman  
    Period from
November 22,
2007
(inception) to
December 31,
   Year Ended
December 31,
    Six Months Ended
June 30,
 
    2007    2008    2009     2009     2010  
    (in thousands, except for unit cost)  

Other Financial and Operating Data:

           

Polysilicon production volume (in MT)

       291      1,523        500        1,826   

Polysilicon sales volume (in MT)

       237      1,498 (1)      443 (1)      1,710 (2) 

Unit cost of polysilicon sold (in $/kg)

       81.7      43.9        48.4        33.5   

EBITDA (in thousands)(3)

     $ 35,029    $ 52,512      $ 27,167      $ 42,618   

 

Notes:

(1)   In addition, we used approximately 16 MT of our polysilicon to process cells through our tolling arrangements with third party cell manufacturers in the six months ended June 30, 2009.
  (2)   In addition, we used approximately 69 MT of our polysilicon to process wafers through our tolling arrangements with third party wafer manufacturers in the six months ended June 30, 2010.

 

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  (3)   EBITDA is defined as net income plus interest expenses, taxes and depreciation and amortization less interest income. EBITDA is used by management to evaluate our financial performance and determine the allocation of resources and provides the management with the ability to determine our return on capital expenditures relating to capacity expansion of our business. In addition, we believe that EBITDA will be a key metric analyzed in determining the amount of new debt financing that may be available to us and, therefore, we believe this measure provides investors with additional information about our ability to fund our growth through debt financing, if needed. Furthermore, EBITDA eliminates the impact of items that we do not consider indicative of the performance of our business. For example, depreciation and amortization expenses relating to capacity expansion are capital expenditures that are not indicative of the operating performance of our business during the periods presented. We believe investors will similarly use EBITDA as one of the key metrics to evaluate our financial performance and to compare our current operating results with corresponding historical periods and with other companies in the photovoltaic manufacturing industry. The presentation of EBITDA should not be construed as an indication that our future results will be unaffected by other charges and gains we consider to be outside the ordinary course of our business.

 

The use of EBITDA has certain limitations. Items excluded from EBITDA are significant components in understanding and assessing our operating and financial performance. Depreciation and amortization expense, income tax expense, interest expense and interest income have been and will be incurred in our business and are not reflected in the presentation of EBITDA. Each of these items should also be considered in the overall evaluation of our results. Additionally, EBITDA does not consider capital expenditures and other investing activities and should not be considered as a measure of our liquidity. We compensate for these limitations by providing the relevant disclosure of our depreciation and amortization expense, interest expense and interest income and income tax expense both in our reconciliations to the U.S. GAAP financial measures and in our consolidated financial statements, all of which should be considered when evaluating our performance. The term EBITDA is not defined under U.S. GAAP, and EBITDA is not a measure of net income, operating income, operating performance or liquidity presented in accordance with U.S. GAAP. When assessing our operating and financial performance, you should not consider this data in isolation or as a substitute for our net income, operating income or any other operating performance measure that is calculated in accordance with U.S. GAAP. In addition, our EBITDA may not be comparable to EBITDA or similarly titled measures utilized by other companies since such other companies may not calculate EBITDA in the same manner as we do.

 

A reconciliation of EBITDA to net income, which is the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, is provided below:

 

     Year Ended
December 31,
    Six Months
Ended June 30,
     2008    2009     2009     2010
     (in thousands)

Net income attributable to Daqo New Energy Corp.’s shareholders

   $ 21,525    $ 30,835      $ 15,107      $ 18,032

Add: net loss (income) attributable to noncontrolling interest

     327      (899     (937     117
                             

Net income

     21,852      29,936        14,170        18,149

Plus: interest expenses

     3,873      6,462        3,248        5,359

Less: interest income

     115      214        167        160

Plus: income tax expenses

     1,602      240        2,475        3,859

Plus: depreciation expenses

     7,817      16,088        7,441        15,411
                             

EBITDA

   $ 35,029    $ 52,512      $ 27,167      $ 42,618

 

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    Predecessor Business   Daqo Cayman
    As of December 31,   As of
June 30,
  As of December 31,   As of
June 30,
    2006   2007   2008   2007     2008   2009   2010
    (in thousands)

Consolidated Balance Sheet Data:

             

Cash and cash equivalents

  $ 7,902   $ 3,842   $ 4,112   $      $ 3,304   $ 81,414   $ 63,384

Restricted cash

        15,562     16,908            20,430     8,810     1,999

Property, plant and equipment, net

    333     76,179     111,681            314,507     399,985     378,483
                                           

Total assets

  $ 9,120   $ 101,005   $ 158,452   $      $ 350,105   $ 523,923   $ 516,412
                                           

Short-term borrowings, including current portion of long-term borrowings

  $   $   $   $      $ 10,389   $ 43,826   $ 48,972

Long-term borrowings

        27,380     77,270            84,299     144,936     128,534

Total liabilities

    472     54,232     109,968     48        279,052     287,829     259,664

Mezzanine equity

                           55,603     57,803

Total Daqo New Energy Corp. shareholders’ (deficit) equity

    8,647     46,773     48,485     (48     22,042     52,496     69,982

Noncontrolling interest

                       49,011     127,996     128,964
                                           

Total (deficit) equity

    8,647     46,773     48,485     (48     71,053     180,492     198,946
                                           

Total liabilities and equity

  $ 9,120   $ 101,005   $ 158,452   $      $ 350,105   $ 523,923   $ 516,412
                                           

 

Recent Developments

 

In July and August 2010, we produced approximately 671 MT of polysilicon, sold approximately 643 MT to customers and used approximately 17 MT of our polysilicon to process wafers through tolling arrangements with third party wafer manufacturers. The average unit cost of polysilicon we produced in July and August 2010 was $30.2 per kilogram. During July and August 2010, substantially all of our polysilicon met the solar grade quality standard, approximately 92% of our polysilicon met the highest specification of the solar grade quality standard and approximately 58% of our polysilicon met the electronic grade quality standard in China.

 

In September 2010, we entered into a polysilicon supply agreement with an affiliate of MEMC, whereby we agree to sell and the customer agrees to purchase 600 MT of polysilicon for 2011. The customer also has an option to purchase 600 MT of polysilicon in 2012, subject to our mutual agreement on the applicable polysilicon sales prices.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial and Operating Data” and the historical consolidated financial statements of our company for the years ended December 31, 2008 and 2009 and the six months ended June 30, 2009 and 2010. 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 prospectus.

 

Overview

 

We are a leading polysilicon manufacturer based in China and we aim to become a vertically integrated photovoltaic product manufacturer. With an installed annual polysilicon production capacity of 3,300 MT as of June 30, 2010, we believe we are one of the largest polysilicon manufacturers in China. We have started expanding downstream into the wafer manufacturing business and are ramping up our module manufacturing business. We also intend to enter into the cell manufacturing business in the future.

 

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 1,826 MT of polysilicon in the first half of 2010, which, on an annualized basis, exceeded our installed annual production capacity of our Phase 1 production line. We plan to increase our annual production capacity to 7,300 MT by the end of 2012 through adding a Phase 2 production line and improving our production efficiency.

 

We currently sell polysilicon to China-based photovoltaic product manufacturers. The majority of our sales are made under framework contracts. We also sell a significant portion of our polysilicon on a spot pricing basis. As of June 30, 2010, our major photovoltaic product customers included operating entities of China Sunergy, Solarfun, Solargiga, Tianwei New Energy and Yingli Green Energy.

 

We aim to become a vertically integrated photovoltaic product manufacturer. We have started expanding downstream into the wafer manufacturing business. We expect to complete the construction of our Phase 1 wafer manufacturing facilities in Chongqing with an annual installed capacity of 250 MW in December 2010 and plan to commence commercial production in the first quarter of 2011 and ramp up to the full capacity by the end of 2011. We will use our own polysilicon to produce wafers. In addition, we are ramping up our module manufacturing business. We plan to sell module products to photovoltaic system integrators and distributors in China and internationally, leveraging our well-recognized “Daqo” brand. We expect this downstream market to grow rapidly. We source cells for our module production through direct purchases and tolling arrangements, and we assemble modules at our own facilities. As of June 30, 2010, we had an annual module production capacity of 50 MW at our facilities in Nanjing and plan to increase our production capacity to 200 MW in the first quarter of 2011. We commenced commercial production in May 2010 and shipment to Europe in July 2010. We also intend to enter into the cell manufacturing business in the future.

 

We have achieved substantial growth since we commenced commercial production of polysilicon in July 2008. In 2009, we produced 1,523 MT of polysilicon and sold 1,498 MT, compared to 291 MT of polysilicon produced and 237 MT sold in 2008. In the six months ended June 30, 2010, we produced 1,826 MT of polysilicon and sold 1,710 MT. We generated revenues of $111.2 million and $97.6 million and achieved net income of $30.8 million and $18.0 million in 2009 and the first six months of 2010, respectively.

 

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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.

 

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 that unfolded in 2008 and continued in 2009, 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.

 

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 second half of 2009 due to industry-wide excessive supply but stabilized in recent months due to end-customers’ increasing demand in response to the significantly lowered prices in the second half of 2009. The decline in polysilicon market price had resulted in an approximately 78.0% decrease in our average selling price of polysilicon from the year ended December 31, 2008 to the six months ended June 30, 2010. As a result, our revenues from sales of polysilicon increased moderately from $56.4 million in the year ended December 31, 2008 to $89.3 million in the six months ended June 30, 2010 despite the significant growth in sales volume to customers from 237 MT for the year ended December 31, 2008 to 1,710 MT for the six months ended June 30, 2010. Our gross margin decreased from 65.6% in 2008 to 37.7% in 2009 and decreased from 49.4% in the six months ended June 30, 2009 to 34.4% in the six months ended June 30, 2010. We may continue to face downward price pressure as the global sales prices for photovoltaic products continue to fluctuate over time. We expect that our future financial results will also be affected by prices of our wafers, cells and modules.

 

Product mix

 

The proportion of our revenues that are generated from the sales of other photovoltaic products, also referred to as product mix, affect our revenues and profitability. We currently generate substantially all of our revenues from sales of polysilicon. In 2009, we generated other revenues from sales of cells that we processed through tolling arrangements with third party cell manufacturers and; in the first half of 2010, we also generated

 

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other revenues from sales of wafers that we processed through tolling arrangements with third party wafer manufacturers. As we expand our wafer and module businesses, we expect that the absolute dollar amounts and the percentage of our revenues generated from sales of these products will increase, while our profit margins will decrease due to the lower profit margins of wafer and module products as compared to polysilicon. We expect revenues from module sales to account for an increasing portion of our total revenues in the future. Sales prices of modules are higher than those of polysilicon and wafers, and we plan to utilize our in-house produced polysilicon and wafers for our module products and sell modules directly to customers.

 

Our production capacity and utilization

 

We plan to significantly increase our production capacity and utilization to meet the long-term growth in demand for photovoltaic products and to improve our economies of scale. For our polysilicon business, we ramped up our Phase 1a facilities to its full annual capacity of 1,500 MT in early 2009 and ramped up production at the Phase 1b facilities to its full annual capacity of 1,800 MT in January 2010. We also plan to expand the capacity of our Phase 1 facilities and commence the construction of our Phase 2 facilities in the fourth quarter of 2010 and expect to increase our total annual production capacity to 7,300 MT by the end of 2012. For our wafer business, we have started construction of our Phase 1 250 MW wafer facilities and plan to commence commercial production in the first quarter of 2011 and fully ramp up production to 250 MW in the fourth quarter of 2011. For our module business, we plan to increase our production capacity from 50 MW as of June 30, 2010 to 200 MW in the first quarter of 2011. We believe that our planned expansion will help us improve economies of scale in production by reducing the unit cost of our products and our equipment costs while significantly increasing our capital expenditures and depreciation expenses.

 

Our production costs

 

Our polysilicon production costs consist primarily of the costs of electricity and other utilities, raw materials and labor. As electricity is the largest component of our polysilicon production costs, we anticipate our production costs to fluctuate from quarter to quarter correlating with the different seasonable electricity rates that the local power grid charges. Daqo Chongqing uses electricity generated from the hydropower station in Chongqing which generates electricity mostly during times of high precipitation, primarily in the second and third quarters of each year. As a result, the electricity costs of Daqo Chongqing are generally lower in the second and third quarters and higher in the first and fourth quarters, which in turn affects our cost of revenues. Our wafer production costs consist primarily of the costs of polysilicon, other raw materials, tolling fees charged by third party wafer manufacturers, labor and depreciation. We believe that as we commence and fully ramp up our in-house wafer production capacity, we will be able to reduce the extent of our reliance on tolling arrangements with third party wafer manufacturers, which in turn will reduce unit cost of our wafers. Our module production costs consist primarily of costs of photovoltaic cells, other raw materials, tolling fees charged by third party cell manufacturers, labor and depreciation. We believe that unit cost of our modules will decrease over time as we develop our in-house module production capability and fully integrate our polysilicon, wafer and module manufacturing businesses. With the completion of construction and the gradual ramp-up of our production facilities, we will seek to implement additional measures to reduce our production costs. Effective cost-reduction measures will have a direct impact on our financial condition and results of operations. If we fail to continue to reduce our production costs, our profitability and competitiveness will be adversely affected.

 

Components of Results of Operations

 

Revenues

 

Substantially all of our revenues are derived from the sale of polysilicon. In 2009, we generated other revenues from sales of cells that we processed through tolling arrangements and, in the first half of 2010, we also generated other revenues from sales of wafers that we processed through tolling arrangements with third party wafer manufacturers. We expect revenues from module sales to account for an increasing portion of our total revenues in the future. Sales prices of modules are higher than those of polysilicon and wafers, and we plan to utilize our in-house produced polysilicon and wafers for our module products and sell modules directly to customers.

 

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We commenced polysilicon production in July 2008 and therefore did not have any revenues for the period from our inception in 2006 to June 2008. In 2008, we produced 291 MT and sold 237 MT of polysilicon. In 2009, we produced 1,523 MT of polysilicon, sold 1,498 MT to our customers and used approximately 16 MT to process cells through our tolling arrangements. In the first six months of 2010, we produced 1,826 MT of polysilicon, sold 1,710 MT to our customers and used approximately 69 MT to process wafers through our tolling arrangements. 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 78.0% in the six months ended June 30, 2010 as compared to that in the year ended December 31, 2008, which in turn adversely affected our revenues in 2008, 2009 and in the first six months of 2010.

 

We generated revenues of $56.4 million, $111.2 million and $97.6 million and achieved net income attributable to our shareholders of $21.5 million, $30.8 million and $18.0 million in 2008, 2009 and the first six months of 2010, respectively. Our revenues in 2009 included $106.2 million generated from sales of polysilicon and $5.0 million from sales of photovoltaic cells processed from our polysilicon through tolling arrangements. Our revenues in the first six months of 2010 include $89.3 million generated from sales of polysilicon and $8.3 million from sales of wafers processed from our polysilicon through tolling arrangements.

 

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 period. 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. We also sold a significant portion of products at spot market prices.

 

In 2009, our top three customers, Yingli Green Energy, ReneSola and Solargiga, accounted for approximately 28%, 13% and 12% of our total revenues, respectively, and the three customers in aggregate accounted for approximately 54% of our total revenues. During the six months ended June 30, 2010, our top three customers, Solargiga, China Sunergy and Tianwei New Energy, accounted for approximately 18%, 15% and 9% of our total revenues, respectively, and the three customers in aggregate accounted for approximately 42% of our total revenues.

 

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.

 

Due to our capacity expansion, depreciation in absolute terms has increased significantly and we expect this trend to continue as we further expand our polysilicon production capacity and develop our wafer and module businesses. We also expect that our total cost of revenues will increase as we increase our sales volume. We expect the cost of revenues as a percentage of total revenues may continue to increase as we undertake our vertical integration initiatives while we expect that such increase will be partially offset.

 

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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, execute our vertical integration strategy, 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 significantly 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 business beyond polysilicon manufacturing.

 

Other operating income

 

Our other operating income reflects government subsidies that we receive from time to time, including financial incentives from Chongqing 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.

 

Share-based compensation expenses

 

On October 31, 2009, our board of directors 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 exercise price of all of the options is $1.38 per share. Twenty-five percent of the ordinary shares subject to the options will vest one year following the vesting commencement 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.

 

We will determine share-based compensation expenses based on the fair value of the options as of the date of grant and recognize such expenses over the vesting period of the options. The change of share-based compensation expenses will affect our operating expenses, net income and earnings per share.

 

We have engaged an independent appraiser to assist us in assessing the fair value of our options and ordinary shares underlying the options. Determining the fair value of options and ordinary shares requires making complex and subjective judgments regarding projected financial and operating results, our unique business risks, the liquidity of our shares and our operating history and prospects at the time of grant.

 

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In assessing the fair value of our ordinary shares, the following principal factors were considered:

 

   

the nature of our business and the contracts and agreements relating to our business;

 

   

our financial conditions;

 

   

the economic outlook in general and the specific economic and competitive elements affecting our business;

 

   

the growth of our operations; and

 

   

our financial and business risks.

 

We used the income approach to estimate the fair value of the ordinary shares on October 31, 2009 and the market approach as a cross check and determined that the fair value of our ordinary shares was $1.80 per share on October 31, 2009.

 

The income approach involved applying appropriate discount rates to discount cash flows that were based on our earnings forecasts. The major assumptions used in deriving the fair value of our ordinary shares were consistent with our business plan and outlook as of October 31, 2009. Other major assumptions used in determining the fair value of our ordinary share as of October 31, 2009 included the following:

 

   

Weighted average costs of capital of 18.8% as at October 31, 2009 was used. This was developed based on capital-asset pricing model, with a consideration of the risk-free rate and the industry beta.

 

   

Comparable companies. In deriving discount rate, certain publicly traded companies in polysilicon industry were selected for reference as our comparable companies.

 

   

Discount for lack of marketability of 6% was used in the valuations.

 

We also used other general assumptions, including the following: no material changes in the existing political, legal, fiscal and economic conditions and polysilicon industry in China; our ability to retain competent management and key personnel to support our ongoing operations; and no material deviation in market conditions from economic forecasts.

 

We estimated the fair value of the options using the Black-Scholes option pricing model with the assistance of the appraiser. As we did not have historical share option exercise experience, the expected term was estimated as the average between the vesting term of the options and the original contractual term. The volatility of the underlying ordinary shares during the life of the options was estimated based on the historical stock price volatility of listed comparable companies over a period comparable to the expected term of the options. The risk-free interest rate was estimated based on the yield to maturity of China international government bonds with a maturity period close to the expected term of the options. The dividend yield was estimated based on the expected dividend policy over the expected term of the options.

 

We recognized share-based compensation expenses of $0.3 million and $0.8 million in the year ended December 31, 2009 and the six months ended June 30, 2010, respectively, in connection with the options to purchase 5,350,000 ordinary shares that we granted to officers, directors, employees and consultants on October 31, 2009. As of June 30, 2010, we had $5.2 million unrecognized compensation costs related to the non-vested options, which is expected to be recognized as a charge to expense over the remaining vesting period of 3.33 years from the grant date.

 

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We believe that the increase in the fair value of our ordinary shares from $1.80 per share on October 31, 2009 to $2.30 per share, the midpoint of the estimated range of the initial public offering price, is attributable to the following significant factors and events since October 31, 2009:

 

   

Since October 2009, we have steadily increased our polysilicon production output at our Phase 1 production facilities. In particular, we commenced commercial production of polysilicon at our Phase 1b production facility in December 2009 and fully ramped up to our full capacity in January 2010.

 

   

Starting from January 2010, we have significantly improved our production efficiency and successfully reduced the average unit cost of polysilicon that we sold from above $40 in the four quarter of 2009 to $32 in the second quarter of 2010.

 

   

In November 2009, Daqo Cayman issued and sold 29,714,103 shares of Series A convertible preferred shares in a private placement for a total consideration of $55.0 million. The per share purchase price of the Series A convertible preferred shares is approximately $1.85, which resulted from arms length negotiations between us and the investors. The investment provided us with additional capital resources that were instrumental for our further expansion of production capacity.

 

   

In the second half of September 2010, we and the underwriters agreed to a plan to launch the road show before the end of September in connection with this offering. The offering is expected to increase the value of our ordinary shares as a result of the increased liquidity and marketability of our ordinary shares.

 

Interest income and expenses

 

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.

 

Taxation

 

Cayman Islands tax

 

We are a tax 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 became effective on January 1, 2008, the Chinese enterprise income tax rate applicable to manufacturing entities is 25%.

 

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. In December 2009, Chongqing Daqo was qualified as a “Chongqing Municipality High and New Technology Enterprise,” subject to the government’s grant of a formal certificate. This will entitle it to a preferential income tax rate of 15% for three years from the grant date of the certificate and can be renewed for additional three-year terms upon Chongqing Daqo’s application and the government’s approval.

 

Daqo New Material, our consolidated variable interest entity and a domestic Chinese enterprise, was subject to an income tax rate of 33% for the period from November 16, 2006 to December 31, 2007 and 25% from January 1, 2008 onward.

 

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Nanjing Daqo, our wholly owned Chinese subsidiary and a foreign invested enterprise, is subject to an income tax rate of 25%.

 

Under the EIT Law and implementation regulations issued by the State Council of China, a dividend payment by a foreign-invested entity to its foreign shareholders is subject to a 10% withholding tax. We intend to reinvest all of Chongqing Daqo’s undistributed earnings into our capacity expansion 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. Furthermore, when exporting goods, 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 sale of polysilicon products to China-based purchasers, we are subject to the 17% VAT without any VAT refunds for such sales.

 

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, wafer and module 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 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.

 

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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.

 

Depreciation

 

Our long-lived assets mainly include property, plant and equipment. We depreciate our property, plant and equipment on a straight-line basis over the estimated useful lives of the assets, taking into account the assets’ estimated residual values. We estimate the useful lives and residual values at the time we acquire the assets based on our management’s knowledge on the useful lives of similar assets and replacement costs of similar assets having been used for the same useful lives in the market, and taking into account anticipated technological or other changes. On this basis, we have estimated the useful lives of our buildings and plants to be 20 years, our machinery and equipment to be 10 years, our furniture and office equipment to be 3 to 5 years and our motor vehicles to be 6 years. We review the estimated useful life and residual value for each of our long-lived assets on a regular basis. If technological changes occur more rapidly than anticipated, we may shorten the useful lives or lower the residual value assigned to these assets, which will result in the recognition of increased depreciation and amortization expense in future periods.

 

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. When these events occur, we measure impairment by comparing the carrying amount of the asset group to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flows is less than the carrying amount of the assets, we would recognize an impairment loss equal to the excess of the carrying amount over the fair value of the assets. For the periods presented, we recorded no impairment of our long-lived assets.

 

Consolidation of variable interest entity

 

In addition to the financial statements of Chongqing Daqo and Nanjing Daqo, our wholly owned subsidiaries in China, we also consolidated the financial statements of Daqo New Material as a variable interest entity of Chongqing Daqo starting from July 1, 2008.

 

We were incorporated in November 2007 in the Cayman Islands. Our principal operating subsidiary, Chongqing Daqo, was established in China in January 2008. Daqo New Material was established by Daqo Group, an affiliated company controlled by our current shareholders, on November 16, 2006. Daqo New Material’s activities included acquiring land use rights for our polysilicon manufacturing and constructing certain production infrastructure prior to the incorporation of our company and Chongqing Daqo.

 

After its establishment, Chongqing Daqo entered into a lease agreement with Daqo New Material dated June 30, 2008 to rent all of Daqo New Material’s land, production infrastructure and machinery and equipment for our polysilicon production. The initial lease agreement has a five-year term starting July 1, 2008, with monthly lease payments at a fixed amount of RMB9.95 million ($1.4 million). The rental amount under the initial lease agreement was determined based on factors, such as Daqo New Material’s operating expenses, interest expenses and the return on investment required by Daqo New Material’s owners. The initial lease agreement also provided that if Daqo New Material transferred the ownership of the leased assets to any third party, the lease agreement will remain effective and enforceable against the new owner until its expiry. One month before the expiry of the initial lease term, the lease agreement could be renewed for an additional five- year term upon mutual consent. Chongqing Daqo had the right of first refusal to rent the leased assets under the initial lease agreement.

 

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The lease agreement was amended and restated in August 2009, with retrospective effect from January 1, 2009. After one year of operations, Daqo New Material and Chongqing Daqo concluded that the lease payments under the original lease agreement would result in excessive return on investment to Daqo New Material in the foreseeable future. The amount of the monthly lease payment was thus reduced to RMB6.1 million ($0.9 million) in the amended and restated lease agreement. Under the amended and restated lease agreement, the lease period is from January 1, 2009 until December 31, 2013. One month before the expiry of the lease period, Chongqing Daqo has the option to renew the lease on the same terms and conditions for additional five-year periods. Furthermore, the amended and restated lease agreement provides that Chongqing Daqo has the option to purchase, or to designate any person to purchase, the leased assets at the then fair value at any time during the lease period or within one year following the lease period, if permitted by the PRC laws and regulations. If Daqo New Material desires to transfer the ownership of the leased assets to a third party, Chongqing Daqo has the right of first refusal to acquire the leased assets under the same conditions, and if the leased assets are transferred to a third party, the lease agreement will remain effective and enforceable against the new owner.

 

On November 9, 2009, Chongqing Daqo entered into a supplemental lease agreement with Daqo New Material to lease the production facilities for Phase 1b from November 9, 2009 until December 31, 2013 at a fixed amount. The other terms of the supplemental lease agreement are the same as those of the amended and restated lease agreement of Phase 1a.

 

As the aggregate value of the monthly rental payments that Chongqing Daqo is contractually obligated to make to Daqo New Material represents the majority of the value of Daqo New Material’s assets, Daqo Group has less investment risk in Daqo New Material, its wholly owned subsidiary, than does Chongqing Daqo. Under U.S. GAAP, these contractual obligations represent an implicit guarantee between related parties, and Daqo New Material is considered to be our “variable interest entity.” We considered the accounting guidance for variable interest entities and concluded that we have the characteristics of a controlling financial interest. Therefore, Chongqing Daqo is considered the “primary beneficiary” of Daqo New Material. As a result, we have consolidated Daqo New Material’s financial results into our own since July 1, 2008. Even though we do not directly or indirectly hold any equity interests in Daqo New Material, Daqo New Material has been deemed to be our predecessor business from November 16, 2006 through June 30, 2008 under U.S. GAAP.

 

The assets and liabilities of Daqo New Material are consolidated at historical cost. Daqo Group’s total equity interests in Daqo New Material are presented as a noncontrolling interest on our financial statements. The amount of net income (loss) attributable to noncontrolling interest is equivalent to the rental income that Daqo New Material receives from Chongqing Daqo minus depreciation and interests costs during each reporting period. Please refer to note 16 to our unaudited condensed consolidated financial statements included elsewhere in this prospectus for details of Daqo New Material’s total assets and liabilities as of June 30, 2010 and its net revenues, operating costs and expenses, net income for the six months ended June 30, 2010.

 

Income taxes

 

As required by Accounting Standards Codification 740, “Income Taxes,” we periodically evaluate the likelihood of the realization of deferred tax assets, and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. Deferred income taxes are recognized for (1) temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, or (2) net operating loss carry forwards and credits by applying enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on the characteristics of the

 

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underlying assets and liabilities, or the expected timing of their use when they do not relate to a specific asset or liability.

 

Valuation of inventories

 

Our inventories are stated at the lower of cost or net realizable value. The valuation of inventory involves our management’s determination of the value of excess and slow moving inventory, which is based upon assumptions of future demands and market conditions. If actual market conditions are less favorable than those projected by management, inventory write-downs may be required. We routinely evaluate quantities and value of our inventories in light of current market conditions and market trends, and record write-downs against the cost of inventories for a decline in net realizable value. Inventory write-down charges establish a new cost basis for inventory. In estimating obsolescence, we utilize our backlog information and project future demand. Market conditions are subject to change and actual consumption of inventories could differ from forecasted demand. Furthermore, the price of polysilicon is subject to fluctuations based on global supply and demand. If actual market conditions are less favorable or other factors arise that are significantly different than those anticipated by our management, additional inventory write-downs or increases in obsolescence reserves may be required. Our management continually monitors the spot price of polysilicon to ensure that inventory is recorded at the lower of cost or net realizable value.

 

Share-based compensation expenses

 

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.

 

Internal Control Over Financial Reporting

 

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls over financial reporting. Our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in connection with the audits of our consolidated financial statements as of and for the years ended December 31, 2009, we and our independent registered public accounting firm identified one “material weakness” and one “significant deficiency” in our internal control over financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board of the United States. The material weakness identified related to our lack of sufficient accounting resources and expertise necessary to comply with U.S. GAAP and SEC reporting and compliance requirements. The significant deficiency identified related to our lack of sufficient and formally documented procedures for the financial closing and reporting process.

 

To address the weakness and the deficiency that have been identified, we are in the process of implementing a number of measures, including: (1) hiring an outside consulting firm to review our internal control processes, policies and procedures in order to assist us in identifying any weaknesses or deficiencies in our internal control over financial reporting, (2) providing further training to our financial and accounting staff to enhance their knowledge of U.S. GAAP, and (3) adopting and implementing additional policies and procedures, including an enterprise resource planning system, to strengthen our internal control over financial reporting. We are working to implement these measures during 2010, although we cannot assure you that we will complete such implementation in a timely manner.

 

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Results of Operations

 

Results of Operations of Daqo Cayman

 

The following table sets forth a summary of our statement of operations for the periods indicated, a percentage of total revenues. Our historical results presented below are not necessarily indicative of the results that may be expected for any future period.

 

     Year Ended
December 31,
    Six Months
Ended

June 30,
 
     2008     2009     2009     2010  
                 (unaudited)  

Revenues

        

Polysilicon

   100.0   95.5   89.9   91.5

Other revenues

        4.5      10.1      8.5   
                        

Total revenues

   100.0      100.0      100.0      100.0   

Cost of revenues

   (34.4   (62.3   (50.6   (65.6
                        

Gross profit

   65.6      37.7      49.4      34.4   

Operating expenses/income:

        

Selling, general and administrative expenses

   (8.8   (8.4   (6.8   (8.0

Research and development expenses

   (8.6   (2.5   (4.6   (1.0

Other operating income

   0.1      5.9      2.1      2.5   
                        

Total operating expenses

   (17.3   (5.0   (9.3   (6.5
                        

Income from operations

   48.3      32.8      40.1      27.9   

Interest expense

   (6.9   (5.8   (6.6   (5.5

Interest income

   0.2      0.2      0.3      0.2   
                        

Income before income taxes

   41.6      27.1      33.9      22.6   

Income tax expense

   (2.8   (0.2   (5.0   (4.0
                        

Net income

   38.8      26.9      28.8      18.6   

Net income attributable to noncontrolling interest

   0.6      (0.8   (1.9   0.1   
                        

Net income attributable to Daqo New Energy Corp.’s shareholders

   38.2   27.7   30.7   18.5
                        

 

Six Months ended June 30, 2009 and 2010

 

Total revenues. Our total revenues increased by 98.5% from $49.2 million in the six months ended June 30, 2009 to $97.6 million in the six months ended June 30, 2010. The increase in total revenues was primarily attributable to an increase in revenues generated from sales of polysilicon from $44.2 million to $89.3 million. The increase in our revenues was also due to an increase in other revenues from $5.0 million generated from sales of cells that we had acquired through tolling arrangements in the six months ended June 30, 2009 to $8.3 million in the six months ended June 30, 2010 generated from sales of wafers. The increase in revenues generated from sales of polysilicon was due to the increase of our polysilicon sales volume from 443 MT in the six months ended June 30, 2009 to 1,710 MT in the six months ended June 30, 2010, which was offset by a 47.7% decrease in our polysilicon average selling price during the same periods.

 

Cost of revenues. Our cost of revenues increased by 157.5% from $24.9 million in the six months ended June 30, 2009 to $64.0 million in the six months ended June 30, 2010. The increase in costs of revenues was primarily attributable to an increase of $35.9 million in costs of revenues for polysilicon in the six months ended June 30, 2009.

 

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Gross profit. Our gross profit increased by 38.1% from $24.3 million in the six months ended June 30, 2009 to $33.5 million in the six months ended June 30, 2010. Our gross margin decreased from 49.4% in the six months ended June 30, 2009 to 34.4% in the six months ended June 30, 2010. The decrease in profit margin was primarily due to the decrease of our polysilicon average selling price that outpaced the decrease in our per unit cost of revenues, and, to a lesser extent, changes in our product mix during the periods. We sold $5.0 million cells in the six months ended June 30, 2009, which had a higher margin than the $8.3 million wafers we sold in the six months ended June 30, 2010.

 

Selling, general and administrative expenses. Our selling, general and administrative expenses increased by 135.5% from $3.3 million in the six months ended June 30, 2009 to $7.8 million in the six months ended June 30, 2010, and increased as a percentage of total revenues from 6.8% in the six months ended June 30, 2009 to 8.0% in the six months ended June 30, 2010. The increase in our selling, general and administrative expenses was due primarily to an incurrence of $2.6 million expenses in relation to our postponed initial public offering in February 2010 and, to a lesser extent, the share-based compensation expenses of $0.8 million in the six months ended June 30, 2010.

 

Research and development expenses. Our research and development expenses decreased by 58.5% from $2.3 million to $0.9 million, and decreased as a percentage of total revenues from 4.6% in the six months ended June 30, 2009 to 1.0% in the six months ended June 30, 2010. The decrease in our research and development expenses was due primarily to less research and development projects incurred as the result of our ramp-up of Phase 1 polysilicon production facilities, partially offset by an increase in the number of personnel performing research and development functions from 18 in the six months ended June 30, 2009 to 28 in the six months ended June 30, 2010.

 

Other operating income. Our other operating income increased by 137.1% from $1.0 million to $2.4 million, and increased as a percentage of total revenues from 2.1% in the six months ended June 30, 2009 to 2.5% in the six months ended June 30, 2010. Our other operating income mainly represented the financial incentives that we received from local government authorities.

 

Interest expense and income. Our interest expenses increased by 65% from $3.2 million in the six months ended June 30, 2009 to $5.4 million in the six months ended June 30, 2010. Our interest expenses increased due to interest payments in connection with the short-term and long-term borrowings to finance our equipment purchases and the working capital requirements of our business operations and the cessation of interest capitalization of the long-term borrowings used in our Chongqing Phase 1b production facilities construction since November 2009 when Chongqing Phase 1b production facilities was ready for use. Our interest income was $0.2 million in the six months ended June 30, 2009 and in 2010.

 

Income tax expense. Our income tax expense increased by 55.9% from $2.5 million in the six months ended June 30, 2009 to $3.9 million in the six months ended June 30, 2010, primarily due to the increase in our income before taxes.

 

Net income (loss) attributable to the noncontrolling interest. The net income attributable to the noncontrolling interest in the six months ended June 30, 2010 was $0.1 million as compared to the net loss attributable to the noncontrolling interest of $0.9 million in the six months ended June 30, 2009. The net income (loss) attributable to noncontrolling interest is the result of Daqo Group’s share of the profit (loss) in Daqo New Material, which resulted from the various costs and expenses incurred during the period, and the rental income that Daqo New Material received from Chongqing Daqo.

 

Net income attributable to our shareholders. As a result of the factors described above, we had net income attributable to our shareholders of $18.0 million for the six months ended June 30, 2010, compared to net income of $15.1 million for the six months ended June 30, 2009.

 

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Year ended December 31, 2008 and 2009

 

Total revenues. Our total revenues increased by 97.3% from $56.4 million in 2008 to $111.2 million in 2009. The increase in total revenues was primarily attributable to an increase in revenues generated from sales of polysilicon from $56.4 million in 2008 to $106.2 million in 2009. The increase in revenues generated from sales of polysilicon was due to the increase of our polysilicon sales volume from 237 MT in 2008 to 1,498 MT in 2009, offset by a 70.1% decrease in our polysilicon average selling price during the same period. The increase in our revenues was also due to a $5.0 million increase in other revenues generated from sales of cells which we had acquired through tolling arrangements.

 

Cost of revenues. Our cost of revenues increased by 257.1% from $19.4 million in 2008 to $69.3 million in 2009. The increase in costs of revenues was primarily attributable to an increase of $46.4 million in costs of revenues for polysilicon sold and, to a lesser extent, an incurrence of $3.5 million in cost of revenues for photovoltaic cell production, including the costs of 16 MT of our polysilicon used to process cells and tolling fees charged by third party cell manufacturers.

 

Gross profit. Our gross profit increased by 13.4% from $37.0 million in 2008 to $41.9 million in 2009. Our gross profit margin decreased from 65.6% in 2008 to 37.7% 2009. The decrease in gross margin was primarily due to the decrease of our polysilicon average selling price outpacing the decrease in our per unit cost of revenues and, to a lesser extent, the fact that the proportion of photovoltaic cells sold in 2009, which have lower profit margin than polysilicon, increased in our product mix in 2009.

 

Selling, general and administrative expenses. Our selling, general and administrative expenses increased by 87.4% from $5.0 million in 2008 to $9.3 million in 2009. Such increase was in line with the increase of our net revenues. As a percentage of total revenues, our selling, general and administrative expenses slightly decreased from 8.8% in 2008 to 8.4% in 2009.

 

Research and development expenses. Our research and development expenses decreased by 43.0% from $4.9 million in 2008 to $2.8 million in 2009, and decreased as a percentage of total revenues from 8.6% in 2008 to 2.5% in 2009. The decrease in our research and development expenses was due primarily to less research and development projects incurred as the result of our ramp-up of Phase 1 polysilicon production facilities, partially offset by an increase in the number of personnel performing research and development functions from 17 in 2008 to 22 in 2009.

 

Other operating income. Our other operating income increased from $83.7 thousand to $6.6 million, and increased as a percentage of revenues from 0.1% in 2008 to 5.9% in 2009. Our other operating income was mainly cash subsidies that we received from local government.

 

Interest expense and income. Our interest expenses increased by 66.8% from $3.9 million in the year ended December 31, 2008 to $6.5 million in the year ended December 31, 2009. The increase was due to interest payments in connection with the short-term and long-term borrowings to finance our equipment purchases and the working capital requirements of our business operations and the cessation of interest capitalization of long-term borrowings used in our production facilities in November 2009. Our interest income increased by 86.2% from $0.1 million in the year ended December 31, 2008 to $0.2 million in the year ended December 31, 2009 primarily due to interest accrued on increased deposits of our restricted cash with Chinese banks.

 

Income tax expense. Our income tax expense decreased by 85.0% from $1.6 million in the year ended December 31, 2008 to $0.2 million in the year ended December 31, 2009. The decrease was mainly due to $3.8 million tax credit we received from the local government for our purchase of qualified energy conservation machinery and equipment, which was partly offset by our increased tax payable on the increased taxable income in 2009.

 

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Net income (loss) attributable to noncontrolling interest. The net income attributable to the noncontrolling interest was $0.3 million in the year ended December 31, 2008 as compared to the net loss attributable to the noncontrolling interest of $0.9 million in the year ended December 31, 2009. The net income (loss) attributable to noncontrolling interest represents Daqo Group’s share of the net income (loss) of Daqo New Material, which equals the rental income that Daqo New Material received from Chongqing Daqo minus various costs and expenses incurred during the period.

 

Net income attributable to our shareholders. As a cumulative result of the factors described above, we had net income attributable to our shareholders of $21.5 million for the year ended December 31, 2008, compared to net income of $30.8 million for the year ended December 31, 2009.

 

Results of Operations of Daqo New Material

 

Our predecessor business and consolidated variable interest entity, Daqo New Material, was established in China in November 2006. Daqo New Material was a development stage company. We have consolidated Daqo New Material’s financial statements into ours since July 1, 2008. For the period from November 16, 2006 to June 30, 2008, Daqo New Material incurred expenses related to its start-up activities and had no revenues. We do not believe it is material or meaningful to provide a period-to-period comparison of the results of operations of Daqo New Material from its inception to June 30, 2008.

 

The following table sets forth a summary of the statement of operations for Daqo New Material for the periods indicated:

     Period from
November 16,
2006
(inception) to
December 31,
2006
    Year Ended
December 31,

2007
    Six Months
Ended June 30,
2008
    Accumulated
from
November 16,
2006
(inception) to
June 30,

2008
 

Operating expenses:

        

General and administrative expenses

   $ (489,748   $ (1,052,794   $ (2,059,789   $ (3,602,331

Other operating income

                   157,417        157,417   
                                

Total operating expenses

     (489,748     (1,052,794     (1,902,372     (3,444,914
                                

Loss from operations

     (489,748     (1,052,794     (1,902,372     (3,444,914

Interest income

     3,882        74,491        185,258        263,631   
                                

Loss before income taxes

     (485,866     (978,303     (1,717,114     (3,181,283

Income tax benefit

     160,336        207,067        427,813        795,216   
                                

Net loss

   $ (325,530   $ (771,236   $ (1,289,301   $ (2,386,067
                                

 

Revenues. As Daqo New Material was a development stage company during the period from November 16, 2006 to June 30, 2008, it had no revenues during the period.

 

Operating expenses. Daqo New Material incurred $3.4 million operating expenses for the period from November 16, 2006 to June 30, 2008. These expenses reflected $3.6 million general and administrative expenses related to the initial business start-up costs to fund the construction of production capacities, partially offset by other operating income of $0.2 million as a result of cash subsidies that we received from the Chongqing government.

 

Interest income. Daqo New Material had $0.3 million of interest income attributable to interest on its bank deposits for the period from November 16, 2006 to June 30, 2008.

 

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Income tax benefit. Daqo New Material recognized an income tax benefit of $0.8 million for the period from November 16, 2006 to June 30, 2008, resulted from deferred tax benefits attributable to its net loss of $3.2 million carryforwards for this period.

 

Net loss. As a cumulative result of the factors described above, Daqo New Material had a net loss of $2.4 million for the period from November 16, 2006 to June 30, 2008.

 

Selected Quarterly Results of Operations

 

The following table presents our unaudited condensed consolidated quarterly results of operations for the eight quarterly periods ended June 30, 2010. You should read the following table in conjunction with our audited and unaudited consolidated financial statements and related notes included elsewhere in this prospectus. We have prepared the unaudited condensed consolidated quarterly financial information on the same basis as our audited consolidated financial statements. This unaudited condensed consolidated financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair representation of our financial position and operating results for the quarters presented. Because our business is relatively new, our operating results for any particular quarter are not necessarily indicative of our future results.

 

    Quarter Ended  
    September 30,
2008
    December 31,
2008
    March 31,
2009
    June 30,
2009
    September 30,
2009
    December 31,
2009
    March 31,
2010
    June 30,
2010
 
    (in thousands)  

Revenues

               

Polysilicon

  $ 19,715      $ 36,653      $ 26,605      $ 17,579      $ 30,324      $ 31,716      $ 42,308      $ 47,013   

Other revenues

                         4,969                      2,793        5,468   
                                                               

Total revenues

    19,715        36,653        26,605        22,548        30,324        31,716        45,101        52,481   

Cost of revenues

    (9,130     (10,262     (8,164     (16,708     (20,745     (23,635     (30,971     (33,073
                                                               

Gross profit

    10,585        26,391        18,441        5,840        9,579        8,082        14,130        19,408   

Selling, general and administrative expenses

    (1,230     (1,050     (1,248     (2,079     (2,228     (3,779     (5,321     (2,514

Research and development expenses

    (1,918     (1,940     (1,164     (1,093     (108     (410     (453     (483

Other operating income

           84               1,029        848        4,715        2,367        74   
                                                               

Total operating (expenses) income

    (3,148     (2,906     (2,412     (2,143     (1,488     526        (3,407     (2,924
                                                               

Income from operations

    7,437        23,485        16,029        3,697        8,091        8,608        10,723        16,484   

Interest expense

    (1,810     (1,883     (1,711     (1,537     (1,487     (1,727     (2,748     (2,611

Interest income

    57        36        108        59        20        27        126        34   
                                                               

Income before income taxes

    5,684        21,638        14,426        2,219        6,624        6,908        8,101        13,907   

Income tax benefit (expense)

    (823     (1,393     (2,096     (379     (918     3,153        (1,712     (2,147
                                                               

Net income

  $ 4,861      $ 20,245      $ 12,330      $ 1,840      $ 5,706      $ 10,061      $ 6,389      $ 11,760   
                                                               

 

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The following table sets forth our historical unaudited consolidated selected quarterly results of operations for the periods indicated, as a percentage of total revenues.

 

    Quarter Ended  
    September 30,
2008
    December 31,
2008
    March 31,
2009
    June 30,
2009
    September 30,
2009
    December 31,
2009
    March 31,
2010
    June 30,
2010
 

Revenues

               

Polysilicon

  100.0   100.0   100.0   78.0   100.0   100.0   93.8   89.6

Other revenues

                 22.0                6.2      10.4   
                                               

Total revenues

  100.0      100.0      100.0      100.0      100.0      100.0      100.0      100.0   

Cost of revenues

  (46.3   (28.0   (30.7   (74.1   (68.4   (74.5   (68.7   (63.0
                                               

Gross profit

  53.7      72.0      69.3      25.9      31.6      25.5      31.3      37.0   

Selling, general and administrative expenses

  (6.2   (2.9   (4.7   (9.2   (7.3   (11.9   (11.8   (4.8

Research and development expenses

  (9.7   (5.3   (4.4   (4.8   (0.4   (1.3   (1.0   (0.9

Other operating income

       0.2           4.6      2.8      14.9      5.2      0.1   
                                               

Total operating (expenses) income

  (16.0   (7.9   (9.1   (9.5   (4.9   1.7      (7.6   (5.6
                                               

Income from operations

  37.7      64.1      60.2      16.4      26.7      27.1      23.8      31.4   

Interest expense

  (9.2   (5.1   (6.4   (6.8   (4.9   (5.4   (6.1   (5.0

Interest income

  0.3      0.1      0.4      0.3      0.1      0.1      0.3      0.1   
                                               

Income before income taxes

  28.8      59.0      54.2      9.8      21.8      21.8      18.0      26.5   
                                               

Net income

  24.7   55.2   46.3   8.2   18.8   31.7   14.2   22.4
                                               

 

Our revenues and operating results have fluctuated in the past from quarter to quarter due primarily to changes in our polysilicon sales volumes, fluctuations in the average selling prices of our polysilicon caused by global supply and demands and changes in our photovoltaic product mix. For example, our gross margins declined from the quarter ended March 31, 2009 to the quarter ended June 30, 2009 as a result of the significant decrease in our polysilicon average selling price due to the industry-wide reduction in polysilicon prices. We also experience seasonal changes in our electricity costs as a result of the different seasonal electricity rates that the local power grid charges. Daqo Chongqing uses electricity generated from the hydropower station in Chongqing which generates the majority of electricity during times of high precipitation, primarily in the second and third quarters of each year. As a result, the electricity costs of Daqo Chongqing are generally lower in the second and third quarters and higher in the first and fourth quarters, which in turn affects our costs of revenues.

 

The following table sets forth our sales volume of polysilicon for the periods indicated.

 

     Quarter Ended
    September 30,
2008
  December 31,
2008
  March 31,
2009
  June 30,
2009
  September 30,
2009
  December 31,
2009
  March 31,
2010
  June 30,
2010

Polysilicon sales volume (in MT)

  67   170   179   264   458   597   814   896

 

In the quarter ended June 30, 2009, we used approximately 16 MT of our polysilicon to process cells through tolling arrangements. In the two quarters ended June 30, 2010, we used 69 MT of our polysilicon to process wafers through tolling arrangements with wafer manufacturers.

 

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Capital Expenditures and Plan of Operations

 

We made capital expenditures of $101.8 million and $10.4 million for construction of our polysilicon and module production facilities and purchase of polysilicon and module production equipment in the year ended December 31, 2009 and the six months ended June 30, 2010, respectively. These capital expenditures mainly related to the construction of our Phase 1 facilities in Chongqing. We have also entered into agreements for future purchases of property, plant and equipment. These commitments as of December 31, 2009 and June 30, 2010 amounted to approximately $0.6 million and $2.2 million in total, respectively. We expect that purchases of equipment for our polysilicon capacity expansion will continue to constitute a significant portion of our capital expenditures. Our capital expenditures will increase in the future as we expand our polysilicon manufacturing capacity and wafer and module capacity and enter into the wafer businesses.

 

We expect that we will require approximately $100 million for capital expenditures in the second half of 2010 and approximately $210 million in 2011. Such projected capital expenditures will be used primarily for technological improvements and equipment enhancements for our Phase 1 polysilicon facilities, construction of our Phase 2 polysilicon facilities and wafer facilities, and the gradual increase of our module production capacity.

 

We believe that our current cash and cash equivalents, anticipated cash flow from our operations, proceeds from additional bank borrowings and this offering will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures, for at least the next 12 months. We intend to use cash generated from operations to fund our expansion in the module manufacturing business. We intend to use a portion of the proceeds from this offering to meet our capital expenditure requirements, but in the event that this offering is not completed, we plan to finance this expansion plan by using cash generated from operating activities and take other actions to obtain alternative sources of financing, such as obtaining loan facilities from financial institutions or entering into capital lease arrangements. As of the date of this prospectus, we have not identified a committed source of funding in this respect nor can we guarantee one would ever be available. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or expansions we may decide to pursue. If we do not have sufficient cash to meet our requirements, we may seek to issue additional equity securities or debt securities or to borrow from lending institutions.

 

For additional information relating to our plan of operations in the second half of 2010 and 2011, see “Use of Proceeds,” “—Liquidity and Capital Resources” and “Business—Manufacturing Capacity” in this prospectus.

 

Liquidity and Capital Resources

 

Cash Flows and Working Capital

 

Polysilicon production requires intensive capital investment. Due to our relatively short operating history, our financing is primarily through advances from customers and financing from Daqo Group, in addition to cash flow from sales of polysilicon and from bank borrowings. 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 if our cash on hand and cashflow from our operations are insufficient for our future capital needs.

 

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The following table sets forth a summary of our cash flows for the periods indicated:

 

     Year Ended December 31,     Six Months Ended
June 30,
 
     2008     2009     2009         2010      
                 (unaudited)  
     (in thousands)  

Net cash provided by (used in) operating activities

   $ 102,655      $ (2,730   $ (8,001   $ 6,756   

Net cash used in investing activities

     (138,301     (109,670     (92,502     (13,932

Net cash provided by financing activities

     38,931        190,502        101,499        (10,884

Effect of exchange rate changes

     20        7        0.2        29   
                                

Net increase (decrease) cash and cash equivalents

     3,304        78,110        996        (18,030

Cash and cash equivalents at the beginning of the year/period

            3,304        3,304        81,414   
                                

Cash and cash equivalents at the end of the
year/period

   $ 3,304      $ 81,414      $ 4,300      $ 63,384   
                                
Supplemental disclosure of cash flow information:         

Interest paid

   $ 3,313      $ 3,732      $ 4,473      $ 5,150   

Income taxes paid

            1,818        1,340        271   
Supplemental schedule of non-cash investing activities:         

Purchases of property, plant and equipment included in payable

   $ 71,146      $ 53,224      $ 86,581      $ 24,699   

 

As of June 30, 2010, we had $2.0 million in restricted cash and $63.4 million in cash and cash equivalents. Approximately $8.9 million and $0.1 million of our restricted cash and cash and cash equivalents were held by Chongqing Daqo and Daqo New Material, respectively, in RMB. 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 notes in support of our purchases of property, plant and equipment. 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.

 

Operating Activities

 

Net cash provided by operating activities for the six months ended June 30, 2010 was $6.8 million, primarily resulted from $79.4 million of cash we received from the sale of polysilicon, our payments for raw materials and utilities of $54.0 million, taxes paid of $6.2 million, employee salaries and welfare payment of $5.0 million. Our accounts receivable increased significantly from $16.7 million as of December 31, 2009 to $51.9 million June 30, 2010, primarily due to the significant increase of our revenues from polysilicon sales during the same period and to a lesser extent due to the longer credit term that our customers required in the first half of 2010. We continue to closely monitor collections and will adjust our bad debt estimates accordingly.

 

Net cash used in operating activities for the year ended December 31, 2009 was $2.7 million primarily resulting from our payments for raw materials and utilities of $78.2 million, taxes paid of $8.5 million, employee salaries and welfare payment of $5.8 million, partially offset by $89.0 million of cash we received from the sale of polysilicon.

 

Net cash provided by operating activities for the year ended December 31, 2008 was $102.7 million, primarily resulting from $63.5 million of cash we received from the sale of polysilicon and $59.3 million advance payments that we received from our customers, which was partially offset by our payments for raw materials and utilities and employee salaries and welfare.

 

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Investing Activities

 

Net cash used in investing activities for the six months ended June 30, 2010 was $13.9 million. Net cash used in investing activities for the six months ended June 30, 2010 primarily resulted from payments for the purchase of property, plant and equipment in a total amount of $20.7 million and a decrease in restricted cash of $6.8 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.

 

Net cash used in investing activities for the year ended December 31, 2009 was $109.7 million, primarily resulting from payments for the purchase of property, plant and equipment in a total amount of $121.3 million, offset by a decrease in restricted cash of $11.6 million that we placed in our bank accounts as guarantee deposits for the banks’ issuance of short term letters of credit in support of our purchases of property, plant and equipment.

 

Net cash used in investing activities for the year ended December 31, 2008 was $138.3 million, primarily resulting from payments for the purchase of property, plant and equipment in a total amount of $138.9 million, and an increase in restricted cash of $3.5 million that we placed in our bank accounts as guarantee deposits for the banks’ issuance of short term letters of credit in support of our purchases of property, plant and equipment. The cash outflow was partially offset by a $4.1 million increase in cash as a result of our consolidation of Daqo New Material as a variable interest entity.

 

Financing Activities

 

Net cash used in financing activities for the six months ended June 30, 2010 was $10.9 million, primarily resulting from the repayment of bank borrowing in the amount of $13.5 million, and offset by advances from Daqo Group in the amount of $0.4 million and the proceeds of other borrowings from a third party in the amount of $2.2 million.

 

Net cash provided by financing activities for the year ended December 31, 2009 was $190.5 million, primarily resulting from the net proceeds of our borrowings of $94.0 million, net proceeds of $54.9 million from issuance of Series A preferred shares and cash in the amount of $41.5 million financed by Daqo Group to settle the outstanding accounts payable for property, plant and equipment that we purchased.

 

Net cash provided by financing activities for the year ended December 31, 2008 was $38.9 million, resulting from the proceeds of our bank borrowings of $16.5 million and cash at the amount of $21.5 million financed by Daqo Group to settle the outstanding accounts payable for property, plant and equipment that we purchased.

 

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Contractual Commitments

 

Contractual Obligations and Commercial Commitments

 

The following table sets forth our contractual obligations and commercial commitments as of June 30, 2010:

 

     Payments Due by Period
     Total    Less Than
1 Year
   1-3 Years    3-5 Years    More Than
5 Years
     (in thousands)
Contractual obligations:               

Short-term debt(1)(3)

   $ 16,958    $ 16,958    $    $    $

Long-term debt(2)(3)

     153,418      31,114      90,158      32,146     

Capital commitments(4)

     2,217      2,217               

Other long-term borrowings

     7,130      900      6,230          

Operating lease obligations(5)

     3,778           3,778          
                                  

Total obligations

   $ 183,501    $ 51,189    $ 100,166    $ 32,146    $
                                  

 

Notes:

(1)   The weighted average interest rate on the short-term bank borrowings as of June 30, 2010 was 5.31%.
  (2)   Includes floating rate interest payments. Our floating rate debts are all RMB-denominated and the interest rates will be adjusted annually by the lenders based on the updated benchmark interest rates published by the People’s Bank of China. Our weighted average floating interest rate as of June 30, 2010 was 5.85%, which was used for the calculation of the total amount of our long-term debts.
  (3)   As of June 30, 2010 bank loans in the amount of $168.2 million were guaranteed by Daqo Group.
  (4)   Represents commitments relating to our purchase of property, plant and equipment for our production capacity expansion, including payment commitments to our project contractors.
  (5)   Represents Chongqing Daqo’s obligation to settle its land use right fees with the local Chinese government pursuant to a land use right agreement. Pursuant to the agreement, Chongqing Daqo was required to settle land use right fees of $3.8 million to obtain a 50-year land use right.

 

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. 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.

 

Inflation

 

In recent years, China has not experienced significant inflation, and thus inflation has not had a material impact on our results of operations. According to the National Bureau of Statistics of China, the consumer price index in China increased 4.8% and 5.9% in 2007 and 2008, respectively, and decreased 0.7% in 2009. In the first six months of 2010, the consumer price index increased 2.6%.

 

Market Risks

 

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 U.S. dollar or Euro income that we may generate in the future for sale of our photovoltaic products in the international market, (2) the U.S. dollar proceeds of this offering, most or substantially all of which we expect to convert into RMB over time for the uses discussed under “Use of

 

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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 we receive from this offering 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.

 

Interest Rate Risk

 

Our exposure to interest rate risk primarily relates to interest expenses incurred by 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 June 30, 2010, we had outstanding short-term bank borrowings of $14.7 million and outstanding long-term bank borrowings of $153.4 million, with a weighted average floating interest rate of 5.80%. We are currently not engaged in any interest rate hedging activities.

 

Recent Accounting Pronouncements

 

As of January 1, 2010, we adopted ASU 2010-10 “Consolidation (Topic 810) Amendments for Certain Investment Funds” to defer the application of SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” for a reporting entity’s interest in an entity (1) that has all the attributes of an investment company or (2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The adoption of ASU 2010-10 did not affect our consolidated financial statements.

 

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INDUSTRY

 

Photovoltaic Market

 

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. Solarbuzz reports that the global photovoltaic market reached 7.3 GW in 2009, an increase from 1.7 GW in 2006, representing a three-year compound annual growth rate of 62.5%. At the end of 2009, cumulative global photovoltaic installations were 23.1 GW.

 

Solar power systems use solar cells based on two main technologies: crystalline-silicon, or C-Si, and thin-film. According to Solarbuzz, C-Si based solar cells dominate the photovoltaic market, accounting for 82% of the total solar cell production in 2009 due to their high energy conversion efficiency and reliability.

 

Despite the photovoltaic market slowdown during the first half of 2009, customers purchased more photovoltaic products in response to significantly lowered price in the second half of 2009, which led to a 20% increase in demand of photovoltaic products. It is expected that the photovoltaic market will continue to grow. The following diagram illustrates the forecast of the world’s photovoltaic demand from 2010 to 2014 under Solarbuzz’s production-led energy scenario.

 

LOGO

 

Source:   Marketbuzz, 2010
*   Solarbuzz lays out three scenarios: balanced energy, green world and production-led scenarios. The balanced energy scenario assumes that the photovoltaic market’s growth is limited by restrictions on incentives and policies and projects the world’s photovoltaic market to reach 15.4 GW in 2014. The green world energy scenario assumes a higher level of installation resulting from growth led by new and growing market incentive programs for grid-connected photovoltaics, and projects the world’s photovoltaic market to reach 24.7 GW in 2014. The production-led scenario assumes the most aggressive photovoltaic market growth led by pricing decline and strong growth in the U.S. market and projects the world’s photovoltaic market to reach 37.1 GW in 2014. We believe that among the three scenarios, the production-led scenario provides the most convincing projection of market growth given the growth of the market size in 2009 and therefore we have presented the production-led scenario instead of the other two scenarios.

 

Key Drivers of the Photovoltaic Industry

 

Advantages of Solar Power

 

Solar power has several advantages over conventional and other forms of renewable energy:

 

   

Reduced Dependence on Finite Conventional Energy Sources. Solar power is an optimal renewable energy source. Using solar power reduces the need for a country to access the global commodity markets and allows it to rely on its own solar resources for power supply.

 

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Ease of Installation Close to Demand Centers. Currently, most electricity is generated in centralized plants that rely on transmission systems to transport electricity to demand centers. Solar power systems can be modular and installed close to the demand centers in many instances, lessening the need to invest capital in new transmission systems and electricity grids.

 

   

Ability to Meet Peak Demand. Solar power systems generate electricity when the sun is available, coinciding with the higher demand for electricity during the daytime.

 

   

Environmental Friendliness. Greenhouse gas emissions and their impact on climate change continue to be a global concern. Solar power systems emit no greenhouse gases, making them a ready solution to replace current power production that is dependent on fossil fuels.

 

   

Low Variable Cost. In addition to requiring no fuel supply, solar power systems also have limited operational and maintenance variable costs. After payment of the fixed installation cost, solar power becomes one of the lowest variable cost sources of energy.

 

Government Incentives

 

Many governments worldwide, such as Germany, Spain, the United States and China, have implemented programs that encourage the use of renewable energy sources, including solar power.

 

Decreasing Costs of Solar Energy

 

Solar energy has become an attractive alternative energy source because of narrowing cost differences between solar energy and conventional energy sources due to market-wide decreases in the average selling prices for solar power products due to lower raw materials costs and increased production efficiencies.

 

Key Challenges for the Photovoltaic Industry

 

Need to Improve Cost Competitiveness Against Other Energy Sources. The primary challenge for the photovoltaic industry is to reduce the price per watt of energy for end-users. It remains a challenge for the photovoltaic industry to reach a sufficient scale to be cost-effective in a non-subsidized marketplace.

 

Possible Reduction or Elimination of Government Subsidies and Incentives. The current growth of the photovoltaic industry substantially relies on the availability and size of government subsidies and economic incentives, such as capital cost rebates, favorable feed-in-tariff, tax credits, net metering and other incentives.

 

Ability to Obtain Financing. Due to the high initial and continuing capital expenditure requirements, it is crucial for photovoltaic industry participants to obtain large amount of financing to fund their operations, expansions and research and development activities on a timely manner in order to survive or succeed.

 

Photovoltaic Market in China

 

The photovoltaic market in China is at an initial stage of development. According to Solarbuzz, the photovoltaic market in China was 208 MW in 2009, compared to 35 MW in 2008. However, according to Solarbuzz, the Chinese photovoltaic market is expected to undergo a significant transformation “from a market dominated by off-grid rural and industrial projects, to one marked by a significant increase in large on-grid, ground mounted systems” as the result of changing project economics and increasing governmental support. China’s energy policy is shaped by the Chinese government’s central planning agency, the National Development and Reform Commission, along with the National Energy Administration, or the NEA, which focuses on regulation of energy supply and production. The Chinese government acknowledges its role in global

 

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carbon emissions and has enacted a series of laws and policies emphasizing China’s objective to reduce emissions through the use of renewable energy sources. These laws and policies include the Renewable Energies Law enacted in February 2005 (as amended in December 2009) and the Medium and Long-Term Development Plan for the Renewable Energy Industry put forth in August 2007, which, among other things, set forth the goals for renewable energy to comprise 10% of total energy consumption by 2010 (with 300 MW from solar energy) and 15% by 2020 (with 1,800 MW from solar energy).

 

Central Government Incentives. In July 2009, the Ministry of Science and Technology and NEA announced the “Golden Sun” program, which will support a minimum of 500 MW of installations (with a cap of 20 MW per province) over the next two to three years with a 50% subsidy of the total investments for on-grid and a 70% subsidy of the total investments for off-grid applications.

 

Provincial Level Incentives. Jiangsu Province, where Nanjing Daqo is located, has announced a solar feed-in-tariff program to support 400 MW of solar installations from 2009 to 2011. The target feed-in-tariff rates for 2010 under this program is RMB1.7 per kWh inclusive of VAT for ground mounted systems, RMB3.0 per kWh inclusive of VAT for rooftop systems, and will be lower for 2011.

 

Restrictions on Import of Recoverable Silicon Materials. The tightened regulation on the import of recoverable silicon materials in 2009 may result in an increased reliance by photovoltaic product manufacturers on virgin polysilicon produced in China, which will in turn benefit China-based polysilicon manufacturers. So far, photovoltaic product manufacturers in China have imported virgin polysilicon and recoverable silicon raw materials, including polysilicon scraps, from overseas suppliers to meet a substantial portion of their polysilicon requirements. The Chinese government revised its waste materials import catalogues in 2009. According to the new catalogues which became effective on August 1, 2009, recoverable silicon materials with a purity rate below 99.99% are deemed as waste materials that are prohibited from import and recoverable silicon materials with a purity rate at or above 99.99% are added to the “restricted” category, the import of which has become subject to more strict examination and approval requirements. The implementation of the new catalogues will raise the barriers for Chinese photovoltaic product manufacturers to import recoverable silicon materials and encourage them to rely more on polysilicon produced in China, which provides new opportunities for China-based polysilicon manufacturers.

 

Photovoltaic Product Value Chain

 

The following diagram illustrates the value chain for the manufacture of C-Si based photovoltaic products:

 

LOGO

 

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Polysilicon Market

 

Polysilicon is the primary raw material for the photovoltaic and semiconductor industries. Historically, the semiconductor industry has been the dominant user of polysilicon. Due to the recent rapid growth of the photovoltaic industry, the polysilicon consumption by the photovoltaic industry has exceeded that by the semiconductor industry. As a result of this rapid expansion, sales to the photovoltaic industry are now the key factor affecting the price, profit and growth of the polysilicon market.

 

LOGO

 

Source:   Marketbuzz, 2010

 

The recent growth of the photovoltaic industry has increased the demand for polysilicon. According to Solarbuzz, total global polysilicon manufacturing capacity grew by 75% to approximately 164,500 MT per annum by the end of 2009. The rapid capacity expansion was driven by an increase in capacity of the established polysilicon manufacturers and new entrants to the market.

 

 

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BUSINESS

 

Overview

 

We are a leading polysilicon manufacturer based in China and we aim to become a vertically integrated photovoltaic product manufacturer. With an installed annual polysilicon production capacity of 3,300 MT as of June 30, 2010, we believe we are one of the largest polysilicon manufacturers in China. We have started expanding downstream into the wafer manufacturing business and are ramping up our module manufacturing business. We also intend to enter into the cell manufacturing business in the future.

 

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. We strive to improve our 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 1,826 MT of polysilicon in the first half of 2010, which, on an annualized basis, exceeded our installed annual production capacity. We plan to increase our annual production capacity to 7,300 MT by the end of 2012 by adding a Phase 2 production line and improving our production efficiency.

 

We believe that we have a competitive cost structure in polysilicon manufacturing primarily due to our strategic location in China and our manufacturing process. As our operations are based in Chongqing, which is in the western area of China where the cost of doing business is generally lower than the coastal areas in China, we have significant advantages in electricity, raw material and labor costs over our competitors that are based in developed countries or in the coastal areas of China. In addition, we utilize the chemical vapor deposition process, or the “modified Siemens process,” to produce polysilicon, as do the vast majority of polysilicon manufacturers in the world. We have fully implemented the closed loop system to produce high-quality polysilicon cost-effectively. Our fully implemented closed loop system differentiates us from manufacturers that only implement the closed loop system in some, but not all, of their manufacturing lines, and from manufacturers that are in the process of converting their open loop system to the closed loop system. Compared to the open loop system that many of our China-based competitors use, our closed loop system uses raw materials more efficiently, requires less electricity and causes less pollution even though manufacturing facilities based on the open loop system can be built within a shorter period of time with less initial capital expenditures on equipment. The average unit cost of polysilicon we sold in the second quarter of 2010 was $32.0 per kilogram.

 

We believe that our focus on producing high quality polysilicon in a cost-efficient manner has contributed to our market position. 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 both our existing Phase 1 facilities in Chongqing. In the second quarter of 2010, approximately 99% of our polysilicon met the solar grade quality standard, approximately 82% of our polysilicon met the highest specification of the solar grade quality standard and approximately 46% of our polysilicon met the electronic grade quality standard in China.

 

We currently sell polysilicon to China-based photovoltaic product manufacturers. The majority of our sales, are made under framework contracts. We also sell a significant portion of our polysilicon on a spot pricing basis. As of June 30, 2010, our major photovoltaic product customers included operating entities of China Sunergy, Solarfun, Solargiga, Tianwei New Energy and Yingli Green Energy.

 

We aim to become a vertically integrated photovoltaic product manufacturer. We have started expanding downstream into the wafer manufacturing business. We have placed initial orders for equipment to construct our Phase 1 wafer manufacturing facilities in Chongqing with an annual installed capacity of 250 MW and expect to complete the construction in December 2010. We plan to commence commercial production of wafers in the first

 

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quarter of 2011 and ramp up to full capacity by the end of 2011. We will use our own polysilicon to produce wafers. In addition, we are ramping up our module manufacturing business. We plan to sell our modules to photovoltaic system integrators and distributors in China and internationally, leveraging our well-recognized “Daqo” brand. We expect the downstream module market to grow rapidly. We source cells for our module production through direct purchases and tolling arrangements, and we assemble modules at our own facilities. As of June 30, 2010, we had an annual module production capacity of 50 MW at our facilities in Nanjing and plan to increase our production capacity to 200 MW in the first quarter of 2011. We commenced commercial production of modules in May 2010 and shipment to Europe in July 2010. We also intend to enter into the cell manufacturing business in the future. Our expansion into downstream businesses involves risks and uncertainties, such as limited supply of cells for our module business, our lack of experience, financing, construction and operational uncertainties, potential competition and regulatory risks. See “Risk Factors—Risks Relating to Our Business” for details. Other than the risks and uncertainties highlighted in the Risk Factors section, we do not currently expect to encounter material hurdles for expanding downstream into the wafer manufacturing business and ramping up our module manufacturing business.

 

We have achieved substantial growth since we commenced commercial production of polysilicon in July 2008. In 2009, we produced 1,523 MT of polysilicon and sold 1,498 MT, compared to 291 MT of polysilicon produced and 237 MT sold in 2008. In the six months ended June 30, 2010, we produced 1,826 MT of polysilicon and sold 1,710 MT. We generated revenues of $111.2 million and $97.6 million and achieved net income of $30.8 million and $18.0 million in 2009 and the first six months of 2010, respectively.

 

Our Strengths

 

We believe that the following strengths enable us to compete effectively and further increase our profitability:

 

Competitive cost structure

 

We believe that we have a competitive cost structure in polysilicon manufacturing as a result of the following factors:

 

Competitive electricity, raw material and labor costs and governmental support. As our operations are based in Chongqing, an area in western China where the cost of doing business is generally lower than the coastal areas, we have significant cost advantages in electricity, raw material and labor over our competitors that are based in developed countries or in the coastal areas of China. We can also source other raw materials such as liquid chlorine and hydrogen at low cost due to our proximity to a major salt mine and a chemical industry park. Furthermore, as one of the most populous cities in the world and one of the most developed cities in western China, Chongqing offers an abundant source of low-cost skilled workers. The average unit cost of polysilicon we sold in the second quarter of 2010 was $32.0 per kilogram. We also enjoy preferential tax treatment and other financial incentives provided by the Chinese government under its policy to foster and encourage the economic and industrial development of the western inland regions of China. In particular, Chongqing Daqo qualified as a “Chongqing High and New Technology Enterprises” in December 2009 and currently enjoys a preferential enterprise income tax rate of 15%, which is lower than the 25% uniform national tax rate.

 

Closed loop manufacturing system. We have implemented the modified Siemens process to produce high-quality polysilicon cost-effectively in a completely closed loop system. The closed loop system is an advanced polysilicon manufacturing process, and we believe we are one of the few China-based polysilicon manufacturers that have fully implemented the closed loop system. We generate TCS in-house using liquid chlorine and metallurgical silicon powder, two readily available and relatively inexpensive industrial materials. Compared to the open loop system that many of our China-based competitors use, the closed loop system uses raw materials more efficiently, requires less electricity and causes less pollution. In addition, we have achieved effective heat and water conservation in our closed loop system, thereby enhancing our production efficiency and reducing our operational costs.

 

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Consistently high-quality products

 

We focus on ensuring customer satisfaction and consistently delivering high-quality products. Our closed loop modified Siemens manufacturing process, and in particular our capacity to produce TCS in-house and to control its quality, enables us to produce high-quality polysilicon efficiently. In July and August 2010, substantially all of our polysilicon met the solar grade quality standard, approximately 92% of our polysilicon met the highest specification of the solar grade quality standard in China, and approximately 58% of our polysilicon met the electronic grade quality standard in 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 production 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.

 

China-based manufacturing capacity with abundant growth opportunities

 

Our strategic location in China provides us with abundant growth opportunities. In recent years, China has become an important global center for manufacturing photovoltaic products with a growing number of leading photovoltaic companies. However, polysilicon production capacity in China has lagged behind the demand from manufacturers of downstream photovoltaic products in China. Due to changing project economics and increasing governmental support, we expect that the Chinese domestic photovoltaic market will grow in the next several years. Our China-based manufacturing capacity offers us significant competitive advantages in terms of greater geographic proximity to customers, quicker response, more efficient inventory management and cost savings.

 

Proven execution capabilities

 

We have proven our capability to construct and ramp up polysilicon production capacity. We completed construction of our Chongqing Phase 1a facilities within 12 months and we shipped the first batch of polysilicon to a major photovoltaic wafer manufacturer within two months afterwards. We also completed construction of our Chongqing Phase 1b facilities within 12 months. We believe that our management’s execution and coordination capability and their industry knowledge and experience have enabled us to overcome the substantial difficulties accompanying the design, installation and operation of polysilicon production facilities and to optimize our production lines. We currently have an annual production capacity of 3,300 MT, and we produced 1,826 MT in the first six months of 2010. Through the cost-control initiatives implemented in our Phase 1b facilities construction process, we have managed to reduce the construction costs compared with construction costs in Phase 1a. We have a dedicated and experienced in-house construction and engineering team with significant experience gained from the construction of our Phase 1 facilities who can apply our technological know-how and our experience in ramping up production capacity quickly to successfully execute our future expansion plans.

 

Strong focus on technologies and research and development

 

We are highly focused on the development, introduction and implementation of advanced technologies and intellectual property. We believe that we have one of the strongest research and development teams among polysilicon manufacturers in China. Our team consists of 29 experienced researchers and engineers, including 4 experts who enjoy industry-wide recognition in China and internationally and 1 full-time technical consultant with extensive industry experience. We have applied high pressure throughout the manufacturing process to reduce our production cycle time and produce polysilicon more quickly. Utilizing the know-how our research and development team has developed, we are able to fine-tune the process parameters and technical recipes for our key equipment to further improve our production efficiency. As a result of the technological improvement, process innovation and equipment enhancement initiatives, we produced 1,826 MT of polysilicon in the first half of 2010, which on an annualized basis exceeded our installed annual design capacity.

 

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Experienced management team

 

Our board of directors and management team consist of an experienced and diversified group of entrepreneurs and professionals who have significant industry and managerial experience and contacts throughout the electricity generation industry, which is evidenced by their records of founding and managing successful enterprises. For example, Mr. Guangfu Xu, our chairman, is a pioneer in the electrical equipment industry in China and has over 40 years’ experience in founding and managing businesses. Mr. Xu has been chairman of Daqo Group, a well-known large scale electrical equipment company in China, since its inception. We believe Mr. Xu’s experience and expertise provide a solid foundation in formulating the vision for our long-term development. Dr. Gongda Yao, our chief executive officer, has over a decade’s experience as a key management team member of Applied Materials, a leading U.S. supplier of semiconductor manufacturing systems. The experience and vision of our directors and senior management provide us with valuable industry insight and management expertise in our business operations.

 

Our Strategies

 

Our goal is to become a leading global supplier of polysilicon for the photovoltaic industry and an important player in the downstream photovoltaic market. We intend to achieve this by pursuing the following strategies:

 

Reduce our production costs

 

We seek to become one of the most cost-effective polysilicon manufacturers in the world. We intend to further reduce our costs through technological improvements, increasing economies of scale and in operational improvements. We have been able to reduce our production costs through measures such as in-house production of TCS from TET and effective heat and water conservation. We plan to reduce our polysilicon production cycle time, electricity consumption and use of raw materials and to improve our TCS recycling efficiency. To implement this plan, we will continue to improve the high pressure techniques used in our manufacturing process, to refine the design of our furnaces and reactors in order to increase their production yields, and to adopt the hydrochlorination technology in our Phase 2 facilities. We believe we will be able to achieve greater economies of scale as we ramp up our business.

 

Expand polysilicon production capacity

 

We plan to significantly increase our production capacity to meet the long-term growth we expect in demand for polysilicon and to improve our economies of scale. We plan to upgrade our Phase 1 facilities and commence the construction of our Phase 2 facilities in the fourth quarter of 2010 and expect to increase our total production capacity to 7,300 MT by the end of 2012. We believe that our planned expansion will help us enhance economies of scale in production and reduce materials procurement costs as well as rationalize our equipment costs and general and administrative expenses.

 

Establish and expand downstream capabilities

 

We plan to vertically integrate our business by expanding into the wafer manufacturing business, and we may also consider expanding further downstream into the cell manufacturing business in the future. Since polysilicon is the largest cost component for wafers, we believe our ability to produce high quality polysilicon at low cost will effectively reduce our wafer manufacturing cost, allowing us to offer competitive pricing to our customers. Our presence in the wafer business will also allow us to work with additional industry leaders and broaden our customer base, which in turn will enable us to capture greater market opportunities and diversify revenue sources. We plan to use our polysilicon for wafer manufacturing. We have started construction of our Phase 1 250 MW wafer facilities and plan to commence commercial production in the first quarter of 2011 and ramp up production to the full capacity of 250 MW in the fourth quarter of 2011. With our in-house produced high quality polysilicon and strong execution capabilities, we believe our wafer business will further enhance our leading position within the solar industry.

 

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Further expansion of module manufacturing business

 

We plan to further expand our photovoltaic module manufacturing business and sell our products in China and in Europe and North America. We expect this downstream market to grow rapidly in light of the significant market potential. We have entered into strategic cooperation agreements with cell manufacturers to establish tolling arrangements, under which we would supply polysilicon to them in exchange for cells for module manufacturing. By further expanding our module business, we expect to gain direct contact with solar power end users to obtain real-time information on market demand, diversify our product offerings and enhance awareness of our “Daqo” brand. We will also leverage our relationship with Daqo Group and benefit from their relationships in the electrical equipment industries. In addition to commencing sales of modules with our own brand, we will continue to expand sales of modules to customers who will use their own brands. We believe that becoming a vertically integrated solar company will enable us to increase our ability to weather any future industry downturn or volatility and achieve synergies by sharing our industry expertise and management know-how in the photovoltaic industry and collaborating our purchasing, manufacturing, marketing, warehousing and distributing functions. We intend to increase our module production capacity to 200 MW in the first quarter of 2011.

 

Deepen and broaden customer relationships

 

We plan to deepen our existing customer relationships and broaden our customer base to capitalize on new market opportunities and to reduce our reliance on any particular geographic region or a small number of customers.

 

China market. We will continue to focus on the China market, where many leading photovoltaic companies are located. We believe that China’s photovoltaic market will grow rapidly. We intend to strengthen our existing relationships with leading photovoltaic cell and module manufacturers and become one of their preferred polysilicon suppliers by providing them with consistently high-quality polysilicon and wafers. Furthermore, we intend to leverage our reputation among our customers as a high-quality polysilicon manufacturer to attract and establish long-term business relationships with other leading photovoltaic product manufacturers.

 

Overseas markets. With our increased production, we intend to sell a portion of our polysilicon and modules outside of China. In the future, we may also sell wafers outside of China. We established our initial footprint in the U.S. market by supplying polysilicon to a leading U.S. solar power company for testing in February 2009. This company confirmed that our products met its quality standards, which are regarded as among the highest in the solar industry. We are currently in polysilicon sales contract negotiations with this company. Due to the positive response we obtained in the test sale and the increasing interests in our products, we established a marketing office in California in January 2009 to coordinate our marketing efforts. In the future, we plan to launch marketing initiatives in the European market to capture opportunities in those markets.

 

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. We aim to become a vertically integrated photovoltaic product manufacturer by strategically expanding downstream into wafer and ramping up module manufacturing businesses.

 

In the first half of 2010, we sold a small amount of wafers through tolling arrangements with third party wafer manufacturers, pursuant to which we supplied polysilicon to them in exchange for wafers. We plan to commence commercial production of mono-crystalline and multi-crystalline wafers in the first quarter of 2011 at our Phase 1 wafer production facilities, once construction of these facilities are completed. To meet the currently prevailing market demands, we intend to initially focus on producing multi-crystalline wafers with dimension of

 

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156 millimeters x 156 millimeters and thickness of 200 microns. Meanwhile, we will produce mono-crystalline and multi-crystalline wafers of other dimensions from time to time in response to market demands and customers’ requirements.

 

We commenced commercial production of mono-crystalline and multi-crystalline modules at our Nanjing module production facilities in May 2010, and shipped modules to Europe in July 2010. We source cells for module production through tolling arrangements with third party cell manufacturers and assemble the finished cells to modules at our own facilities. We plan to sell our modules to photovoltaic system integrators and distributors in China and internationally, leveraging our well-recognized “Daqo” brand. Our modules meet international standards for electrical, quality and safety requirements and have been certified by TÜV Rheinland LGA Products GmbH and Underwriters Laboratories Inc. We currently manufacture three major types of modules:

 

Dimension and specification

  

Maximum power

  

Current at maximum
power

  

Operating voltage

(mm x mm)    (watts)    (Amp)    (volts)
125×125 mono-crystalline    165-190    5.0    36
156×156 multi-crystalline    200-240    7.5    30
156×156 multi-crystalline    170-210    7.4    27

 

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. In addition to the three main technologies, Tokuyama has developed a manufacturing polysilicon technology called the “vapor-to-liquid deposition” process. The Siemens process is an existing and well proven process technology predominantly used in high purity silicon feedstock production in the solar industry. The other three 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. We have been licensed by Poly Engineering, an industry recognized polysilicon production technology consulting firm based in Europe, with the exclusive rights in China, Taiwan, Hong Kong and Macau to utilize a modified Siemens process to produce polysilicon in our facilities. We further developed our manufacturing process by applying the modified Siemens process licensed from Poly Engineering.

 

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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 general manufacturing process:

 

LOGO

 

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. Whereas many of our China-based competitors lack the capacity to produce TCS, the most costly production input for polysilicon production, 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. The unused HCl and TET, a by-product, are also separated from TCS through distillation and condensation. The HCl is recycled to produce TCS and TET is recycled to produce TCS through hydrogenation.

 

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.

 

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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. We believe we are one of the few China-based polysilicon manufacturers that have fully implemented the closed loop system in the polysilicon production process. 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 recycle the exhaust stream from our manufacturing process into components that can be reused. 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.

 

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.

 

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.

 

Wafers

 

We currently conduct our wafer business through tolling arrangements with third party wafer manufacturers. We started construction of our Phase 1 250 MW wafer production facilities in July 2010. We have placed initial orders for equipment and plan to commence commercial production of mono-crystalline and multi-crystalline silicon wafers in the first quarter of 2011. We expect our in-house wafer production to be cost competitive due to our access to high quality polysilicon feedstock and the integration of our polysilicon and wafer operations at facilities adjacent to each other. We expect that our in-house wafer operations will help lower our wafer production costs and produce wafers with consistent quality compared to outsourcing production to third party wafer manufacturers through tolling arrangements. Prior to production capacity ramp-up and full implementation of our wafer expansion plan, we anticipate that we will continue to utilize tolling arrangements to produce a significant portion of our wafers.

 

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, while mono-crystalline ingots are made from single crystal silicon. Silicon ingots will then be shaped to the required sizes and sliced to wafers by wire saws.

 

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Modules

 

We produce mono-crystalline and multi-crystalline modules.

 

To assemble photovoltaic modules, we interconnect multiple photovoltaic cells by soldering and stringing cells into a desired electrical configuration. Cells with similar electrical characteristics are matched during module assembly process to minimize efficiency losses. The interconnected cells are laid out, sandwiched with two layers of polymer, then laminated in a vacuum and cured by heating. The laminated module piece will then be assembled with aluminum frame and connected to a junction box and sent for final testing.

 

Manufacturing Capacity

 

The following table sets forth our major installed 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:

 

   

Annual Production
Capacity

 

Construction Period

 

Commercial
Production
Commencement

  Fully Ramped-up
Production

Polysilicon:(1)

       

Phase 1a facilities

  1,500MT   June 2007—May 2008   July 2008   March 2009

Phase 1b facilities

  1,800MT   May 2008—May 2009   December 2009   January 2010

Capacity enhancement of Phase 1 facilities

 

1,000MT

 

December 2010

 

December 2010

 

December 2010

Phase 2 facilities

  3,000MT   December 2010—
March 2012
(2)
  July 2012(2)   December  2012(2)

Wafer:(1)

       

Phase 1 facilities

  250MW   July 2010—
December 2010
(2)
 

February 2011(2)

  November  2011(2)

Module:(3)

       

Phase 1 facilities

  200MW   September 2009—
April 2010
  May 2010   March 2011(2)

 

Note:

(1)   The facilities are located in Chongqing.
  (2)   Time schedules are estimated based on our current plans.
  (3)   The facilities are located in Nanjing.

 

We achieved annual polysilicon production capacity of 3,300 MT in January 2010 and expect to further ramp up our production capacity to 4,300 MT by the end of 2010 and to 7,300 MT by the end of 2012. We have recently installed five additional deposition reactors to further improve our operational efficiency and to increase our output. In addition, we plan to increase the hydrogenation conversion rate to 17% and 22% for our Phase 1a and 1b manufacturing facilities, respectively. We believe these improvements may lead to an increase of our maximum fully ramped-up annual production capacity of our Phase 1 manufacturing facilities by approximately 15%. We also plan to adopt the hydrochlorination technology in our Phase 2 facilities to improve TCS recycling efficiency and to reduce our electricity consumption and use of raw materials.

 

Our capacity expansion plan is preliminary and subject to risks and uncertainties that may be out of our control. See “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 “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.”

 

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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.

 

The costs of electricity are significant in the production of polysilicon. The electricity costs in Chongqing are much lower than those in coastal areas in China and those in developed countries due to Chongqing’s abundant hydroelectric 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 historically relied upon a local supplier as the sole source of steam for our production and, since June 2009, we started producing steam in-house to partially satisfy our needs for steam.

 

Wafers

 

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

 

Modules

 

Raw materials required for the module manufacturing process primarily include high efficiency mono-crystalline and multi-crystalline photovoltaic cells, ethylene-vinyl acetate, tempered glasses, back films, aluminum frames and junction boxes. We intend to continue to utilize tolling arrangements with third party cell manufacturers to exchange our polysilicon for cells to be further assembled into modules.

 

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. The major module production equipment includes automatic laminating machines, auto framing machines, automatic glue injection machines 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

 

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systematically inspect raw materials from our suppliers, such as MG-Si, liquid chlorine and various consumables for our polysilicon business and photovoltaic cells for our module 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 9001:2000 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 and included our polysilicon in its 2009 list of key new products.

 

We currently conduct our wafer business through tolling arrangements with third party wafer manufacturers. In deciding whether to engage in tolling arrangements with a manufacturer, we conduct due diligence and evaluate the manufacturer based on several criteria, such as qualification and certification, product quality and internal quality assurance standards and procedures. We require third party wafer manufacturers to test the technical specifications and quality of each batch of wafers before shipping them to our customers. We plan to conduct in-house quality inspection once we commence wafer production at our own facilities.

 

We inspect and test the quality of photovoltaic cells sourced from third party cell manufacturers, which are raw materials for our module production. Cells that fail to pass our initial inspection are returned to the suppliers. After cells are assembled into modules, we conduct a quality check prior to packaging. Our modules meet international standards for electrical, quality and safety requirements and have been certified by TÜV Rheinland LGA Products GmbH and Underwriters Laboratories Inc. We provide our customers with a five-year limited product warranty against defective materials and workmanship and a 25-year limited power output warranty against loss in power for our modules.

 

In order to facilitate our production of photovoltaic products and ensure the quality of the finished product, we have set up a laboratory for the analysis of raw materials, in-process quality control and finished products and the supervision of environmental pollution and safety.

 

Customers and Sales

 

We currently sell polysilicon and wafers to China-based photovoltaic product manufacturers and modules to photovoltaic system integrators in Europe. Our customers are mainly China-based photovoltaic companies. As of June 30, 2010, our major customers included operating entities of China Sunergy, Solarfun, Solargiga, Tianwei New Energy and Yingli Green Energy. We sell a substantial portion of our photovoltaic products to a limited number of customers. In 2009, our top three customers in aggregate accounted for 53.6% of our total revenues. During the first six months of 2010, our top three customers in aggregate accounted for 41.9% of our total revenues. In August 2010, we entered into a polysilicon supply agreement with an existing customer, Yingli Green Energy, whereby we agree to sell and they agree to purchase 1,500 MT of polysilicon for each of 2011 and 2012.

 

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 also sell a significant portion of our polysilicon products to various China-based customers on a spot pricing basis. We currently sell all of our wafer and module products on a spot pricing basis.

 

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

 

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supply and demand planning. In addition, to develop our module business internationally, we have recently established a dedicated sales team focused on international sales. Members of this team attend international industrial conferences and trade fairs and pay on-site visits to our potential module customers outside of China.

 

Research and Development

 

We believe that the continual development of our technology will be vital to maintaining our long-term competitiveness. Therefore, we intend to significantly increase our investment of management and financial resources in research and development.