Quarterly Report

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include all statements other than statements of historical fact contained in this Quarterly Report on Form 10-Q, including, but not limited to, statements about:

 

In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail in Part II, Item I,. “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date hereof. We hereby qualify all of our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

The following discussion should be read in conjunction with our financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q and with our financial statements and notes thereto for the fiscal year ended March 31, 2007, contained in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on June 29, 2007.

 

Overview

 

Hoku Scientific, Inc. is a materials science company focused on clean energy technologies. We were incorporated in Hawaii in March 2001, as Pacific Energy Group, Inc. In July 2001, we changed our name to Hoku Scientific, Inc. In December 2004, we were reincorporated in Delaware.

 

We have historically focused our efforts on the design and development of fuel cell technologies, including our Hoku membrane electrode assemblies, or MEAs, and Hoku Membranes. In May 2006, we announced our plans to form a photovoltaic, or PV, module and system installation business, and our plans to produce polysilicon, a primary material used in the manufacture of PV modules, to complement our fuel cell business. In fiscal 2007, we reorganized our business into three business units: Hoku Materials, Hoku Solar and Hoku Fuel Cells. In February and March 2007, we incorporated Hoku Materials, Inc. and Hoku Solar, Inc., respectively, as wholly-owned subsidiaries to operate our polysilicon and solar businesses, respectively.

 

Hoku Materials

 

In February 2007, in order to ensure an adequate supply of polysilicon for Hoku Solar’s modules, we incorporated Hoku Materials to produce this key material for consumption by Hoku Solar and for sale to the larger solar market. We commenced construction of our planned polysilicon production facility in May 2007 and anticipate the availability of polysilicon beginning in the first half of calendar year 2009. We intend to finance the construction of this facility through a combination of prepayments from customers and debt and/or equity financing.

 

 

Polysilicon Sales Agreements

 

Sanyo Electric Co., Ltd. In January 2007, we signed a fixed price/fixed volume contract with Sanyo Electric Company, Ltd., or Sanyo, to provide Sanyo with up to approximately $371 million of polysilicon sales over a seven year period and Sanyo advanced to us $2 million and deposited an additional $109 million into an escrow account at Bank of Hawaii to be released to us upon achievement of certain polysilicon production and quality milestones. In October 2007, we amended the agreement with Sanyo by extending the date to complete the financing for the construction of our polysilicon production plant from October 17, 2007 to December 31, 2007.   In December 2007, we further amended the agreement with Sanyo by extending the date to complete the financing for the construction of our polysilicon production plant from December 31, 2007 to February 15, 2008.  

 

In January 2008, we amended our polysilicon supply contract with Sanyo to increase the term of the contract from seven to ten years. The total amounts that may be payable to us under the contract have increased from up to approximately $371 million for the seven year contract, to up to approximately $530 million for the amended ten year contract. The contract provides for the delivery of predetermined volumes of polysilicon to Sanyo each year at set prices from January 2010 through December 2019. The contract also extends the date when either party may terminate the supply agreement if we are unable to complete the financing for our polysilicon production plant from February 15, 2008 to May 31, 2008.

 

The amendment also extends the dates when Sanyo may terminate the agreement if we are unable to complete the various polysilicon production, process implementation, and shipment milestones as follows:

 

•

if we fail to deliver a predetermined quantity of our manufactured product by April 2010,

 

•

if we fail to deliver the minimum monthly quantity of product in any month beginning in April 2010,

 

•

if we fail to deliver the minimum annual quantity of polysilicon product in any year beginning in calendar year 2010; or

 

•

if we fail to complete successfully any of the polysilicon quality, production volume tests or the process implementation test set forth in the agreement within specified periods of time.

 

Upon the expiration or termination of the agreement, we are generally required to refund to Sanyo the entire amount of the deposit and authorize the Bank of Hawaii to return the funds held in escrow, less any part of the deposit and escrow that has been applied to the purchase price of products delivered under the agreement.

 

Wuxi Suntech Power Co. Ltd. In June 2007, we entered into a fixed price/fixed volume agreement with Wuxi Suntech Power Co., Ltd., or Suntech, to provide Suntech with up to approximately $678 million of polysilicon sales over a ten year period. Pursuant to the agreement, Suntech advanced to us $2 million and will make additional prepayments for products of $45 million in installments upon achievement of certain polysilicon production and quality milestones. In August 2007, a s security for Suntech’s prepayment obligation, Suntech delivered a $45 million letter of credit issued to us by the Chicago branch of ABN AMRO Bank NV. The contract also includes a provision that allows for either party to cancel years 8 through 10 of delivery for any reason. Such cancellation notice must be delivered to the other party prior to the end of the fourth year of delivery under the agreement.

 

Global Expertise Wafer Division Ltd . In June 2007, we entered into a fixed price/fixed volume agreement with Global Expertise Wafer Division Ltd., or GEWD, a wholly-owned subsidiary of Solar-Fabrik AG, to provide GEWD with up to approximately $185 million of polysilicon sales over a seven year period. Pursuant to the agreement, GEWD advanced to us $2 million and was required to make additional prepayments for products of $51 million in installments upon achievement of certain polysilicon production and quality milestones.   As security for GEWD’s $51 million prepayment obligation, GEWD obtained a $25 million letter of credit in our favor from Dresdner Bank AG. GEWD was also required to provide an additional $26 million bank letter of credit to us on or before September 30, 2007. As GEWD did not obtain the additional $26 million letter of credit, in December 2007, we exercised our option to reduce the predetermined volume of polysilicon and increased the predetermined price under the agreement. As a result, we will now provide GEWD with up to $117 million of polysilicon sales over a seven year period, and GEWD’s prepayment obligation has been reduced to $27 million, comprised of the $2 million already paid to us in cash and the $25 million that is supported by the Dresdner Bank standby letter of credit.

 

 

Solarfun Power Hong Kong Limited. In November 2007, we entered into a fixed price/fixed volume agreement with Solarfun Power Hong Kong Limited, or Solarfun, a subsidiary of Solarfun Power Holdings Co., Ltd., to provide Solarfun with up to $306 million of polysilicon sales over an eight year period. Pursuant to this agreement, Solarfun paid us $10 million as a prepayment for future product deliveries. Under an amended contract executed in January 2008, Solarfun has until February 15, 2008 to obtain a $44 million standby letter of credit in our favor and requires Solarfun to pay us an additional $44 million in three installments: the first payment is due on September 30, 2008 and the final payment is due on March 31, 2010 . In connection with the amended contract, Solarfun made an additional prepayment of $1 million, bringing the total prepayments made to date to $11 million.

 

Under the amended and restated contract, if Solarfun does not deliver the $44 million stand-by letter of credit or deposit $44 million into an escrow account, by February 15, 2008, then we may immediately terminate the agreement and retain the $11 million initial cash deposit as liquidated damages.

 

Construction and Other Related Agreements  

 

City of Pocatello . In May 2007, the City of Pocatello approved an ordinance that would provide us with tax incentives related to the cost of infrastructure necessary for the completion of our planned polysilicon plant. We would receive up to $25.9 million in property tax reimbursements for infrastructure improvements and up to $17.4 million in property tax reimbursements based on employment numbers.  Reimbursements are based on actual tax payments and are paid over time.    The ordinance is in effect through year 2030.

 

Stone & Webster, Inc. In August 2007, we entered into an agreement with Stone & Webster, Inc., or S&W, a subsidiary of The Shaw Group Inc., for engineering, procurement, and construction management services, or the EPCM Agreement, for the construction of a polysilicon production plant with an annual capacity of 2,000 metric tons. We will pay S&W on a time and materials basis plus a fee for its services and incentives if certain schedule and cost targets are met. The target cost for the services to be provided under the EPCM Agreement is $41.5 million, plus up to $5.0 million of additional incentives that may be payable.   In October 2007, we issued a change order under the EPCM Agreement to increase the rated polysilicon production capacity of our planned facility to up to 2,500 metric tons per year. The change order did not change S&W’s target costs or their incentives under the EPCM Agreement.

 

JH Kelly LLC. In August 2007, we entered into an agreement with JH Kelly LLC., or JH Kelly, for construction services for the construction of a polysilicon production plant with an annual capacity of 2,000 metric tons, or the Construction Agreement. We will pay JH Kelly on a time and materials basis plus a fee for its services and incentives if certain schedule, cost and safety targets are met. The target cost for the services to be provided under the Construction Agreement is $120.0 million, including up to $5.0 million of incentives that may be payable. In October 2007, we issued a change order under the Construction Agreement to increase the rated polysilicon production capacity of our planned facility to up to 2,500 metric tons per year. The change order increased JH Kelly’s target cost by $1.0 million; however there is no change to the additional incentives of the contract.

 

Dynamic Engineering Inc. In October 2007, we entered into an agreement with Dynamic Engineering Inc., or Dynamic, for design and engineering services, and a related technology license, for the process to produce and purify trichlorosilane, or TCS. Under the agreement, Dynamic is obligated to design and engineer a TCS production facility that is capable of producing a sufficient quantity of TCS for us to produce up to 2,500 metric tons of polysilicon per year at our planned polysilicon production facility. The Dynamic process is to be integrated by S&W into the overall polysilicon production facility, and will be constructed by JH Kelly. Dynamic's engineering services will be provided and invoiced on a time and materials basis, and the license fee will be calculated upon the successful completion of the TCS production facility, and demonstration of certain TCS purity and production efficiency capabilities. The maximum aggregate amount that we may pay Dynamic for the engineering services and the technology license is $12.5 million, which includes an incentive for Dynamic to complete the engineering services under budget. Dynamic is guaranteeing the quantity and purity of the TCS to be produced at the completed facility, and has agreed to indemnify us for any third party claims of intellectual property infringement.

 

 

GEC Graeber Engineering Consultants GmbH and MSA Apparatus Construction for Chemical Equipment Ltd. In October 2007, we entered into an amended and restated contract with GEC Graeber Engineering Consultants GmbH, or GEC, and MSA Apparatus Construction for Chemical Equipment Ltd., or MSA, to include an option for us to purchase additional hydrogen reduction reactors and hydrogenation reactors for the production of polysilicon, or the Reactor Contract, for a total purchase price of up to approximately 6.7 million Euros ($9.9 million as of December 31, 2007). The option will enable us to produce up to an additional 500 metric tons of polysilicon per year, which, if exercised, would bring our total polysilicon production capacity to 2,500 metric tons per year, and the total amounts payable to GEC and MSA up to 27 million Euros ($39.7 million as of December 31, 2007). In addition, we, GEC and MSA agreed to eliminate the requirement from our prior contract that we establish an irrevocable Letter of Credit for 65% of the total contract amount, providing instead for us to make monthly progress payments. As of December 31, 2007, we have paid GEC and MSA 6.3 million Euros.

 

Bank of Hawaii . In January 2008, we entered into an agreement with Bank of Hawaii to purchase in increments an aggregate amount of 8.7 million Euros on various maturity dates beginning in April 2008 and ending in July 2010 at a fixed U.S dollar amount of $12.8 million. We expect to use the purchased Euros to make payments pursuant to the GEC and MSA contracts. As part of the agreement, we are required to place deposits with Bank of Hawaii for 20% of the notional value of the outstanding transactions, which can fluctuate based on the U.S Dollar/Euro exchange rate. We will earn interest on our deposit, which will be recorded as restricted cash. As of January 15, 2008, our restricted cash balance related to these deposits was $2.6 million.

 

Idaho Power Company . In December 2007, we entered into an agreement with Idaho Power Company to complete the construction of the electric substation to provide power for our planned polysilicon production plant in Pocatello, Idaho. We are obligated to pay Idaho Power Company an aggregate of $14.8 million for the completion of the substation and associated facilities. In January 2008, we made an initial payment under the contract of $3.7 million. Under the terms of the agreement, the substation and associated facilities are scheduled to be completed on or before February 15, 2009. The agreement provides that Idaho Power Company may invoice us additional amounts for temporary power to enable the start-up and operation of the planned polysilicon production plant prior to February 15, 2009.

 

Merrill Lynch. In December 2007, we signed a non-binding term sheet with Merrill Lynch to finance up to approximately $185 million for the construction, procurement and start-up of our planned polysilicon production plant in Pocatello, Idaho. The closing of the loan and the availability of the funds is subject to several conditions, including the completion by Merrill Lynch of its due diligence, the negotiation and execution of definitive loan and collateral documents, and the receipt of third-party consents. In addition, prior to receiving any of the loan proceeds, we will be required to provide approximately $35 million for use in the construction of the planned polysilicon plant. To meet this and other capital requirements, we will be required to secure additional financing.

 

Based on our recent developments, we have decided to increase the annual capacity of Phase I of our planned polysilicon facility from the previously planned 2,500 metric tons per year to 3,500 metric tons per year. Once our plant is operating at full capacity, we will be able to meet the annual delivery requirements in our four existing polysilicon sales contracts, and we will have some additional polysilicon available for sale. Although we have increased the planned size our polysilicon facility, we believe we are still on track to deliver polysilicon in the first half of calendar year 2009, and expect that we will be running at full 3,500 metric tons per year capacity in the first half of 2010. We also still plan to have a Phase II expansion. We believe we have sufficient space to expand our polysilicon production to up to 8,000 metric tons per year on our existing 67-acre property; however the expansion size will primarily be determined based on new polysilicon sales contracts that we may sign.

 

We are in negotiations with S&W, JH Kelly, Dynamic and GEC and MSA to increase their respective scope of services to accommodate the increased capacity of our planned polysilicon facility, which we expect will result an increase in their respective costs. We estimate the cost of our planned 3,500 metric tons per year facility to be approximately $400 million. We intend to use the $240 million in advance payment commitments from our polysilicon customer agreements to contribute to the financing of the construction and for working capital, subject to our successful achievement of various polysilicon production and quality milestones for Sanyo, Suntech and GEWD. We have already received $17 million of this $240 million from our customers, and anticipate that we will receive $135 million in the second half of calendar year 2008, $68 million in the first half of 2009 and the remaining $20 million subsequent to the first half of 2009. The previously announced proposed financing from Merrill Lynch will help finance the remaining construction costs and we do not believe that our increased Phase I capacity will change the amount we need from Merrill Lynch or adjust the amount we will need to provide. However, there are no assurances that we will be able to obtain the financing for the remaining construction costs on satisfactory terms, or at all.

 

 

Hoku Solar

 

In March 2007, we incorporated Hoku Solar to assemble and install photovoltaic, or PV, systems. In December 2007, we completed installations for Paradise Beverages, Bank of Hawaii and other commercial and residential customers.

 

In July 2007, we signed a non-binding letter of intent with Bank of Hawaii for us to explore additional turnkey PV system installations for Bank of Hawaii’s other neighbor island facilities on the islands of Hawaii, Maui and Kauai.

 

As of January 2008, Hawaiian Electric Company has submitted for an approval from the Hawaii Public Utilities Commission to purchase electricity generated by a PV system that we would install. If approved, we will install a 167 kilowatt PV system and the sell the power generated by that system over a 20-year period to Hawaiian Electric Company.

 

In January 2008, we entered into an agreement with The James Campbell Company to plan the Kapolei Sustainable Energy Park, which would be capable of generating approximately 1.5 megawatts of PV power and would be the largest PV facility on Oahu. The agreement is non-binding on us or The James Campbell Company, and is subject to various conditions and government approvals related to the capped solid waste storage area on the site. 

 

We plan to continue to market, sell and install turnkey PV systems and will use modules purchased from third party suppliers. In addition, we continue to explore the sale of our land and facility in Kapolei, Hawaii and our relocation to a smaller leased warehouse and office space on Oahu.

 

Hoku Fuel Cells

 

Under the name Hoku Fuel Cells, we operated our fuel cell business, which has designed, developed and manufactured MEAs for proton exchange membrane, or PEM, fuel cells. Hoku MEAs are designed for the residential primary power, commercial back-up, and automotive hydrogen fuel cell markets. To date, our customers have not commercially deployed products incorporating Hoku MEAs or Hoku Membranes, and we have not sold any products commercially. In August 2007, we completed our contract with the U.S. Navy, and have one testing agreement with another customer; however, there are no current testing activities under this agreement. We do not currently plan on actively pursuing any new contracts or committing resources to further develop our fuel cell products   and intend to selectively pursue patent applications in order to protect our technology, inventions and improvements related to our fuel cell products.

 

Financial Operations Review

 

Prior to the three months ended December 31, 2007, we derived substantially all of our revenue from contracts with the U.S. Navy, Nissan Motor Co., Ltd., or Nissan, and Sanyo Electric Co., Ltd., or Sanyo, related to testing and engineering services related to Hoku Fuel Cells. Our fiscal 2008 revenue from Hoku Fuel Cells is principally comprised of service and license revenue from the U.S. Navy. Revenue under our service contracts are recognized based on the last deliverable as the contracts contain multiple elements. Revenue under our license contracts is recognized upon shipment of the associated licensed products.

 

During the three months ended December 31, 2007, we derived all of our revenue through PV system installation contracts related to Hoku Solar. We expect that all of our revenue will be derived through PV system installations and the sale of electricity until the first half of calendar year 2009, when Hoku Materials is expected to generate revenue through the sale of polysilicon.

 

 

Hoku Solar

 

During the three months ended December 31, 2007, all of our revenue was comprised of commercial and residential PV system installations. Our revenue was primarily from two installations for Paradise Beverages totaling $987,000 in the aggregate and an installation for the Bank of Hawaii for $135,000.

 

Hoku Fuel Cells

 

In March 2005, we were awarded a contract with the U.S. Navy to develop and demonstrate a PEM fuel cell power plant prototype that incorporates our Hoku MEAs within IdaTech, LLC, or IdaTech, fuel cell stacks and integrated fuel cell systems. We received payments of $4.5 million, the aggregate amount of the contract and recognized $1.3 million in revenue during the nine months ended December 31, 2007. We completed all work related to this contract in August 2007, and no revenue was recorded for the three months ended December 31, 2007.

 

Consolidated Results of Operations

 

The following analysis of the unaudited consolidated financial condition and results of operations of Hoku Scientific, Inc. and its subsidiaries should be read in conjunction with the consolidated financial statements and the related notes thereto in this Quarterly Report on Form 10-Q.

 

Three Months Ended December 31, 2007 and 2006

 

Revenue. Revenue was $1.3 million for the three months ended December 31, 2007 compared to $1.1 million for the same period in 2006. Revenue for the three months ended December 31, 2007 was comprised of PV system installations primarily from contracts with Paradise Beverages and Bank of Hawaii compared to service and license revenue from contracts with the U.S. Navy for the same period in 2006.

 

Cost of Service and License Revenue. Cost of service and license revenue was $805,000 for the three months ended December 31, 2007 compared to $978,000 for the same period in 2006. The cost of service and license revenue for the three months ended December 31, 2007 related to PV system installation primarily from contracts with Paradise Beverages and Bank of Hawaii compared to cost of service and license revenue from contracts with the U.S Navy contracts for the same period in 2006. Cost of service license revenue primarily consisted of employee compensation and supplies and materials.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $1.3 million for the three months ended December 31, 2007 compared to $645,000 for the same period in 2006. The increase of $700,000 was primarily due to an increase in professional fees consisting principally of legal, accounting, consulting and other service fees of $384,000. In addition, employee compensation, including stock-based compensation, increased by $233,000 due to additional employees and the issuance of stock awards.

 

Research and Development Expenses . Research and development expenses were $3,000 for the three months ended December 31, 2007 compared to $1.0 million for the same period in 2006. The decrease was primarily due to the $786,000 write down of equipment and inventory used in our fuel cell business Additionally, the reduction of employees in our fuel cell business resulted in reductions in payroll and stock-based compensation expense of $138,000 and we reduced costs related to materials and services used for research and development by $86,000.

 

Interest and Other Income . Interest and other income was $344,000 for the three months ended December 31, 2007, compared to $255,000 for the same period in 2006. The increase of $89,000 was primarily due to the release of excise tax reserves and other miscellaneous accruals.

 

Nine Months Ended December 31, 2007 and 2006

 

Revenue. Revenue was $2.6 million for the nine months ended December 31, 2007 compared to $4.2 million for the same period in 2006. Revenue for the nine months ended December 31, 2007 was comprised of service and license revenue from contracts with the U.S. Navy and PV system installations compared to service and license revenue primarily from contracts with Nissan and the U.S. Navy of $2.1 million and $2.0 million, respectively, for the same period in the 2006.

 

 

Cost of Service and License Revenue. Cost of service and license revenue was $1.8 million for the nine months ended December 31, 2007 compared to $2.3 million for the same period in 2006. The cost of service and license revenue for the nine months ended December 31, 2007 related to contracts with the U.S. Navy and installation of PV systems compared to cost of service and license revenue primarily related to the Nissan and the U.S Navy contracts for the same period in 2006. Cost of service license revenue primarily consisted of manufacturing expenses, including employee compensation and supplies and materials.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $3.8 million for the nine months ended December 31, 2007 compared to $2.1 million for the same period in 2006. The increase of $1.7 million was primarily due to an increase in employee compensation, including stock-based compensation, of $605,000 due to additional employees and the issuance of stock awards. In addition, the increase was due to professional fees consisting principally of legal, accounting, consulting and other service fees of $335,000 and travel expenses of $84,000. Furthermore, the increase was due to redeployment of personnel, supplies and other costs, which were previously captured in customer contracts as costs of uncompleted contracts or cost of service and license of $324,000, loss on the sale of solar cells of $286,000, and an impairment of assets of $79,000.

 

Research and Development Expenses . Research and development expenses were $85,000 for the nine months ended December 31, 2007 compared to $1.6 million for the same period in 2006. The decrease of $1.5 million was primarily due to the $786,000 write down of equipment and inventory used in our fuel cell business. In addition, the decrease was due to the reduction of employees in our fuel cell business resulting in reductions in payroll and stock-based compensation expense of $282,000 and by reductions in costs related to materials and services used for research and development of $278,000, depreciation of $79,000, and insurance of $46,000.

 

Interest and Other Income . Interest and other income was $824,000 for the nine months ended December 31, 2007, compared to $798,000 for the same period in 2006. The increase of $26,000 was primarily due to the release of excise tax reserves and other miscellaneous accruals offset by a reduction in interest income, primarily due to lower average balances of cash equivalents and short-term investments.

 

Liquidity and Capital Resources

 

We have incurred cumulative net losses and as of December 31, 2007, we had an accumulated deficit of $10.1 million. During the nine months ended December 31, 2007, Hoku Materials did not generate any revenue. Our revenue was limited to our contract with the U.S. Navy from Hoku Fuel Cells which was completed in August 2007 and from PV system installations primarily from Hoku Solar contracts with Paradise Beverages and Bank of Hawaii. We expect that our Step 3 Contract with Nissan, which ended in September 2006, our Testing Agreement with Sanyo, which ended in July 2006, and our contracts with the U.S. Navy, which ended in August 2007, will be our final engineering service contracts with these companies. At this time, we do not believe we will receive any meaningful revenue from Nissan, Sanyo or the U.S. Navy relating to Hoku Fuel Cell products and services in the foreseeable future. In addition, Nissan, Sanyo or the U.S. Navy may require additional testing of our Hoku Membrane and Hoku MEA products before purchasing commercial quantities of our products. We cannot predict when such sales will occur, if at all. As of December 31, 2007, there were no additional costs or obligations to Nissan, Sanyo or the U.S. Navy relating to Hoku Fuel Cells.

 

Although we have completed PV system installations, our near term revenue will be limited to our ability to enter into PV system installation agreements and/or agreements to sell electricity and our ability to install our PV systems.

 

We will also need approximately $400 million to successfully complete our planned construction of our polysilicon manufacturing facilities. See “Solar and Polysilicon Facilities” below. The result is that we expect our costs to increase significantly, which will result in further losses.

 

Net Cash Provided By (Used In) Operating Activities Net cash provided by operating activities was $948,000 for the nine months ended December 31, 2007 compared to net cash used of $4.5 million for the same period in 2006. The increase of $5.4 million was primarily a result of inventory used in PV system installations.

 

 

Net Cash Provided By (Used In) Investing Activities Net cash used in investing activities was $1.7 million for the nine months ended December 31, 2007 compared to net cash provided by investing activities of $4.5 million for the same period in 2006. The decrease of $6.2 million was primarily due to the use of investments to pay operating expenses.

 

Net Cash Provided By Financing Activities Net cash provided by financing activities was $15.0 million for the nine months ended December 31, 2007 compared to net cash provided by financing activities of $7,000 for the same period in 2006. The increase of $15 million was primarily due to deposits received related to polysilicon supply agreements.

 

Contractual Obligations

 

The following table summarizes the contractual obligations that existed at December 31, 2007:

 

		Payments Due by Period
Contractual Obligations		Total			Less Than One Year			One to Three Years			Three to Five Years			More Than Five Years
		(in thousands)
Construction in progress obligations		$	16,323		$	15,823		$	500		$	—		$	—
Equipment purchase obligations			21,504			—			21,504			—			—
Total		$	37,827		$	15,823		$	22,004		$	—		$	—

 

Stone & Webster, Inc. In August 2007, we entered into an agreement with S&W, a subsidiary of The Shaw Group Inc., for engineering, procurement, and construction management services, or the EPCM Agreement, for the construction of a polysilicon production plant with an annual capacity of 2,000 metric tons. S&W will be paid on a time and materials basis plus a fee for its services and incentives if certain schedule and cost targets are met. The target cost for the services to be provided under the EPCM Agreement is $41.5 million, plus up to $5.0 million of additional incentives that may be payable. In October 2007, we issued a change order under the EPCM Agreement to increase the rated polysilicon production capacity of our planned facility to up to 2,500 metric tons per year. The change order did not change S&W’s target costs or their incentives under the EPCM Agreement. During the three months ended December 31, 2007, we made payments to S&W of $2.5 million, and as of December 31, 2007, we had paid S&W an aggregate amount of $2.7 million.

 

JH Kelly LLC . In August 2007, we entered into an agreement with JH Kelly for construction services for the construction of a polysilicon production plant with an annual capacity of 2,000 metric tons, or the Construction Agreement. We will pay JH Kelly on a time and materials basis plus a fee for its services and incentives if certain schedule, cost and safety targets are met. The target cost for the services to be provided under the Construction Agreement is $120.0 million, including up to $5.0 million of incentives that may be payable. In October 2007, we issued a change order under the Construction Agreement to increase the rated polysilicon production capacity of our planned facility to up to 2,500 metric tons per year. The change order increased JH Kelly’s target cost by $1.0 million; however, there is no change to the additional incentives of the contract. During the three months ended December 31, 2007, we made payments to JH Kelly of $1.9 million, and as of December 31, 2007, we had paid JH Kelly an aggregate amount of $2.0 million.

 

Dynamic Engineering Inc. In October 2007, we entered into an agreement with Dynamic for design and engineering services, and a related technology license for the process to produce and purify TCS. Dynamic's engineering services will be provided and invoiced on a time and materials basis, and the license fee will be calculated upon the successful completion of the TCS production facility, and demonstration of certain TCS purity and production efficiency capabilities. The maximum aggregate amount that we may pay Dynamic for the engineering services and the technology license is $12.5 million, which includes an incentive for Dynamic to complete the engineering services under budget. During the three months ended December 31, 2007, we made payments to Dynamic of $375,000.

 

 

GEC Graeber Engineering Consultants GmbH and MSA Apparatus Construction for Chemical Equipment Ltd. In January 2007, we entered into a contract with GEC Graeber Engineering Consultants GmbH, or GEC, and MSA Apparatus Construction for Chemical Equipment Ltd., or MSA, for the purchase and sale of hydrogen reduction reactors and hydrogenation reactors for the production of polysilicon, and related engineering and installation services. Under the contract, we will pay up to a total of 20.9 million Euros ($30.8 million as of December 31, 2007) for the reactors. The reactors are designed and engineered to produce approximately 2,000 metric tons of polysilicon per year. The term of the contract extends until the end of the first month after the expiration date of the warranty period, but may be terminated earlier under certain circumstances. In May 2007, we paid GEC and MSA 3.1 million Euros ($4.2 million on the date of payment) for the initial deposit of 15% for hydrogen reduction reactors capable of producing 2,000 metric tons of polysilicon per year. In October 2007, we, amended and restated the contract with GEC and MSA to eliminate the requirement that an irrevocable letter of credit equal to 65% of the purchase price for the reactors to be delivered, and to include an option for us to order additional reactors capable of producing an additional 500 metrics of polysilicon per year for a total purchase price of approximately 6.7 million Euros ($9.9 million as of December 31, 2007). As of December 31, 2007, we had paid GEC and MSA $6.3 million Euros.

 

Bank of Hawaii . In January 2008, we entered into an agreement with Bank of Hawaii to purchase in increments an aggregate amount of 8.7 million Euros on various maturity dates beginning in April 2008 and ending in July 2010 at a fixed U.S dollar amount of $12.8 million. We expect to use the purchased Euros to make payments pursuant to the GEC and MSA contracts. As part of the agreement, we are required to place deposits with Bank of Hawaii for 20% of the notional value of the outstanding transactions, which can fluctuate based on the U.S Dollar/Euro exchange rate. We will earn interest on our deposits, which will be recorded as restricted cash. As of January 15, 2008, our restricted cash balance related to these deposits was $2.6 million.

 

Idaho Power Company . In June 2007, we entered into an Agreement for Engineering of Hoku Electric Substation and Associated Facilities, or the Engineering Agreement, with Idaho Power Company to begin the engineering and procurement process for the electric substation to provide power for the planned polysilicon production plant in Pocatello, Idaho. We paid Idaho Power Company two payments of $458,500 each in June and September 2007. In December 2007, we entered into a second agreement with Idaho Power Company to complete the construction of the electric substation to provide power for our planned polysilicon production plant. We have agreed to pay Idaho Power Company an aggregate of $14.8 million for the completion of the substation and associated facilities. In January 2008, we made an initial payment of $3.7 million to Idaho Power Company. Under the terms of the agreement, the substation and associated facilities are scheduled to be completed on or before February 15, 2009. The agreement provides that Idaho Power Company may invoice us additional amounts for temporary power to enable the start-up and operation of the planned polysilicon production plant prior to February 15, 2009.

 

We are in negotiations with S&W, JH Kelly, Dynamic and GEC and MSA to increase their respective scope of services to accommodate the increased capacity of our planned polysilicon facility, which we expect will result in an increase in their respective costs.

 

Bank of Hawaii. We maintain a credit facility expiring on March 31, 2008 for up to $13.0 million with Bank of Hawaii. Loans under the credit facility will bear interest, dependent upon our election at the time of the advance, at either: (1) a floating rate per annum equal to the sum of the primary index rate established from time to time by the Bank of Hawaii minus 1.25%, or (2) a rate per annum equal to the sum of LIBOR for such LIBOR interest period plus 0.50%. Loans under the credit facility are secured by a first priority security interest in Hoku Materials’ cash, cash equivalents, short-term investments and marketable securities contained in an account at Piper Jaffray. Hoku Materials must maintain a loan-to-value ratio between 70% to 95% dependent upon the collateral type in such account. Hoku Scientific and Hoku Materials are also subject to certain financial and operational covenants, including maintaining an effective tangible net worth of not less than $20.0 million. Effective tangible net worth is defined as GAAP net worth, less intangible assets.

 

We used these funds to pay in part, certain expenses related to its polysilicon production facility in Pocatello, Idaho. In November 2007, we repaid Bank of Hawaii $10.9 million, which was the entire amount outstanding under the credit facility. As of December 31, 2007, we did not have an outstanding balance related to the credit facility and we were in compliance with the covenants of the credit facility.

 

 

Polysilicon Production Plant and Financing Requirements

 

In May 2006, we announced our intention to form an integrated PV module and polysilicon production business to complement our fuel cell business. This planned expansion included developing manufacturing and production capabilities and the eventual production of polysilicon and manufacture of PV modules. In June 2007, we announced our strategy to focus on the sale of turnkey PV system installations, and related services, and our decision not to enter the solar module manufacturing business. Furthermore, due to the change in our business strategy to not manufacture solar modules, along with the downsizing of our fuel cell business, we are exploring the sale of our land and facility in Kapolei, Hawaii and our relocation to a smaller leased warehouse and office space on Oahu, Hawaii. To date, our business has solely been focused on the stationary and automotive fuel cell markets and we have no experience in the polysilicon business, and limited experience in the PV system installation business.

 

We intend to produce polysilicon at our planned polysilicon production plant in Pocatello, Idaho. We commenced construction in May 2007 and anticipate the availability of polysilicon beginning in the first half of calendar year 2009. In December 2007, we indicated that we plan on building a facility capable of producing approximately 2,500 metric tons of solar-grade polysilicon per year when it is running at full capacity, and the first customer shipments are planned for the beginning of 2009. In addition, we announced our plans for a second phase, which would increase our capacity beyond 2,500 metric tons per year to meet our obligations to Solarfun Power Hong Kong Limited.

 

Based on our recent developments, we have decided to increase the annual capacity of Phase I of our planned polysilicon facility from the previously planned 2,500 metric tons per year to 3,500 metric tons per year. Once our plant is operating at full capacity, we will be able to meet the annual delivery requirements in our four existing polysilicon sales contracts, and we will have some additional polysilicon available for sale. Although we have increased the size our polysilicon facility, we believe we are still on track to deliver polysilicon in the first half of calendar year 2009, and expect that we will be running at full 3,500 metric tons per year capacity in the first half of 2010. We also still plan to have a Phase II expansion. We believe we have sufficient space on our existing 67-acre property to expand our polysilicon production to up to 8,000 metric tons per year; however, the expansion size will primarily be determined based on new polysilicon sales contracts that we may sign.

 

We estimate the cost of our planned 3,500 metric tons per year facility to be approximately $400 million. We intend to use the $240 million in advance payment commitments from our polysilicon customer agreements to contribute to the financing of the construction and for working capital, subject to our successful achievements of various polysilicon production and quality milestones for Sanyo, Suntech and GEWD. We have already received $17 million of this $240 million from our customers, and anticipate that we will receive $135 million in the second half of calendar year 2008, $68 million in the first half of 2009 and the remaining $20 million subsequent to the first half of 2009. We have signed a non-binding letter of intent with Merrill Lynch to help finance the remaining construction costs and do not believe that our increased Phase I capacity, will change the amount we will need to borrow from Merrill Lynch or adjust the amount we will need to contribute. However, there are no assurances that we will be able to obtain the financing for the remaining construction costs on satisfactory terms, or at all.

 

Pursuant to our polysilicon supply agreements with Suntech and Sanyo, we must obtain financing of at least $100 million by March 31, 2008 and May 31, 2008, respectively, for the construction of our planned polysilicon production plant. If these deadlines are not met, Sanyo and Suntech may terminate their respective agreements with us. Pursuant to our polysilicon supply agreement with GEWD, we must obtain financing for the construction of our planned polysilicon production plant by March 31, 2008, or GEWD may also terminate their agreement with us.

 

We had engaged Calyon Securities Inc., or Calyon, as our financial advisor in our efforts to obtain debt and/or equity financing; however, our agreement with Calyon expired on October 31, 2007 and was not renewed. In December 2007, we signed a non-binding term sheet with Merrill Lynch to finance up to $185 million for the construction, procurement and start-up of our planned polysilicon production plant. We believe that although we have increased the first phase of our polysilicon facility from an annual capacity of 2,500 metric tons to up to 3,500 metric tons, we will not need to increase the amount we are financing through Merrill Lynch.

 

Prior to obtaining debt financing we will also have to adequately address principal risks associated with the project including risks that: (1) the construction of the polysilicon plant is not completed on time, on budget, or at all; (2) the polysilicon plant does not operate at its full capacity; or (3) the polysilicon plant fails to generate sufficient revenue to service the debt. In order to address these risks we are taking the following actions:

 

 

In March 2007, we awarded a contract to VECO USA, Inc. for initial design phase engineering, procurement and construction management services related to our polysilicon plant. VECO has completed this initial design phase, and in August 2007, we entered into an agreement with S&W to provide the additional engineering, procurement, and construction management services for a polysilicon production plant with an annual capacity of up to 2,500 metric tons. S&W will be paid on a time and materials basis plus a fee for its services and incentives if certain schedule and cost targets are met. The target cost for the services to be provided under the EPCM Agreement is $41.5 million, plus up to $5.0 million of additional incentives that may be payable.

 

We also entered into an agreement with JH Kelly for construction services for the construction of a polysilicon production plant with an annual capacity of up to 2,500 metric tons. We will pay JH Kelly on a time and materials basis plus a fee for its services and incentives if certain schedule, cost and safety targets are met. The target cost for the services to be provided by JH Kelly is $120.0 million, including up to $5.0 million of incentives that may be payable.

 

We will need to amend our contracts with S&W and JH Kelly to increase the capacity of our planned polysilicon production plant from 2,500 metric tons to up to 3,500 metric tons. In addition, there will be additional costs primarily for equipment and other services necessary for the completion of the polysilicon production plant, which will result in an aggregate project cost for a polysilicon facility with an annual capacity of 3,500 metric tons of approximately $400 million.

 

Each of Sanyo, Suntech, GEWD, and Solarfun must agree to assign any purchase payments for polysilicon made to Hoku Materials to the benefit of the lenders that may provide us with debt financing. Sanyo, Suntech, GEWD, and Solarfun must also agree to subordinate each of their pari passu security interests in Hoku Materials to the senior security interest of such lenders. While we expect that Sanyo, Suntech, GEWD, and Solarfun will each agree to such assignments and to execute a subordinated intercreditor agreement, they are not contractually obligated to do so at this time. In addition, each of S&W, JH Kelly, Dynamic, Idaho Power Company, Bank of Hawaii, as escrow agent, GEC and MSA and other potential vendors must also agree to assign their respective construction and/or service contracts to the lenders that may provide us with debt financing.

 

We have received the air permit and filed the Notice of Intent (NOI) for storm water discharges associated with construction activity under a National Pollutant Discharge Elimination System (NPDES) general permit. We had implemented the required storm water pollution prevention plan, which is necessary for construction of our polysilicon plant, and as of January 2008, the plan is now being administered and managed by JH Kelly, our general construction contractor, in order to maintain compliance for continued construction. We also obtained our building permit in January 2008, which allows us to submit design documents for approval by the City of Pocatello, prior to the start of the various phases of the construction project. We will need to apply for additional permits with federal, state and local authorities to continue the construction of the plant, and permits to operate the plant when construction is complete. The government regulatory process is lengthy and unpredictable. We expect to obtain the necessary permits when and as required to continue construction and to operate our polysilicon plant, but we may experience delays which could cause additional expense and harm our business.

 

We currently have limited access to our polysilicon plant site across an at-grade railroad crossing pursuant to a private crossing agreement with Union Pacific Railroad that will expire on December 31, 2012. We believe that this agreement is sufficient to continue construction, and to date we have only experienced minor and temporary physical limitations in our ability to access the site due to the operation of the rail line by Union Pacific Railroad. In January 2008, the City of Pocatello signed a temporary construction and access agreement with an adjoining property owner providing us with an alternative means of site access. We plan to build an overpass across the railroad for access to the site after construction and during the operation of the polysilicon facility; however, prior to completion of the overpass, our lenders may require that we obtain traditional road access to the site through other legally enforceable rights of access, such as an easement, from adjoining property owners who are under no obligation to provide us with such legally enforceable rights of access. We currently are in discussions with the property owners.

 

We also expect that we will need to obtain a report from an independent engineering firm which supports our construction plans, our operating plans and our pro forma financial models which support the feasibility of our operating plans and business model. Although we believe we have made significant progress, at any point in time we may conclude that our plans are not financially or technologically feasible and abandon our efforts to establish a polysilicon business. Such abandonment after substantial investment of time and resources could harm our business. Lenders, suppliers, contractors, customers and regulatory agencies may have additional consents, permits and requirements which we have not anticipated that could delay or prevent us from obtaining debt financing or completing construction as currently planned. If we fail to successfully achieve any or all of the above objectives necessary to obtain financing, we will be unable to complete construction of our planned polysilicon production plant and we may be forced to delay, alter or abandon our planned polysilicon business. In addition, any delay in achieving these objectives may result in additional expense. Even if we achieve all of these objectives on a timely basis, obtain the needed financing and complete the construction of our production plant as currently planned, we may still be unsuccessful in developing, producing and/or selling polysilicon for numerous reasons.

 

 

In addition, to adequately addressing the principal risks associated with the project, we will be required to provide approximately $35 million for use in the construction of the planned polysilicon plant. To meet this and other capital requirements, we will be required to secure additional financing.

 

Operating Capital and Capital Expenditure Requirements

 

As we invest resources towards a polysilicon production and PV systems installation service business, develop our products, expand our corporate infrastructure, prepare for the increased production of our products and evaluate new markets to grow our business, we expect that our expenses will continue to increase and, as a result, we will need to generate significant revenue to maintain profitability.

 

We do not expect to generate significant revenue until we successfully commence the production of polysilicon and begin meeting the obligations under our supply contracts. We believe that our cash, cash equivalent and short-term investment balances will be sufficient to meet the anticipated capital expenditures and cash requirements for Hoku Solar and Hoku Fuel Cells through at least the next 12 months; however, we expect that we will need to raise up to $400 million to support the construction of our planned polysilicon facility and the operations of Hoku Materials. The sale of additional equity securities or securities that are convertible into equity may result in additional dilution to our current stockholders. If we raise additional funds through the issuance of equity securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay or eliminate some or all of our planned research, development and commercialization and manufacturing activities, which could harm our business. Our forecasts of the period of time through which our financial resources will be adequate to support our operations are forward-looking statements and involve risks and uncertainties. Actual results could vary as a result of a number of factors, including the factors discussed in Part II, Item 1.A. “Risk Factors” and the section above entitled “Forward-Looking Statements.”

 

Critical Accounting Policies and Significant Judgments and Estimates

 

Our management’s discussion and analysis of our financial condition and results of operations are based on our unaudited consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles for interim financial statements and the instructions to Form 10-Q and Regulation S-X. The preparation of these consolidated financial statements requires us to make estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 

While our significant accounting policies are more fully described in note 1 to the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q and note 1 to the audited financial statements included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on June 29, 2007, we believe that the following accounting policies and estimates are critical to a full understanding and evaluation of our reported financial results.

 

 

Revenue Recognition. Revenue from polysilicon and PV system installations is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition , when there is evidence of an arrangement, delivery has occurred or services have been rendered, the arrangement fee is fixed or determinable, and collectability of the arrangement fee is reasonably assured. PV system installation contracts may have several different phases with corresponding progress billings, however, revenue is recognized when the installation is complete and accepted by the customer. Stock-Based Compensation. We account for stock-based employee compensation arrangements using the fair value method in accordance with the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, or SFAS 123(R). In accordance with SFAS 123(R), the fair value of stock options and/or restricted stock awards granted to our employees and non-employees is determined using the Black-Scholes pricing model. The Black-Scholes pricing model requires the input of several subjective assumptions including the expected life of the option/restricted award and the expected volatility of the option/restricted award at the time the option/restricted award is granted. The fair value of our option/restricted award, as determined by the Black-Scholes pricing model, is expensed over the requisite service period, which is generally five years for stock options and varies between two and five years for restricted stock awards.

 

The assumptions used in calculating the fair value of our stock options and restricted stock awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, changes in these inputs and assumptions can materially affect the measure of the estimated fair value of our stock options and restricted stock awards. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those options and shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. Furthermore, this accounting estimate is reasonably likely to change from period to period as further stock options and restricted stock awards are granted and adjustments are made for stock option and restricted stock awards forfeitures and cancellations. In accordance with SFAS 123(R), we do not record any deferred stock-based compensation on our balance sheet for our stock options and restricted stock awards.

 

We expect our stock-based compensation expense from stock options and restricted stock awards to increase as we expand our operations and hire new employees. These expenses will increase our overall expenses and may increase our losses for the foreseeable future. As stock-based compensation is a non-cash expense, it will not have any effect upon our liquidity or capital resources.

 

  Accounting for the Impairment or Disposal of Long Lived Assets. In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal for Long-Lived Assets, or SFAS No. 144, we evaluate the carrying value of our long-lived assets whenever certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Such events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in our market value, or significant reductions in projected future cash flows.

 

As a result of the downsizing of our fuel cell business, and the change in business strategy to not manufacture solar modules, we are exploring the potential sale of our land and facility in Kapolei, and our relocation to a smaller leased warehouse and office space on Oahu. As we have not exited any business and are only exploring the possibility of the sale of the land and facility, there are no costs to be recorded in accordance with SFAS No. 144.

 

Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, or SFAS 157. This new standard establishes a framework for measuring the fair value of assets and liabilities. This framework is intended to provide increased consistency in how fair value determinations are made under various existing accounting standards which permit, or in some cases require, estimates of fair market value. SFAS 157 also expands financial statement disclosure requirements about a company’s use of fair value measurements, including the effect of such measures on earnings. This standard is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. While we are currently evaluating the provisions of SFAS 157, we do not expect the adoption of this statement to have a material impact on our consolidated financial statements.

 

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of SFAS No. 115, or SFAS 159. This new standard permits companies to choose to measure many financial instruments and certain other items at fair value that are currently not required to be measured at fair value. This standard is effective for fiscal years beginning after November 15, 2007. While we are currently evaluating the provisions of SFAS 159, we do not expect the adoption of this statement to have a material impact on our consolidated financial statements.

 

Off-Balance Sheet Arrangements

 

In January 2008, Hoku Materials entered into an agreement with Bank of Hawaii to purchase in increments an aggregate amount of up to 8.7 million Euros on various maturity dates beginning in April 2008 and ending in July 2010 at a fixed U.S dollar amount of $12.8 million. Hoku Materials expects to use the purchased Euros to make payments pursuant to its Amended and Restated Contract with GEC Graeber Engineering Consultants GmbH, or GEC, and MSA Apparatus Construction for Chemical Equipment Ltd., or MSA, for the purchase of hydrogen reduction and hydrogenation reactors for the production of polysilicon. As part of the agreement, the Company is required to place deposits with Bank of Hawaii for 20% of the notional value of the outstanding transactions, which can fluctuate based on the U.S Dollar/Euro exchange rate. The Company will earn interest on its deposits, which will be recorded as restricted cash. As of January 15, 2008, the restricted cash balance related to these deposits was $2.6 million.