DQ

Business Context and Reporting Period

Company: DAQO NEW ENERGY CORP. (Daqo)

Filing Type: Form 20-F (Annual Report)

Reporting Period: Fiscal year ended December 31, 2010

Business Overview: Daqo is a leading polysilicon manufacturer based in China, aiming to become a vertically integrated photovoltaic product manufacturer. The company manufactures and sells high-purity polysilicon to photovoltaic product manufacturers. As of December 31, 2010, it had an installed annual polysilicon production capacity of 4,300 metric tons (MT). The company also began expanding downstream into wafer and module manufacturing, with module production commencing in May 2010.

Accounting Basis: U.S. GAAP

Key Financial Metrics (Year Ended Dec 31, 2010)

Operational Data (2010):

• Polysilicon Production: 3,771 MT
• Polysilicon Sales: 3,650 MT
• Unit Cost of Polysilicon Sold: $31.3/kg

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 118.3% from 2009 to 2010, driven primarily by a 105% increase in polysilicon sales volume (from 1,498 MT to 3,650 MT), which offset an 18% decrease in average selling price.
• Profitability: Net income attributable to shareholders more than doubled to $68.6 million. Gross margin improved to 43.8% due to lower production costs per kilogram.
• Product Mix: In 2010, the company began generating significant revenue from non-polysilicon products, including $14.0 million from modules and $10.8 million from wafers (processed via tolling arrangements).
• Liquidity: Cash and cash equivalents increased significantly to $203.6 million, bolstered by the October 2010 Initial Public Offering (IPO) which raised approximately $79.5 million in net proceeds.
• Debt Reduction: Total borrowings decreased from $188.8 million in 2009 to $154.6 million in 2010.

Guidance, Outlook, Risks, and Unusual Items

Outlook and Guidance

• Capacity Expansion: The company plans to increase annual polysilicon production capacity to 7,300 MT by the end of 2012 via Phase 2 facilities in Xinjiang (construction commenced March 2011).
• Vertical Integration: Plans to ramp up wafer production to 250 MW by end of 2011 and module production to 200 MW by Q3 2011.
• Capital Expenditures: Projected capital expenditures for 2011 are approximately $210 million.

Risks and Contingencies

• Internal Controls: The company identified one material weakness (lack of sufficient accounting resources/expertise for U.S. GAAP compliance) and one significant deficiency (lack of documented financial closing procedures) in its internal controls over financial reporting. Remediation is ongoing.
• Market Volatility: Polysilicon prices are subject to global supply and demand fluctuations. The company faces downward price pressure if global supply exceeds demand.
• Customer Concentration: The top three customers accounted for 35.1% of total revenues in 2010 (down from 53.6% in 2009).
• Regulatory & Tax: The company relies on preferential tax rates (15%) in China. There is uncertainty regarding the classification of the Cayman holding company as a "resident enterprise" under Chinese tax law, which could impact withholding taxes on dividends.
• Insurance: The company does not maintain product liability or business interruption insurance.

Unusual Items

• Government Subsidies: Recorded $3.4 million in "Other operating income" in 2010, primarily from local government financial incentives.
• Variable Interest Entity (VIE): The company consolidates Daqo New Material as a VIE. Noncontrolling interest in this entity is significant ($132.9 million equity as of Dec 31, 2010).

Key Facts for Investor Verification

• Internal Control Remediation: Verify the progress of remediation efforts for the material weakness in internal controls identified in the 2009 and 2010 audits.
• Phase 2 Construction: Monitor the timeline and cost of the Phase 2 polysilicon facility in Xinjiang, given risks related to location (cold weather, supply chain, political stability).
• Customer Concentration: Track the diversification of the customer base to reduce reliance on the top three customers.
• Polysilicon Pricing: Monitor global polysilicon spot prices and the company's ability to maintain margins amidst potential price declines.
• Tax Status: Verify the company's tax status in China and any potential changes in preferential tax treatment or "resident enterprise" classification.
• Debt Guarantees: Note that a significant portion of bank borrowings ($152.0 million as of Dec 31, 2010) is guaranteed by Daqo Group, an affiliated company.