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.   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 IA. “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, 2010, contained in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on July 14, 2010.

Overview

Hoku Corporation is a materials science company focused on clean energy technologies. We were incorporated in Hawaii in March 2001, as Pacific Energy Group, Inc. and changed our name to Hoku Scientific, Inc. in July 2001.  In December 2004, we were reincorporated in Delaware.  In March 2010, we changed our name from Hoku Scientific, Inc. to Hoku Corporation.

We originally focused our efforts on the design and development of fuel cell technologies, including our Hoku membrane electrode assemblies, or MEA’s, and Hoku Membranes.  In May 2006, we announced our plans to form an integrated photovoltaic, or PV, module business, and our plans to manufacture polysilicon, a primary material used in the manufacture of PV modules, at our polysilicon manufacturing plant in Pocatello, Idaho, or the Polysilicon Plant.  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.

During fiscal 2010, we explored limited future opportunities within the fuel cell market and provided samples for testing to a potential customer.  However, based on discussions with that potential customer we believed that further testing or a contract would not materialize.  In addition, we believe the investment required to capitalize upon future fuel cell opportunities, if any, would exceed the potential benefits realized.  As such, in September 2010, we elected to discontinue the operations of Hoku Fuel Cells.  However, we will maintain ownership of its intellectual property including patents.  Accordingly, the results of operations of Hoku Fuel Cells for the three and six months ended September 30, 2010 have been reported as discontinued operations in the consolidated statements of operations.

Hoku Materials

Hoku Materials was incorporated to manufacture polysilicon, a key material used in photovoltaic, or PV, modules. In May 2007, we commenced construction of our planned polysilicon manufacturing facility in Pocatello, Idaho, which would be capable of producing 4,000 metric tons of polysilicon per year, or the Polysilicon Plant. We previously estimated the total cost for construction of approximately $410 million; however we have now determined that the total costs will be greater than our previous estimates.  We are not providing an estimate of the increase in the total cost of construction as we are exploring opportunities to integrate advanced technology into our second phase, when we increase our capacity from 2,500 metric tons to 4,000 metric tons per year, and are negotiating with vendors to determine the related costs.  In addition, with respect to our 2,500 metric tons facility, we are unable to provide an estimate on the remaining amount of financing we will need to complete this phase by the end of this calendar year, as we will have and will continue to pre-invest in equipment and facilities that will be required to support our expansion to 4,000 metric tons.  This pre-investment allows us to save costs in the construction of our 4,000 metric ton per year plant, but makes it difficult to estimate the amount we will need to reach partial commercial operations.  Furthermore, our engineering contract with Stone & Webster, Inc., and our construction contract with JH Kelly LLC are cost-plus contracts, rather than lump sum, or fixed cost contracts.  As such, there is no guaranteed maximum cost.  Any significant increase in the cost to complete the Polysilicon Plant could have a material adverse effect on our business, financial condition and results of operations.

We installed the first six out of a planned total order of 28 Siemens-process reactors at the Polysilicon Plant and in April 2010 successfully produced polysilicon using two of the six reactors. We produced the material after completing a comprehensive system commissioning protocol, which culminated in deposition runs in a select number of our installed polysilicon reactors. The primary purpose of the testing was to confirm system integrity and validate operating procedures.

 

Contingent on securing additional financing, we expect to commission our reactors capable of producing 2,500 metric tons of polysilicon per annum in the first quarter of calendar year 2011 and begin our first commercial shipment in the second quarter of calendar year 2011.  We intend to ramp-up production throughout calendar year 2011, during which we expect to reach full production capability.

During fiscal 2011, we estimate that we may need to purchase between 200 to 400 metric tons of polysilicon to meet the minimum delivery requirements of our polysilicon contracts.  As of October 2010, we have not entered into any agreements to purchase polysilicon. Based on our anticipated production schedule we do not anticipate we will need to purchase polysilicon in fiscal 2012 and our ramp-up will allow us to meet all delivery obligations to our current customers; however, there are no assurances that we will not need to revise this schedule.

During the three months and six months ended September 30, 2010, Hoku Materials incurred an operating loss of $2.0 million and $4.9 million, which mainly consisted of payroll, including stock compensation, professional fees and travel expenses. In addition, as of September 30, 2010, Hoku Materials has capitalized $365.8 million related to construction costs for the Polysilicon Plant and had received $136.9 million in customer deposits as prepayments under long-term polysilicon supply agreements.

Construction/Financing Update

Notes Payable

Tianwei New Energy Holding Co. Ltd.

As of September 30, 2010, we had $50.0 million in notes payable to Tianwei. We received the first tranche of $20.0 million in January 2010 and received the second tranche of $30.0 million in March 2010.  The notes bear an annual interest rate of 5.94% and have a term of two years.  Pursuant to the loan agreement, we have pledged a security interest in all of our assets to Tianwei.  The $20.0 and $30.0 million in loan proceeds become due in January and March 2012, respectively, with no penalty for earlier prepayment of principal, and interest payments are due quarterly.

As part of the financing agreement, we also granted to Tianwei a warrant to purchase an additional 10 million shares of our common stock.  The terms of the warrant include: (i) a per share exercise price equal to $2.52; (ii) an exercise period of seven years; and (iii) provision for a cashless, net-issue exercise.

The accounting of the warrant and debt was based on their relative fair values and calculated to be $12.9 million and $37.1 million, respectively, in proportion to the $50.0 million in loan proceeds.  The fair value of the warrant was calculated using the Black-Sholes option pricing model, and the fair value of the debt was based on the present value of cash flows, discounted at a 7% interest rate.

We recorded approximately $1.2 million in transaction costs and $12.9 million of related fair value of the warrants as deferred costs of debt financing totaling $14.1 million.  As of September 30, 2010, $12.9 million has been reclassified as a discount on the debt and $1.2 million has been deferred as cost of debt financing.  The deferred cost of debt financing and discount on the debt will be amortized  over the two year term of the $50.0 million in notes payable, using the effective interest method, and capitalized as construction in progress related to the polysilicon production facility.  As of September 30, 2010, the carrying value of the $50.0 million in notes payable was $40.5 million, net of the unamortized discount of $9.5 million.

China Merchants Bank – New York Branch

In May 2010, we entered into a $20.0 million credit agreement with the New York branch of China Merchants Bank Co., Ltd.  The loan under this credit agreement is secured by a standby letter of credit drawn by Tianwei in Chengdu, China and issued to China Merchants Bank, as collateral. The loan bears interest at a per annum rate equal to the LIBOR Rate for the applicable interest period plus 2% or, if we elect, any portion of the loan that is not less than $1 million may bear interest at an annual rate equal to the rate of interest announced by the lender as its “prime rate.”  We entered into a reimbursement agreement with Tianwei pursuant to which we agreed to reimburse Tianwei for all interest, fees and expenses incurred by Tianwei in connection with the negotiation, execution and performance of the standby letter of credit.  As of September 30, 2010 the entire $20.0 million was outstanding.

In August 2010, we entered into two credit agreements with the New York branch of China Merchants Bank Co., Ltd. to borrow $10 million and $5 million.  The loans under these credit agreements are secured by standby letters of credit drawn by Tianwei in Chengdu, China and issued to China Merchants Bank, as collateral. The loans bear interest at a per annum rate equal to the LIBOR Rate for the applicable interest period plus 2% or, if we elect, any portion of the loans that is not less than $1 million may bear interest at an annual rate equal to the rate of interest announced by the lender as its “prime rate.”  We entered into reimbursement agreements with Tianwei pursuant to which we agreed to reimburse Tianwei for all interest, fees and expenses incurred by Tianwei in connection with the negotiation, execution and performance of the standby letters of credit.  As of September 30, 2010 the entire $15.0 million was outstanding.

In September 2010, we entered into a $10.0 million credit agreement with the New York branch of China Merchants Bank Co., Ltd.  The loan under this credit agreement is secured by a standby letter of credit drawn by Tianwei in Chengdu, China and issued to China Merchants Bank, as collateral. The loan bears interest at a per annum rate equal to the LIBOR Rate for the applicable interest period plus 2% or, if we elect, any portion of the loan that is not less than $1 million may bear interest at an annual rate equal to the rate of interest announced by the lender as its “prime rate.”  We entered into a reimbursement agreement with Tianwei pursuant to which we agreed to reimburse Tianwei for all interest, fees and expenses incurred by Tianwei in connection with the negotiation, execution and performance of the standby letter of credit.  As of September 30, 2010 the entire $10.0 million was outstanding.

 

In October 2010, we entered into a $13.0 million credit agreement with the New York branch of China Merchants Bank Co., Ltd.  We received $13.0 million under this credit agreement, which is secured by a standby letter of credit drawn by Tianwei in Chengdu, China and issued to China Merchants Bank, as collateral. The loan bears interest at a per annum rate equal to the LIBOR Rate for the applicable interest period plus 2% or, if we elect, any portion of the loan that is not less than $1 million may bear interest at an annual rate equal to the rate of interest announced by the lender as its “prime rate.”  We entered into a reimbursement agreement with Tianwei pursuant to which we agreed to reimburse Tianwei for all interest, fees and expenses incurred by Tianwei in connection with the negotiation, execution and performance of the standby letter of credit.  

 

China Construction Bank – New York Branch

In June 2010, we entered into a $28.3 million credit agreement with the New York branch of China Construction Bank.  The loan under this credit agreement is secured by a standby letter of credit drawn by Tianwei and issued by the Sichuan branch of China Construction Bank in favor of the New York branch.  The loan will bear interest at a per annum rate equal to the LIBOR Rate for the applicable interest period plus 1.875% or, if we elect, and if the bank agrees, any portion of the loan that is not less than $1 million may bear interest at an annual rate equal to the highest “Prime Rate” as published in the “Money Rates” column of the Eastern Edition of the Wall Street Journal from time to time.  We also entered into a reimbursement agreement with Tianwei pursuant to which we agreed to reimburse Tianwei for all interest, fees and expenses incurred by Tianwei in connection with the negotiation, execution and performance of the standby letter of credit.  As of September 30, 2010 the entire $28.3 million was outstanding.

China Construction Bank – Singapore Branch

In October 2010, we entered into a $29.0 million credit agreement with the Singapore branch of China Construction Bank.  We received $16 million of the loan which is secured by a standby letter of credit issued drawn by China Construction Bank Corporation, Sichuan Branch in favor of China Construction Bank – Singapore Branch.  Tianwei procured the standby letter of credit and has informed us that it intends to issue an additional standby letter of credit for the remaining loan amount.  The loan will bear interest at a per annum rate equal to the LIBOR Rate for the applicable interest period plus 2%.   We also entered into a reimbursement agreement with Tianwei pursuant to which we agreed to reimburse Tianwei for all interest, fees and expenses incurred by Tianwei in connection with the negotiation, execution and performance of the standby letter of credit.

As of October 31, 2010, we are also expecting an additional $8.2 million in customer prepayments from our existing customers, which are payable on polysilicon delivery milestones.  We will need to raise additional capital to complete construction and meet our working capital needs.  We plan on raising this money through one or more subsequent debt and/or equity offerings and possibly prepayments from new customer contracts.  Tianwei has also agreed to use its reasonable best efforts to assist us in obtaining additional financing that may be required by us to construct and operate the Polysilicon Plant.

Polysilicon Supply Agreement Updates

Wuxi Suntech Power Co. Ltd.   In June 2007, we entered into a fixed price, fixed volume supply agreement with Wuxi Suntech Power Co., Ltd., or Suntech, for the sale and delivery of polysilicon. The supply agreement has been subsequently amended and in June 2010, we revised the first delivery of polysilicon products to Suntech to June 2011, and Suntech waived certain milestones required under the agreement. The term of the agreement was shortened to one year and pricing was fixed for the term of the agreement.  The agreement will automatically renew with the same terms unless either party terminates the agreement.  If we fail to commence shipments by June 2011, then Suntech may terminate the supply agreement.

Upon Suntech’s termination of the agreement under certain circumstances, we are required to refund to Suntech all prepayments, which were $2.0 million as of September 30, 2010, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.  Upon termination of the agreement for cause by us, we generally may retain the entire amount of prepayments made as of the date of such termination as liquidated damages, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.

Solarfun Power Hong Kong Limited.   In November 2007, we entered into a fixed price, fixed volume supply agreement with Solarfun Power Hong Kong Limited, or Solarfun, a subsidiary of Solarfun Power Holdings Co., Ltd., for the sale of polysilicon.  As of September 30, 2010, Solarfun has paid to us $49.0 million as a prepayment for future polysilicon product deliveries, and it is obligated to pay us an additional $6.0 million in prepayments.

Further, pursuant to an amendment of the contract in March 2010, we were to use commercially reasonable efforts to make our first shipment to Solarfun by July 2010.  As we did not make the July 2010 shipment target, we must provide a purchase price adjustment since we did not supply any product by September 2010.  Provided that the first delivery occurs by December 2010, the term of the agreement will remain in force for eleven years.  Based on the amendment, we estimate aggregate revenues of up to $383.4 million from the sale of polysilicon to Solarfun.  The price adjustment for the second year is contingent on Solarfun’s timely payment of the remaining $3.0 million in deposits due to us.  After the first two years, the price will increase and then gradually decrease over the rest of the term.  Solarfun retains the right to terminate the agreement if we have not commenced shipments by December 2010.

 

Upon Solarfun’s termination of the agreement under certain circumstances, we are required to refund to Solarfun all prepayments made as of the date of termination, which were $49.0 million as of September 30, 2010, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.  Upon termination of the agreement by us, we generally may retain the entire amount of prepayments made as of the date of such termination as liquidated damages, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.

Jinko Solar Co., Ltd.   In July 2008, we entered into a fixed price, fixed volume supply agreement with Jinko Solar Co., Ltd., formerly known as Jiangxi Jinko Solar Co., Ltd., or Jinko, for the sale and delivery of polysilicon.  In November 2009, we amended the supply agreement under which Jinko could pay us up to approximately $106.0 million during a nine-year period, subject to product deliveries and other conditions.  The average price for polysilicon paid by Jinko will decrease gradually over the term of the agreement.  Pursuant to the amendment, our first delivery of polysilicon products to Jinko is due in December 2010.  As of September 30, 2010, Jinko has paid us a total cash deposit of $20.0 million as prepayment for future product deliveries.

Upon Jinko’s termination of the agreement under certain circumstances, we may be required to refund to Jinko all prepayments made as of the date of termination, which were $20.0 million as of September 30, 2010, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.  Upon termination of the agreement by us, we generally may retain the entire amount of prepayments made as of the date of such termination as liquidated damages, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.

Tianwei New Energy (Chengdu) Wafer Co., Ltd. In fiscal 2009, we entered into two fixed price, fixed volume supply agreements with Tianwei New Energy (Chengdu) Wafer Co., Ltd., or Tianwei Wafer, for the sale and delivery of polysilicon. In December 2009, we amended the agreements pursuant to which we converted $50.0 million of the total $79.0 million of prepayments previously paid into shares of our common stock and reduced the price at which Tianwei Wafer purchases polysilicon by approximately 11% per year.  The amount of polysilicon to be delivered remains unchanged and Tianwei Wafer is required to pay us an additional $2.0 million in prepayments; however, the total revenue for the polysilicon to be sold by us to Tianwei Wafer has been modified such that up to approximately $418.0 million may be payable to us during the ten-year term (exclusive of amounts Tianwei Wafer may purchase pursuant to its right of first refusal), subject to acceptance of product deliveries and other conditions.  Our failure to commence shipments of polysilicon by June 2011 constitutes a material breach by us under the terms of the agreement, among other circumstances.

Upon Tianwei Wafer’s termination of the agreements under certain circumstances, we are required to refund to Tianwei Wafer the $29.0 million in prepayments made as of September 30, 2010, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreements.  Upon a termination of the agreements by us, we generally may retain the entire amount of prepayments made as of the date of such termination as liquidated damages, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreements.

Wealthy Rise International, Ltd.   In September 2008, we entered into a fixed price, fixed volume supply agreement with Wealthy Rise International, Ltd., a wholly owned subsidiary of Solargiga Energy Holdings, Ltd., or Solargiga, for the sale of polysilicon.  In March 2010, we amended the agreement pursuant to which we agreed to sell to Solargiga specified volumes of polysilicon at a predetermined price over a three-year period beginning in calendar year 2011, subject to product deliveries and other conditions.  The aggregate amount that may be paid to us over the three-year term is $60.0 million, which is a reduction from the $455.0 million that would have been payable to us over a ten-year period under the original agreement.  The amendment also extends the date by which we are obligated to commence shipments of polysilicon from October 2010 to January 2011, and it extends the dates for price adjustments and termination rights in the event of a delay in commencing shipment.  Solargiga has the right to terminate the agreement and recover any prepayments made, if we have not commenced polysilicon shipments by May 2011, and we have the right to terminate the agreement and retain all prepayments received, if Solargiga fails to pay any of its future prepayments when due.

Pursuant to the agreement, Solargiga is obligated to pay us additional prepayments in the aggregate amount of $13.2 million that is payable in four increments of $3.3 million in each of April, June, August and October 2010, and a final prepayment of $200,000 upon Solargiga’s receipt of certain aggregate volumes of polysilicon product from us.  We received all four increments from Solargiga of $13.2 million.

Upon Solargiga’s termination of the agreement under certain circumstances, we are required to refund to Solargiga all prepayments made as of the date of termination, which were $16.9 million as of September 30, 2010 ($20.2 million as of October 31, 2010), less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.  Upon termination of the agreement by us, we generally may retain the entire amount of prepayments made as of the date of such termination as liquidated damages, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.

Shanghai Alex New Energy Co., Ltd.   In February 2009, we entered into a fixed price, fixed volume supply agreement with Shanghai Alex New Energy Co., Ltd., or Alex, for the sale and delivery of polysilicon.  Under the agreement, the total amount that may be payable to us is approximately $119.0 million during a ten-year period, subject to product deliveries and other conditions.  Our first delivery of polysilicon products to Alex was due in October 2010.  As we did not make the October 2010 shipment target, we must provide a purchase price adjustment.  Our failure to commence shipments of polysilicon by December 2010 constitutes a material breach by us under the terms of the agreement, among other circumstances.  The average price for polysilicon paid by Alex will decrease gradually over the term of the agreement.  As of September 30, 2010, Alex has paid us cash deposits of $20.0 million as prepayment for future product deliveries.

 

Upon Alex’s termination of the agreement under certain circumstances, we are required to refund to Alex all prepayments made as of the date of termination, which were $20.0 million as of September 30, 2010, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.  Upon termination of the agreement by us, we generally may retain the entire amount of prepayments made as of the date of such termination as liquidated damages, less any part thereof that has been applied to the purchase price of polysilicon delivered under the agreement.

Hoku Solar

Our goal is to be a leading provider in PV system installations. We plan to continue to focus on designing, engineering and installing turnkey PV systems and related services in Hawaii using solar modules purchased from third-party suppliers.

In addition to continuing to focus on our turnkey solar integration business in the coming fiscal year, we also plan to expand our focus on large-scale PV project development within Hawaii and elsewhere. This effort will be focused on leveraging our solar integration, project management and financing expertise to develop a portfolio of rooftop solar energy facilities and multiple utility-scale PV farms, which would generate solar power for sale to utilities and large industrial customers for use on their grids.

During the three and six months ended September 30, 2010, Hoku Solar recognized an operating profit of $86,000 and $170,000, respectively, from its PV system installations and sale of electricity to the Hawaii State Department of Transportation.

Hoku Fuel Cells

Due to insignificant activity related to our Hoku Fuel Cell business, in September 2010, we elected to discontinue the operations of Hoku Fuel Cells.

Financial Operations Review

During the three and six months ended September 30, 2010, we derived all of our revenue through PV system installation and ancillary services 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 third quarter of fiscal 2011, when Hoku Materials is expected to generate revenue through the sale of polysilicon manufactured at our planned polysilicon production facility in Pocatello, Idaho.

During the three and six months ended September 30, 2010, our revenue was $1.2 and $2.1 million, respectively, comprised of PV system installations and the sale of electricity.

Consolidated Results of Operations

The following analysis of the unaudited consolidated financial condition and results of operations of Hoku Corporation 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.

Comparison of Three Months Ended September 30, 2010 and 2009

Revenue. Revenue was $1.2 million for the three months ended September 30, 2010, compared to $1.5 million for the same period in fiscal 2009. Revenue in both periods was primarily comprised of PV system installations and related services.

Cost of  Revenue. Cost of  revenue was $852,000 for the three months ended September 30, 2010, compared to $1.4 million for the same period in fiscal 2009. Cost of revenue primarily consisted of employee compensation and supplies and materials for the PV system installation and related services.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $2.3 million for the three months ended September 30, 2010, compared to $1.5 million for the same period in fiscal 2009. The increase of $711,000 was primarily due to electricity usage as we continue to ramp towards the completion of the Polysilicon Plant of $554,000, payroll expense, including stock based compensation, of $258,000 and rent of $73,000.   In addition, the increase in expenses included professional fees of $57,000 and a decrease in the application of direct and indirect costs of $57,000.  These increases were offset by the decreases   in compensation to Board Directors of $210,000 and retention payments for officers and other key employees of $70,000.

Interest and Other Income/(Loss) . Interest and other loss was $48,000 for the three months ended September 30, 2010 compared to income of $217,000 for the same period in fiscal 2010. Interest and other loss for the three months ended September 30, 2010 was primarily comprised of a foreign currency transaction loss of $70,000 related to Euro-based invoices offset by the reversal of prior accruals for general excise tax reserves due to statute limitations of $22,000. Interest and other income for the three months ended September 30, 2009 was primarily comprised of the reversal of $210,000 in prior accruals for general excise tax reserves due to statute limitations and interest income of $7,000.

Comparison of Six Months Ended September 30, 2010 and 2009

Revenue. Revenue was $2.1 million for the six months ended September 30, 2010, compared to $1.6 million for the same period in fiscal 2009. Revenue in both periods was primarily comprised of PV system installations and related services and sale of electricity to the Hawaii State Department of Transportation.

Cost of Revenue. Cost of revenue was $1.4 million for the six months ended September 30, 2010 and 2009. Cost of revenue primarily consisted of employee compensation and supplies and materials for the PV system installation and related services.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $5.5 million for the six months ended September 30, 2010, compared to $2.6 million for the same period in fiscal 2010. The increase of $2.9 million was primarily due to expenditures related to the reactor demonstration, which was completed in April 2010, of $1.3 million, electricity usage as we continue to ramp towards the completion of the Polysilicon Plant of $554,000, and payroll expense, including stock based compensation, of $471,000 and professional fees of $174,000.  In addition, the increase in expenses included a decrease in the application of direct and indirect costs of $161,000, retention and bonus payments for officers and other key employees of $130,000, rent of $128,000, and franchise fees of $85,000.  These increases were offset by the decreases   in compensation to Board Directors of $85,000 and marketing expenses of $47,000.

Interest and Other Income . Interest and other income was $138,000 for the six months ended September 30, 2010 compared to interest and other income of $251,000 for the same period in fiscal 2010. Interest and other income for the six months ended September 30, 2010 was primarily comprised of a foreign currency transaction gain of $107,000 related to Euro-based invoices and the reversal of prior accruals for general excise tax reserves due to statute limitations of $31,000. Interest and other income for the six months ended September 30, 2009 was primarily comprised of $210,000 in prior accruals for general excise tax reserves due to statute limitations, the sale of fuel cell equipment of $40,000, and interest income of $20,000.

Liquidity and Capital Resources

We have incurred significant net losses since inception and we have relied on our ability to fund our operations principally through both registered and unregistered offerings of our securities, prepayments on long-term polysilicon contracts, and borrowings under credit agreements. Even if we are successful in securing additional long-term polysilicon contracts that could provide additional prepayments, and our existing customers fulfill their obligations to make additional prepayments when due (of which there can be no assurances), we will still need to seek additional financing to complete our Polysilicon Plant.  As of September 30, 2010, we had cash and cash equivalents on hand of $11.4 million and current liabilities of $44.2 million.

To help address our cash needs to meet our obligations during fiscal 2010, we modified payment terms with certain of our vendors to structure payment plans for amounts past due and to be invoiced in the future.  Payment plan terms vary by vendor, although generally include a payment schedule when we pay for prior amounts past due and amounts for specified future work.  We continue to work with our vendors to comply with the negotiated schedules and to have payment terms extended as needed based on our construction schedule and financing.

As of September 30, 2010, we have funded approximately $338.6 million of our Polysilicon Plant.  We previously estimated the total cost for construction of approximately $410 million; however we have now determined that the total costs will be greater than our previous estimates.  We are not providing an estimate of the increase in the total cost of construction as we are exploring opportunities to integrate advanced technology into our second phase, when we increase our capacity from 2,500 metric tons to 4,000 metric tons per year, and are negotiating with vendors to determine the related costs.  In addition, with respect to our 2,500 metric tons facility, we are unable to provide an estimate on the remaining amount of financing we will need to complete this phase by the end of this calendar year, as we will have and will continue to pre-invest in equipment and facilities that will be required to support our expansion to 4,000 metric tons.  This pre-investment allows us to save costs in the construction of our 4,000 metric ton per year plant, but makes it difficult to estimate the amount we will need to reach partial commercial operations.  However, as of October 31, 2010, we expect to complete the construction of the 2,500 metric ton per year plant, or Phase I, through the use of our available cash and the expected receipt of the remaining $13 million of the $29 million credit agreement with China Construction Bank – Singapore, upon the issuance of a standby letter of credit drawn by Tianwei.  Tianwei has agreed to use its reasonable best efforts to assist us in obtaining additional financing for any additional construction costs necessary to complete Phase I, for working capital needs and to purchase polysilicon from third-parties to meet our upcoming commitments.

Once Phase I is completed, we expect to receive an additional $8.2 million in customer prepayments from our existing customers upon reaching certain polysilicon milestones.  We expect to use the prepayments to help fund the construction costs to ramp-up to polysilicon production of 4,000 metric tons per year.  We plan on raising the remaining costs to complete our Polysilicon Plant and working capital needs through debt and/or equity offerings and possibly prepayments from new customer contracts.  Tianwei has also agreed to use its reasonable best efforts to assist us in obtaining additional financing that may be required by us to construct and operate the Polysilicon Plant. There is no guarantee that we will be able to obtain additional financing in terms acceptable to us or at all, even with the assistance of Tianwei.  Furthermore, any significant increase in the cost to complete the Polysilicon Plant could have a material adverse effect on our business, financial condition and results of operations.

The additional capital we have secured during fiscal year 2011 has enabled us to settle accounts payables and accrued capital expenditures, and is providing us with the necessary capital to sustain operations.  In addition, we are reserving adequate funding for the purchase of third-party polysilicon to meet our contractual obligations with our polysilicon customers, beginning in December 2010, and for interest and other financing costs related to our loans.   However, the amount we have secured is not sufficient to complete construction of the Polysilicon Plant, and should there be delays in securing additional financing, we may need to implement cost and expense reduction programs and other programs to generate cash that are not currently planned, but are responsive to our liquidity requirements.  If we are unable to secure additional financing or structure credit terms with our vendors, we would also need to curtail construction of the polysilicon production facility in the fourth quarter of calendar year 2010.  If we have to curtail construction, our excess capital would primarily be used to reduce our current liabilities, purchase of third-party polysilicon and for working capital needs.

 

Net Cash Used In Operating Activities.   Net cash used in operating activities was $2.8 million and $2.7 million for the six months ended September 30, 2010 and 2009, respectively. Net cash used in operating activities for the six months ended September 30, 2010 primarily reflects the net loss of $4.6 million which resulted in a cash deficit of $3.9 million when adjusted for noncash operating activities.  The cash deficit was offset by net cash inflows from working capital of $1.1 million, primarily from decreases in other current assets and increases in accounts payable and accrued operating expenditures and deferred revenue.  In comparison, net cash used in operating activities for the six months ended September 30, 2009 reflected a net loss of $2.2 million or a cash deficit of $1.6 million when adjusted for noncash operating activities and net cash outflows of $1.1 million primarily due to the decrease in accounts payable and accrued operating expenditures and deferred revenue.

We had working capital deficits of $30.9 million, $25.0 million and $20.3 million as of September 30, 2010, March 31, 2010 and March 31, 2009, respectively.  The increasing working capital deficits reflect the increased deployment of funds to construct the Polysilicon Plant in Idaho and our net losses.  In addition, $15.3 million and $11.1 million of deposits from long-term polysilicon contracts were classified as short-term liabilities as of September 30, 2010 and March 31, 2010, respectively, to reflect the prepayments that apply to the product deliveries that are scheduled to ship within one year.

 

Net Cash Used In Investing Activities.   Net cash used in investing activities was $73.2 million for the six months ended September 30, 2010, compared to $40.2 million for the same period in fiscal 2010. The net cash used in investing activities in both periods was related to the continuing construction of  the Polysilicon Plant.

 

Net Cash Provided By Financing Activities.   Net cash provided by financing activities was $80.4 million for the six months ended September 30, 2010, compared to $34.6 million for the same period in fiscal 2010. The net cash provided by financing activities during the three months ended September 30, 2010 was primarily due to loan proceeds from China Construction Bank of $28.3 million, loan proceeds received from China Merchants Bank of $45.0 million and deposits received under polysilicon supply agreements of $9.9 million, offset by cash distributions to the minority investor of Hoku Solar Power I of $2.7 million.  The net cash provided by financing activities during the  six months ended September 30, 2009 was due to deposits received under polysilicon supply agreements of $31.0 million and cash contributions from the minority investor of Hoku Solar Power I of $3.6 million.

Operating Capital and Capital Expenditure Requirements

As we invest resources towards our polysilicon manufacturing and PV systems installation service businesses, 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 achieve profitability.

We do not expect to generate significant revenue until we successfully commence the manufacture and shipment of polysilicon and begin meeting the obligations under our supply contracts.  We previously estimated the total cost for construction of approximately $410 million; however we have now determined that the total costs will be greater than our previous estimates.  We are not providing an estimate of the increase in the total cost of construction as we are exploring opportunities to integrate advanced technology into our second phase, when we increase our capacity from 2,500 metric tons to 4,000 metric tons per year, and are negotiating with vendors to determine the related costs.  In addition, with respect to our 2,500 metric tons facility, we are unable to provide an estimate on the remaining amount of financing we will need to complete this phase by the end of this calendar year, as we will have and will continue to pre-invest in equipment and facilities that will be required to support our expansion to 4,000 metric tons.  This pre-investment allows us to save costs in the construction of our 4,000 metric ton per year plant, but makes it difficult to estimate the amount we will need to reach partial commercial operations.  However, as of October 31, 2010, we expect to complete the construction of the 2,500 metric ton per year plant, or Phase I, through the use of our available cash and the expected receipt of the remaining $13 million of the $29 million credit agreement with China Construction Bank – Singapore, upon the issuance of a standby letter of credit drawn by Tianwei.  Tianwei has agreed to use its reasonable best efforts to assist us in obtaining additional financing for any additional construction costs necessary to complete Phase I, for working capital needs and to purchase polysilicon from third-parties to meet our upcoming commitments.

Once Phase I is completed, we expect to receive an additional $8.2 million in customer prepayments from our existing customers upon reaching certain polysilicon milestones.  We expect to use the prepayments to help fund the construction costs to ramp-up to polysilicon production of 4,000 metric tons per year.  We plan on raising the remaining costs to complete our Polysilicon Plant and working capital needs through debt and/or equity offerings and possibly prepayments from new customer contracts. There is no guarantee that we will be able to obtain additional financing in terms acceptable to us or at all, even with the assistance of Tianwei.  Furthermore, any significant increase in the cost to complete the Polysilicon Plant could have a material adverse effect on our business, financial condition and results of operations.

 

Tianwei has agreed to use its reasonable best efforts to assist us in obtaining additional financing that may be required by us to construct and operate the Polysilicon Plant.  However, Tianwei has advised us that it expects to receive fair compensation for their continuing financing services.  We anticipate that this compensation, if any, will be in the form of equity and it could have material dilutive effect on our stockholders.  We are presently exploring what would constitute fair compensation.  We cannot be certain that we will reach an agreement with Tianwei regarding the appropriate compensation for Tianwei which could affect Tianwei's willingness to continue to assist us in obtaining necessary additional financing.