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Edited Transcript of DQ earnings conference call or presentation 7-Mar-17 1:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Daqo New Energy Corp Earnings Call

Wanzhou, Chongqing Mar 7, 2017 (Thomson StreetEvents) -- Edited Transcript of Daqo New Energy Corp earnings conference call or presentation Tuesday, March 7, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kevin He

Daqo New Energy Corporation - IR

* Gongda Yao

Daqo New Energy Corporation - CEO

* Ming Yang

Daqo New Energy Corporation - CFO

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Conference Call Participants

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* Philip Shen

ROTH Capital Partners - Analyst

* Brad Meikle

Craig-Hallum - Analyst

* Sheng Zhong

Morgan Stanley - Analyst

* Paul Strigler

Esplanade Capital - Analyst

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Presentation

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Operator [1]

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Hello, and welcome to the Daqo New Energy fourth quarter and FY16 results conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Kevin He, Investor Relations. Please go ahead.

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Kevin He, Daqo New Energy Corporation - IR [2]

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Hello, everyone; I'm Kevin He, the Investor Relations of Daqo New Energy. Thank you for joining our conference call today. Daqo New Energy just issued its financial results for the fourth quarter and FY16, which can be found on our website at www.dqsolar.com. To facilitate today's conference call, we also have prepared a PPT presentation for your reference.

Today attending the conference call we have Dr. Gongda Yao, our Chief Executive Officer, and Mr. Ming Yang, our Chief Financial Officer. The call today will feature an update from Dr. Yao on market and operations, and then Mr. Yang will discuss the Company's financial performance for the first quarter and FY16. After that, we will open the floor to Q&A from the audience.

Before we begin the formal results, I would like to remind you that certain statements on today's call, including expected future operational and financial performance and industry growth, are forward-looking statements that are made under the Safe Harbor provisions of the US Private Security Litigation Reform Act of 1995. These statements involve inherent risks and uncertainties. A number of factors could cause actual results to differ materially from those containing any forward-looking statement.

Further information regarding these and other risks is included in the reports or documents we have filed with, or furnished to, the Securities and Exchange Commission. These statements only reflect our current and preliminary view as of today, and may be subject to change. Our ability to achieve these projections is subject to risks and uncertainties. All the information provided in today's call is as of today and we undertake no duty to update such information, except as required under applicable law.

Also, during the call we will occasionally reference monetary amounts in US dollar terms; please keep in mind that our functional currency is the Chinese RMB. We offer these translations into US dollars solely for the convenience of the audience.

Without further ado, I now turn the call over to our CEO, Dr. Yao, please.

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Gongda Yao, Daqo New Energy Corporation - CEO [3]

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Hello, everyone, and thank you for joining our call today. The fourth quarter of 2016 was an important milestone for Daqo New Energy. During the quarter, we successfully completed our annual maintenance work and the interconnections between our new facilities and existing facilities in Xinjiang, and, at the same time, we also successfully completed all the construction installation work related to Phase 3A polysilicon expansion.

As the maintenance construction installation of new equipment and interconnection of the facilities we are conducting concurrently, our annual maintenance for 2016 took longer than usual to complete. However, the combination of these efforts allow us to start initial production of our expansion production capacity in January 2017, months ahead of our original schedule.

We have already reached full production through our throughput of 18,000 metric tonnes per annum by the end of February 2017. At our new production capacity of 18,000 metric tonnes a year, we are achieving significant economic scale which we believe will allow us to achieve further manufacturing efficiencies and cost savings. For example, when we were at 6,000 metric tonnes capacity, we had approximately 900 employees in Xinjiang. When we doubled our capacity to 12,000 metric tonnes a year, we had approximately 1,100 employees. Now that we've reached about 18,000 metric tonnes capacity, we only have approximately 1,300 employees in Xinjiang.

So capacity per person more than doubled from 6.6 metric tonnes per person, when we were at a 6,000 metric tonnes capacity, to currently about 13.8 metric tonnes per person at 18,000 metric tonnes capacity, with significant operational leverage and a reduction in per unit labor costs.

At the same time, we implemented new technology upgrades and special projects that further improved energy efficiency. Based on initial production results, we are seeing encouraging savings in energy usage as well as silicone and raw material utilization. With the combination of these efforts in cost savings, we believe we can achieve our new cost target of about $8.50 per kilo, in average of total production costs in Q1, and reduce it further throughout the year as we further optimize our production process.

During the fourth quarter of 2016, we saw robust demand for polysilicon products, and the strong momentum continued into the first quarter of 2017. Based on the industrial forecasts, the size of solar market was about 70 gigawatts in 2016, with demand from China and India exceeding expectations. The PV market is expecting to continue its growth in 2017, with the market size expecting to the 73 to 79 gigawatts for this year. In particular, the Indian PV market is expecting to grow from about 5 to 6 gigawatts in 2016 to more than 10 gigawatts in 2017.

With a growing PV market and major downstream PV manufacture continuing to add capacities, this bodes well for continued strong demand for the high-purity polysilicon products. In particular, we are seeing a shift in industry trend, with rising demand and increased manufacturer capacities for high-efficiency mono-crystal solar wafers and the solar cells. This has translated to increased demand for high-purity, semiconductor-grade polysilicon, which only very few Chinese domestic manufacturers are able to supply.

At Daqo New Energy, we are currently upgrade our distillation process and adding [special device] into our distillation system, which will further remove impurities and improve the quality of our polysilicon product. With our upgraded process, high-purity products, Daqo New Energy is uniquely positioned to address to growing demand from high-efficiency mono-crystal solar market.

In terms of market demand, based on the feedback from our customers we believe that orders and shipment of downstream PV module products currently have been strong. We are witness strong orders and robust pricing for high-quality polysilicon products for our customers.

And despite our expanding capacities and product volume, customer demand is sill exceeding our production volume. In fact, certain customers are now willing to pay prepayment so that they can take priority in product delivery. This is a testament to both strong market demand and the high quality of our product. As a result, we expecting polysilicon ASP in the first quarter of 2017 will be higher, as compared to the fourth quarter of 2016.

We are also proud of our financial performance we achieved for the year 2016. In 2016, we had revenue of $229 million net income attributable to Daqo New Energy Corp shareholders of $43.5 million, and earnings per basic of ADS of $4.15, all higher as compared to 2015. We generated non-GAAP EBITDA of $99.3 million, and net cash provided by operational activities of $98.7 million in 2016.

The strong cash flow has allowed us to fund and complete the current phase of capacity expansion without significantly increasing bank borrowings.

Now let me provide outlook for the first quarter of 2017. With the successful initial production of Phase 3A capacity, the Company expect that polysilicon production volume will reach 4,300 metric tonnes to 4,500 metric tonnes in the first quarter of 2017. The Company expects to sell about 3,800 metric tonnes to 4,000 metric tonnes of polysilicon to external customers during the first quarter of 2017, a record high for the Company.

The above external sales guidance excludes shipment of polysilicon to be used internally by our Chongqing solar wafer capacity facility, which utilize polysilicon for its wafer manufacture operation. Wafer sales volume is expected to be about 23.5 million to 24 million pieces for the first quarter of 2017.

Now I will turn the call to our CFO, Mr. Ming Yang, for the financial update.

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Ming Yang, Daqo New Energy Corporation - CFO [4]

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Thank you, Dr. Yao, and good day, everyone. Thank you for attending our call today. Now I will provide the financial updates for the fourth quarter and FY16.

Revenues were $46.1 million, compared to $54.3 million in the third quarter of 2016 and $59.3 million in the fourth quarter of 2015. Revenue from polysilicon sales to external customers were $32.8 million, compared to $44.4 million in the third quarter of 2016 and $42.9 million in the fourth quarter of 2015.

External polysilicon sales volume were 2,209 metric tonne, compared to 2,838 metric tonne in the third quarter of 2016 and 3,092 metric tonne in the fourth quarter of 2015. The decrease in polysilicon revenue as compared to the third quarter of 2016 was primarily due to lower polysilicon sales volumes, and lower ASPs.

The Company successfully completed annual maintenance and several efficiency improvement projects, which affected polysilicon production for approximately three weeks during the fourth quarter of 2016. As a result, both of our polysilicon production volume and sales volume were lower in the fourth quarter of 2016 as compared to the third quarter of 2016. However, we successfully resumed production in November 2016.

Revenues from wafer sales were $13.4 million, compared to $9.9 million in the third quarter of 2016 and $16.4 million in the fourth quarter of 2015. Wafer sales volume was 21.3 million pieces, compared to 14.4 million pieces in the third quarter of 2016 and 21 million pieces in the fourth quarter of 2015. The increase in wafer revenue from the third quarter was primarily due to higher sales volume, offset by lower wafer ASPs.

Gross profit was approximately $14.2 million, compared to $20.1 million in the third quarter of 2016 and $16.9 million in the fourth quarter of 2015. Non-GAAP gross profit, which excludes costs related to the non-operational polysilicon assets in Chongqing, was approximately $15.8 million, compared to $21.6 million in the third quarter of 2016 and $18.9 million in the fourth quarter of 2015.

Gross margin was 30.7%, compared to 37.1% in the third quarter of 2016 and 28.5% in the fourth quarter of 2015. The decrease in gross margin as compared to the third quarter of 2016 was primarily due to slightly lower quarterly polysilicon average selling prices and higher polysilicon production costs, affected by annual maintenance as well as lower quarterly wafer ASPs.

In the fourth quarter of 2016, total costs related to non-operational Chongqing polysilicon assets, including depreciation, were $1.6 million, compared to $1.5 million in the third quarter of 2016 and $2 million in the fourth quarter of 2015. Excluding such costs, the non-GAAP gross margin was approximately 34.2% (sic - see press release, "34.1%"), compared to 39.9% in the third quarter of 2016, and 31.9% (sic - see press release, "31.8%") in the fourth quarter of 2015.

Starting in the first quarter of 2017, we expect costs related to the non-operational Chongqing polysilicon assets, including depreciation, will be reduced to approximately $800,000 for the quarter as a significant portion of the equipment has been reutilized in Xinjiang.

Selling, general, and administrative expenses were $3.5 million, compared to $4.9 million in the third quarter of 2016 and $2.3 million in the fourth quarter of 2015.

Research and development expenses were approximately $2.8 million for the quarter, compared to $1 million in the third quarter of 2016 and $0.5 million in the fourth quarter of 2015. The increase in R&D expenses, as compared to the third quarter of 2016, was primarily due to increased research and development activities, and process upgrades for quality enhancement, increased manufacturing throughput, energy efficiency improvements, and cost reduction.

Other operating income was $1.9 million, compared to $2.2 million in the third quarter of 2016 and $1.7 million in the fourth quarter of 2015. Other operating income was mainly composed of unrestricted cash incentives that the Company received from local government authorities, the amount of which varies from period to period.

The Company recognized $0.2 million and $1.6 million in fixed asset impairment loss for its Chongqing (sic - see press release, "Wanzhou") polysilicon facilities in the fourth quarter of 2016 and 2015, respectively. The Company is currently in the process of relocating the Company's temporarily idle polysilicon machinery and equipment in Chongqing to the Company's Xinjiang polysilicon manufacturing facility, and repurposing such assets.

The impairment loss incurred was attributable to the identified relocation assets in Chongqing that were not transferrable, and could not be reutilized by its Xinjiang polysilicon expansion project.

Operating income was $9.6 million, compared to $16.4 million in the third quarter of 2016 and $14.3 million in the fourth quarter of 2015. Operating margin was 20.7%, compared to 30.3% in the third quarter of 2016 and 24.1% in the fourth quarter of 2015.

Interest expense was $4.1 million, compared to $3.1 million in the third quarter of 2016 and $4.3 million in the fourth quarter of 2015.

EBITDA was $17.6, compared to $25 million in the third quarter of 2016 and $23.4 million in the fourth quarter of 2015. EBITDA margin was 38.3%, compared to 46% in the third quarter of 2016 and 39.5% in the fourth quarter of 2015.

Net income attributable to Daqo New Energy shareholders was $4.1 million, compared to $11.2 million in the third quarter of 2016 and $9.6 million in the fourth quarter of 2015.

Earnings per basic ADS were $0.39, compared to $1.07 in the third quarter of 2016 and $0.92 in the fourth quarter of 2015.

As of December 31, 2016, the Company had $31.9 million in cash and cash equivalents and restricted cash, compared to $29.2 million as of September 30, 2016. As of December 31, 2016, the accounts receivable balance was $4.8 million, compared to $4.6 million as of September 30, 2016. As of December 31, 2016, the notes receivable balance was $13 million, compared to $17 million as of September 30, 2016.

As of December 31, 2016, total borrowings were $217.9 million, of which $111.9 million were long-term borrowings, compared to total borrowings of $227.6 million, including $129 million of long-term borrowings, as of September 30, 2016.

For the 12 months ended December 31, 2016, net cash provided by operating activities were $98.7 million, an increase of 48.6% from $66.4 million in the same period of 2015. And for the 12 months ended December 31, 2016, net cash used in investing activities was $66.1 million, compared to $74.1 million in the same period of 2015. The net cash used in investing activities in 2015 and 2016 was primarily related to the capital expenditures of Xinjiang Phase 2B and Phase 3A polysilicon projects.

For the 12 months ended December 31, 2016, net cash used in financing activities was $30.3 million, compared to net cash provided by financing activities of $15.2 million in the same period of 2015. The net cash used in financing activities in 2016 primarily consists of repayment of related party loans and bank borrowings. The net cash provided by financing activities in 2015 was primarily contributed by the net proceeds from the Company's follow-on offering in February 2015 and net bank loan borrowings.

Now we will discuss full-year 2016 results. For the full year of 2016, revenues were $229 million, an increase of 26% from $182 million in 2015. Revenue from polysilicon sales to external customers were $167.5 million in 2016, an increase of 33% from $125.9 million in 2015.

In the third quarter of 2015, we successfully ramped up our Phase 2B expansion projects, which increased our annual capacity from 6,150 metric tonnes to 12,150 metric tonnes. During the whole year of 2016, we were running our Xinjiang polysilicon facilities at full capacity. As a result, our annual polysilicon production volume increased by 33.7%, from 9,771 metric tonnes in 2015 to 13,068 metric tonnes in 2016.

Our external polysilicon sales volume increased by 32.2%, from 8,234 metric tonnes in 2015 to 10,883 metric tonnes in 2016. In addition, our annual polysilicon average selling prices also improved slightly, from $15.29 per kilogram in 2015 to $15.42 per kilogram in 2016.

Revenues from wafer sales were $61.6 million in 2016, an increase of 9.7% from $56.1 million in 2015. Wafer sales volume was 82.8 million pieces, an increase of 8.3% from 76.4 million pieces in 2015. The increase in wafer revenues, as compared to 2015, was primarily due to higher sales volume.

Gross profit was $80.4 million in 2016, an increase of 114% from $37.6 million in 2015. Gross margin was 35.1% in 2016, increased from 20.6% in 2015. The improvement in gross profit and gross margin was primarily attributable to our polysilicon segment.

In 2016, gross profit of our polysilicon segment, excludes costs related to the Chongqing idle polysilicon facilities, was $78.2 million, an increase of 100% from $38.9 million in 2015. Gross margin of our polysilicon segment was 46.7%, an increase from 30.9% in 2015. The increase in polysilicon gross profit and gross margin was primarily due to higher sales volume and significant improvement in our polysilicon cost structure.

We sold 10,883 metric tonnes of polysilicon in 2016, an increase of 32.2% from 8,234 metric tonnes in 2015. Our annual average polysilicon total production cost decreased by 18%, from $11.23 per kilogram in 2015 to $9.23 per kilogram in 2016.

In 2016, gross profit of our wafer sector was $9.2 million, decreased from $9.4 million in 2015. Gross margin of our wafer sector was 14.9%, compared to 16.7% in 2015.

In 2016, total costs related to the non-operational Chongqing polysilicon plant, including depreciation, were $6.9 million, a decrease from $10.7 million in 2015. Excluding such costs, the non-GAAP gross margin was approximately 38.1% in 2016, an increase from 26.5% in 2015.

Selling, general, and administrative expenses were $16.1 million in 2016, compared to $12.6 million in 2015. The increase in selling, general, and administrative expenses was primarily due to increased shipping costs, as a result of higher polysilicon shipping volume, as well as higher relocation and moving expenses related to relocating the Company's idle polysilicon manufacturing machinery and equipment from Chongqing to Xinjiang, which amounted to $2.6 million in 2016.

Research and development expenses were $4 million in 2016, compared to $0.9 million in 2015. The increase in research and development expenses primarily resulted from continuous R&D activities for improvement in manufacturing efficiency and cost reduction.

Other operating income was $5.3 million in 2016, compared to $3.8 million in 2015, which mainly consisted of unrestricted cash incentives that we received from local government authorities, which varies from period to period at the discretion of the government.

Operating income was $65.4 million in 2016, an increase of 150% from $26.2 million in 2015. Operating margin was 28.6% in 2016, increased from 14.4% in 2015.

Interest expense was $14.6 million in 2016, compared to $13.2 million in 2015. Income tax expense were $7.4 million in 2016, compared to $1.1 million in 2015.

Net income attributable to Daqo New Energy shareholders were $43.5 million in 2016, an increase of 237% from $13 million in 2015. Earnings per basic ADS were $4.15 in 2016, an increase of 229% from $1.26 in 2015.

And that concludes the official part of our presentation. Now let's have the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Philip Shen, ROTH Capital.

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Philip Shen, ROTH Capital Partners - Analyst [2]

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My first question is on prepayments. You talked about them in your remarks; can you talk about the magnitude of the prepayments and whether you expect them to continue ahead?

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Ming Yang, Daqo New Energy Corporation - CFO [3]

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Hi, Phil, this is Ming. So total prepayments were approximately $7.5 million as of December 31, 2016. And these were advance payments that were made by customers so that they could take priority delivery over our polysilicon, particularly the higher quality, semi-grade level polysilicon because those are really in shortage right now.

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Philip Shen, ROTH Capital Partners - Analyst [4]

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Okay. And do you expect that trend to continue, or do you expect the prepayments to increase as we go through the first part of the year or decrease?

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Ming Yang, Daqo New Energy Corporation - CFO [5]

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We think the trend should continue and it may increase from this level, but maybe not significantly.

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Philip Shen, ROTH Capital Partners - Analyst [6]

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Okay. And can you update us on what your customer list looks like now? How much has it shifted? Can you talk about what your customer concentration levels -- or just the customer concentration expectations for 2017?

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Ming Yang, Daqo New Energy Corporation - CFO [7]

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I think the main customers are primarily the largest solar module manufacturers within China. You can think of JA Solar, Trina, Jinko, Canadian Solar, so it's a number of leading solar wafer manufacturers within China as well. In particular, I think we're adding a number of the mono-crystalline wafer and solar cell manufacturers within China for the higher efficiency type of solar products. So these are the new customers that we're getting right now.

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Philip Shen, ROTH Capital Partners - Analyst [8]

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Great. Would that include Longi, for example?

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Ming Yang, Daqo New Energy Corporation - CFO [9]

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Yes.

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Philip Shen, ROTH Capital Partners - Analyst [10]

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Okay, great. From a cost standpoint, I think you talked about hitting $8.50 all-in cost in Q1. I think, historically, you've talked about reaching less than $8.50 per kilogram for the full-year all-in cost in 2017. What's the latest view on how low that cost structure could go in 2017?

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Gongda Yao, Daqo New Energy Corporation - CEO [11]

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I think the average will be between $8 to $8.50 for the whole year. But I think by the end of 2017, we're expecting something between $8 to $8.50, because we still have a significant project need to be finished. It will be installed approximately by July. If that's successful, I think we have a chance to step functionally reduce the cost again. But with that, and also we have a continuous program to reduce our costs, as usual, we have high confidence. We will finally approach by Q4, hopefully, achieve the cost very close to $8.

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Philip Shen, ROTH Capital Partners - Analyst [12]

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Great. Thanks, Gongda. And then one more from me and I'll jump in the queue. In terms of Korea, there's been talk about potentially new tariffs or tariffs being increased on certain Korean companies. Can you just update us on how much those tariff increases could be? And do you have a sense for what the timing might be of those actions?

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Gongda Yao, Daqo New Energy Corporation - CEO [13]

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We think that this will not happen in the first half; most likely it will happen second half. The amount, definitely we don't know, and this is by the fact that the government [will find] the sales price versus their cost structures. So they are highly confidential. Normally, the government require those companies provide to the government, so we don't see those materials. Therefore, we don't have that number in mind. But I think the conclusion will be, most likely it will deliver on the second half of this year.

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Philip Shen, ROTH Capital Partners - Analyst [14]

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Okay, great. Thanks, Gongda. Thank you, Ming. I'll jump back in the queue.

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Operator [15]

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Brad Meikle, Craig-Hallum.

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Brad Meikle, Craig-Hallum - Analyst [16]

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What's your view on pricing for the year for silicon pricing?

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Gongda Yao, Daqo New Energy Corporation - CEO [17]

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For the year, right?

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Brad Meikle, Craig-Hallum - Analyst [18]

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Well, first quarter and the year.

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Gongda Yao, Daqo New Energy Corporation - CEO [19]

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I think the first quarter, as Ming said, is slightly higher than in Q4 for 2016. We believe Q1 is [dead set] because we have pretty much orders for March is done. So we can say that for sure almost. But delivery is not done, so we still have some uncertainty there.

But for the second quarter, as of today, we don't see a significant reduction in price yet. So I think it will continue and, of course, with cautions we put some, if you want. In the second half of the year, we see there's some signals, a lot of people saying the downstream demand delivery will be slower, so we're expecting maybe some price change at that point. But that's forward looking, so there's a lot of uncertainty with it.

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Brad Meikle, Craig-Hallum - Analyst [20]

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To what, like $17 for the first quarter and then coming down to $15/$16 in the second half or --?

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Gongda Yao, Daqo New Energy Corporation - CEO [21]

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Yes, probably.

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Ming Yang, Daqo New Energy Corporation - CFO [22]

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Yes, that's likely.

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Gongda Yao, Daqo New Energy Corporation - CEO [23]

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Of course, those forward-looking always not accurate. The market changes so much.

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Brad Meikle, Craig-Hallum - Analyst [24]

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And how much silicon supply do you think is coming online from incumbents and new market entrants?

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Gongda Yao, Daqo New Energy Corporation - CEO [25]

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New added capacity is not much in Q1 and Q2. We don't believe any significant add-on new capacity. Expect we add about 6,000 metric tonnes to [the line of] Q1. And we're expecting maybe some add-on new capacity will come on in the second half of 2017.

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Brad Meikle, Craig-Hallum - Analyst [26]

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Great. What's your broader view? I guess you're estimating 10% demand growth globally from a solar standpoint. So what's your view on supply growth overall for this year? How much do you think it grows versus last year and then also 2018?

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Gongda Yao, Daqo New Energy Corporation - CEO [27]

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We believe the growth is not much. Even we say it's going to 73 gigawatts to about 79 gigawatts. But the major change right now, we see the shift from multi-crystal wafer to mono-crystal wafers. We're started a program in 2015 trying to address that market and we have already shipped a significant amount to those customers. And there are some qualifications that are going out for some key customers, so we're expecting those kinds of shipments will increasing because, as we said, those demands require is high quality compared to multi-crystal wafer use polysilicon.

We normally say high purity of polysilicon to meet those demands. So this portion of demand increasing will strengthen the Daqo New Energy position in the polysilicon market, because we can provide a significant amount of our product to meet the market.

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Brad Meikle, Craig-Hallum - Analyst [28]

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So what portion of your output would be high enough purity that would be acceptable for mono-wafer? And what do you expect your CapEx to be for the year? And can you talk about what you have do from a CapEx and how long it takes in order to upgrade output to be of the purity acceptable for a mono-wafer?

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Gongda Yao, Daqo New Energy Corporation - CEO [29]

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Yes, we expect in 2017 we have more than 50% can do that to provide that market. And CapEx, maybe Ming, you --

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Ming Yang, Daqo New Energy Corporation - CFO [30]

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So CapEx for the full year is approximately $40 million to $45 million for 2017. A portion of that is going to projects that are specifically designed to improve purity of our product. For example, we're upgrading our distillation system; there are special devices that remove impurity from the distillation.

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Brad Meikle, Craig-Hallum - Analyst [31]

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Can you get to 100% acceptable purity for the mono output?

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Ming Yang, Daqo New Energy Corporation - CFO [32]

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Yes. We think over time, as we implement additional projects, so --

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Gongda Yao, Daqo New Energy Corporation - CEO [33]

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I think the CapEx is used for further improve our quality of polysilicon also. And some areas we need to add more efficiency to our production. So either reduced cost or maybe slightly increase -- solve some debottlenecking in the production line. So our output we expect improvement from that. We expecting those things will be done in the middle of this year, so we'll see some good results in the second half.

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Brad Meikle, Craig-Hallum - Analyst [34]

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Thanks very much. Can I just ask one last high-level question? What would be the Company's view -- obviously, it's still early in this silicon cycle and there seems to be a lot of migration upstream in terms of investment. Is the Company open to some type of merger with a downstream partner at some point? Or is it the view that the Company would always be independent, because it seems like strategically that could make sense, given where the cycle's at?

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Gongda Yao, Daqo New Energy Corporation - CEO [35]

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Well, the Company didn't propose any of those kind of things to answer. We also didn't receive any proposals at this moment. But we are open minded to any good suggestions. And, of course, those are subject to our Board of members instead of our management team. So if we see such opportunity, we will forward to the Board members.

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Ming Yang, Daqo New Energy Corporation - CFO [36]

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We will be open to discussions, yes.

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Operator [37]

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Sheng Zhong, Morgan Stanley.

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Sheng Zhong, Morgan Stanley - Analyst [38]

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The first one is, you mentioned that you are relocating some equipment from Chongqing to Xinjiang, so should we expect some capacity increase in some time in near term?

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Ming Yang, Daqo New Energy Corporation - CFO [39]

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That's actually related to our existing phase, the 18,000 metric tonnes, because we moved a significant amount of equipment. So part of that expansion, we moved the equipment from Chongqing to Xinjiang. And so when that started operations in manufacturing in Q1 so the costs that related item facility will come down.

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Gongda Yao, Daqo New Energy Corporation - CEO [40]

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So depreciation from idle equipment of facility in Chongqing were reduced by half from last Q4 to Q1 this year, because those equipment already moved and are also installed in Xinjiang and [participating in] production right now.

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Sheng Zhong, Morgan Stanley - Analyst [41]

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Okay, yes, I see. So do you have any further capacity expansion plan at current stage?

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Gongda Yao, Daqo New Energy Corporation - CEO [42]

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We do have a plan, but we are not immediately started that phase. We will see the polysilicon, the whole total demand, I think there are still a lot of struggling for our competitors within China and we will see that, probably we will see until middle of this year, we will decide to go forward or not. But at this moment, we are not making any decision yet.

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Sheng Zhong, Morgan Stanley - Analyst [43]

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I understand. I think you mentioned that we are still waiting to see the market dynamics. Actually, back to our discussion previously only mono-crystallized demand, we see a lot of mono-wafer capacity is being constructed this year from all the leading wafer and the module makers. And actually, the high-purity polysilicon from the market, especially from the Chinese makers, it's not that much. And if we think about the import perspective, I think the amount is still -- I don't expect a large increase from the import, but you can correct me.

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Gongda Yao, Daqo New Energy Corporation - CEO [44]

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No, you are right.

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Sheng Zhong, Morgan Stanley - Analyst [45]

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Good, thanks. So how do you see the supply/demand balance for the high-purity polysilicon in China market?

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Gongda Yao, Daqo New Energy Corporation - CEO [46]

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Well, those facilities you mentioned increased will take some time. We think probably will significant volume increasing will be later this year. So I have confidence, by end of 2017, most of our product will meet the impurity demand for mono-wafers usage. Now it's only up to certain other things like morphology and also the condition when you harvesting those polysilicon [will meet or not]. And we're trying to become a leading provider for mono-wafer silicon for Chinese market.

With that, it's probably not enough but even we decided expansion right now so they normally take 1.5 year completion. So there will be slow transition; I think it will not be very quick a transaction from multi-crystal wafer for mono-wafers. But it is happening, like you mentioned before. I think this trend is real and I think it will impact a lot of, not only wafer manufacturers, although some polysilicon manufacturers in China as well, if they cannot provide high-purity polysilicon in future.

Now how to balance that? I cannot say, but I think what we can do, or we think about to do, is continue our improvement for high-purity polysilicon and we're trying to increase that portion for [line item] like half to 80%, 90%. So we're positioning ourselves as well in this kind of transition. That's all we can do.

Now if the market is still good after first half and very few people can -- they cannot provide and we will closely work with our key customer with mono-crystal wafer manufacturers in China and maybe we can decide for considered for future expansion. But again, that would take almost like 1.5 years and it's longer than the wafer guys' expansion.

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Ming Yang, Daqo New Energy Corporation - CFO [47]

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And [just let me follow up on] Dr. Yao's comments; if you just look at it from the supply side, I think the amount of product availability that you could see from overseas suppliers like Germany and Korea are pretty much fixed. And you're looking at a very high risk of Korean supply being significantly shut off because of the trade issues with China right now. And then, sometimes it is very limited amount poly, because there will be semi-grade poly available within China. And we're going to be the only major supplier right now.

And if you look from the demand side, right now, it's already very, very [tight]. We have much more demand than we could supply for this type of polysilicon. And going into the second half, without these new capacities coming online, that requires these type of semi-grade poly. I think the supply could get much worse than the current situation right now; [that's what we're looking at right now]. Thanks.

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Sheng Zhong, Morgan Stanley - Analyst [48]

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Thanks very much for the color. So since there is a very high demand, except for the prepayment we've currently seen, do we think that this kind of demand will drive the price difference between the mono-grade polysilicon, versus the [common ones]?

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Gongda Yao, Daqo New Energy Corporation - CEO [49]

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Yes, so let me try to answer. Currently, we don't see much, the gap is very small. But we think the phenomena we discussed just before, with a huge amount mono-wafer manufacturing capacity, and compared with very limited Chinese polysilicon manufacture can made to the products meet that. I'm expecting, if this trend continues, I think price gap between mono-wafer and multi-crystal wafer gap will increasing.

And, secondly, I think polysilicon if it can qualify for mono-wafer will be slightly higher. Starting that trend with the gap between that will increasing. Right now, it's almost nothing because right now, we are [in position] is qualified for those things in 2016. So basically, right now prices are similar, but the future, it's possible this gap will increasing. So that itself was driving more people interesting for moving to a mono-crystal wafer silicon provider in China as well. So that's probably what's happening in the second half, but not right now.

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Sheng Zhong, Morgan Stanley - Analyst [50]

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Okay. Thank you. My last question is about the -- do we have any updates on the [new variable] financing?

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Ming Yang, Daqo New Energy Corporation - CFO [51]

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So we're still in discussions with several domestic investors on new variable financing, but there has been no new updates on that right now. So we continue to be in discussion currently.

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Sheng Zhong, Morgan Stanley - Analyst [52]

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Okay. Thanks, Mr. Yang and --

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Operator [53]

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Paul Strigler, Esplanade.

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Paul Strigler, Esplanade Capital - Analyst [54]

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The EU just extended their minimum import price agreement for 18 months on Chinese imports. Is there a chance that China changes the agreement with the German polysilicon makers, in terms of what's [going to be an import] price for them into China, maybe restrictions on volume? I've just heard some rumblings about that, but could you guys comment anything about European polysilicon and limitations on imports into China?

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Gongda Yao, Daqo New Energy Corporation - CEO [55]

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Yes, we have no comments, because we are not aware any agreement between them. Even before the minimum price actually people guessing, but nobody knows. So probably will continue, I think, because it's European market to Chinese Government -- both governments, and they're trying to get the agreement among them. So I think there's no reason -- we don't see much will change. That's all we can say about it. Yes, we don't have much comments about that. But we think the trend is normal; I think probably, most likely, will continue that kind of arrangement.

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Paul Strigler, Esplanade Capital - Analyst [56]

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And just, I know you can't comment, but just to confirm, the agreement between China and Europe on polysilicon, that expires on April 30 of this year, is that correct?

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Gongda Yao, Daqo New Energy Corporation - CEO [57]

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Expires April 30? I'm not sure. We can check that.

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Paul Strigler, Esplanade Capital - Analyst [58]

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I'll follow up with Ming.

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Gongda Yao, Daqo New Energy Corporation - CEO [59]

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Yes, Kevin can check that and get back to you.

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Paul Strigler, Esplanade Capital - Analyst [60]

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Great. Thanks, guys.

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Operator [61]

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Brad Meikle, Craig-Hallum.

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Brad Meikle, Craig-Hallum - Analyst [62]

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So can we just step back? We had a decade where there was incessant polysilicon expansion. Now it seems like the balance sheets of most of the players are fairly tapped out, and [GCL] told us six months ago they don't really plan to add any more silicon capacity. I guess, there's a possible expansion or greenfield by[New Hope].

Can you just talk about how much actual real capacity you think is coming online over the next three years, and whether you agree with the view that we're moving to more of a balance to sellers' type of market, after really probably eight years of fairly aggressive expansion, especially by GCL? Thanks. And what that does to the longer term balance, and does pricing go back to $12 in 2018, or do you feel like we're more sustainably in [a round] when you can make a consistent margin? Thank you.

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Ming Yang, Daqo New Energy Corporation - CFO [63]

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Brad, thank you for your question. So I think if you look at the current market conditions right now, you're no longer seeing any significant capacity expansions by incumbents. So I think we are adding capacity, we just added some, but we're now taking a more prudent approach and looking at how the market might play out before we announce our next phase of expansion.

We think that's very similar condition for almost majority of our competitors. I think any new capacity that you see are being added or have been added, say over the past 12 months, probably was announced a long time ago. A significant proportion of capacity that are coming online, right now some of it in the US cannot even be imported into China. I think some of what people are talking about, like you said New Hope, I think that's a completely new player with no experience in polysilicon.

We checked out some of the equipment they're buying; some are unproven equipment, have never been actively used in polysilicon production in the past. With that type of experience, we think they're going to have significant amount of challenge trying to ramp up their facility. There's also other players within China trying to ramp up new technology that's also completely unproven for polysilicon manufacturing. The very likely outcome is, I think there's going to be a lot less new production coming into the market than people are thinking.

From that perspective, I think definitely it's a lot more balanced market right now. Specially the past 18 months, we have seen a fairly tightly supplied market for polysilicon and with much more prudent investment from the incumbents. The incumbents now know it's a very challenging market for -- everybody wants to add capacity at the same time. A lot of players, even at today's pricing, they're not very profitable so it's not easy. I think we're very uniquely positioned in this market because of our low cost structure.

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Brad Meikle, Craig-Hallum - Analyst [64]

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Thanks. I guess just last question is, [I get] you guys having over $100 million of free cash flow this year; would you ever pay dividend or return cash to stockholders or buy back stock?

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Ming Yang, Daqo New Energy Corporation - CFO [65]

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That's something that we're actively considering. Right now, I think last year we actually generated free cash flow and we decided to pay down some of our bank debt. I think this year, in the second half, certainly we think our cash flow we'll most likely improve upon versus 2016. Certainly we think dividend or returning cash to shareholders is something that we would actively consider and explore.

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Brad Meikle, Craig-Hallum - Analyst [66]

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Excellent. Thank you. We'd love to see more Chinese companies in the solar business thinking that way. Appreciate it, gentlemen.

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Operator [67]

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Philip Shen, ROTH Capital.

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Philip Shen, ROTH Capital Partners - Analyst [68]

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Just a few housekeeping questions; when you think about your wafer margins, how do you expect them to trend? What were they in Q4 and how do you see them trending in Q1 and beyond?

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Gongda Yao, Daqo New Energy Corporation - CEO [69]

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They'll be flat in Q4. We don't see much change.

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Ming Yang, Daqo New Energy Corporation - CFO [70]

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Roughly breakeven. All the gross profit and gross margin is contributed by our polysilicon business.

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Philip Shen, ROTH Capital Partners - Analyst [71]

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Okay. So you see that breakeven scenario going forward as well?

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Ming Yang, Daqo New Energy Corporation - CFO [72]

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Yes, definitely.

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Gongda Yao, Daqo New Energy Corporation - CEO [73]

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Correct. We don't really see much change.

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Philip Shen, ROTH Capital Partners - Analyst [74]

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Okay. Your R&D in the quarter was pretty high at $2.8 million; what do you see ahead in Q1 for R&D and beyond?

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Ming Yang, Daqo New Energy Corporation - CFO [75]

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We think for the full year 2017 maybe something between $3 million to $5 million full year 2017, and then I think you can just divide that by four per quarter. There might be some fluctuate from period to period but we think for the full year, it should run into that range.

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Philip Shen, ROTH Capital Partners - Analyst [76]

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That's pretty high -- a big change relative to what you guys have spent historically on R&D. I've read what you guys had in your release about R&D, but can you just comment a bit more on the rationale for the spending and what your plans are, or the goals of that spending? Thanks.

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Ming Yang, Daqo New Energy Corporation - CFO [77]

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The R&D expense for Q4 was a bit unique in terms of because we had concurrent maintenance. So it was a perfect timing to do the R&D activities and install new projects equipment at that same time, and especially as we prepare for our new capacity expansion as well. These new R&D projects can be used for the entire 18,000 metric tonnes capacity. That was a little bit unique in terms of timing, so that's how we decided to spend the R&D efforts within the quarter. I think, going forward, it's less likely we're going to see a big one-time event like that.

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Philip Shen, ROTH Capital Partners - Analyst [78]

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Okay. I guess my question is, historically your R&D has been about $1 million or $1.5 million a year and you're looking at $3 million to $5 million for 2017. So just curious to know the rationale for that increase for the full-year 2017.

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Ming Yang, Daqo New Energy Corporation - CFO [79]

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I think for 2016, the full year is now $4 million. It's because we're doing projects. One is to improve the purity, improve the quality and improve the percentage of polysilicon we can do for semi-grade so that requires R&D. At the same time, we're also doing special projects for cost reductions and for improving throughput and debottlenecking. We're doing, for example, cost reduction efforts that lowers energy usage.

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Philip Shen, ROTH Capital Partners - Analyst [80]

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Okay. Great.

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Ming Yang, Daqo New Energy Corporation - CFO [81]

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So it's all these things what we're doing.

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Philip Shen, ROTH Capital Partners - Analyst [82]

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Thanks, Ming.

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Operator [83]

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

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Kevin He, Daqo New Energy Corporation - IR [84]

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Thank you, everyone, again for joining the call today. Should you have any further questions, please feel free to contact us. Thank you and bye-bye.

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Operator [85]

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The conference is now concluded. Thank you for attending today's presentation, you may now disconnect your lines. Have a great day.