Hoku's Pocus

ALTERNATIVE ENERGY company Hoku Scientific (HOKU) got a positive surge this week after the U.S. Navy officially accepted the first two of 10 planned proton exchange membrane (PEM) fuel-cell power plants incorporating Hoku's technology. Hoku's stock sizzled 38% higher to $5.17 Thursday.

The Navy has already paid Hoku $2.1 million for the 10 systems, which will be demonstrated at Pearl Harbor Naval Station, plus an 11th going elsewhere. This has been classified as deferred revenue as of March 31. Hoku will receive an additional $2.5 million for the delivery and maintenance of all 11 systems over the 12-month field test period. The initial 10 systems will be installed on a rolling basis.

"While we are cautious on the fuel-cell industry, we do like Hoku relative to the rest of the group because it's not burning cash," says Jesse Pichel, an analyst at Minneapolis investment bank Piper Jaffray. "It's modestly profitable and its products help commercialize fuel cells, making them more economical." As of March 31 the company had $22.7 million in cash and short-term investments. (Piper Jaffray helped underwrite Hoku Scientific's initial public offering.)

Hoku doesn't make the fuel cells. Its subcontractor, IdaTech, makes them. The Kapolei, Hawaii, company develops and manufacturers the membranes and the membrane electrode assemblies (MEA) for PEM fuel cells.

"We want to be the leading MEA supplier. We're not looking at building the entire systems," says Darryl Nakamoto, the chief financial officer of Hoku Scientific. "We believe that the true technology is in the membrane. This would be our first MEA out in the field as a commercial integration."

The fuel cells produce hydrogen from a mixture of water and methanol, which is then turned into electricity. Each stationary fuel-cell power plant generates net electrical output of approximately 1.5 kilowatts, exceeding the 1.0 kilowatt minimum required in the contract. Alternative-energy enthusiasts favor fuel cells because they burn fossil fuels more efficiently and emit fewer harmful emissions.

Thursday's move was welcome relief from the 45% plunge the stock suffered in the wake of fiscal fourth-quarter financial results. For the three months ended March 31, revenues fell 51% to $1.3 million. Hoku posted a profit of $508,000, or three cents a share, compared with $1.4 million, or 11 cents, in the year-earlier period. The bottom line topped the Thomson First Call consensus estimate of a penny-per-share loss. For the full year, net income came to $1.3 million, or nine cents a share, reversing the net loss of $728,000, or 13 cents, in the previous fiscal year.

March-quarter revenues were made up mostly of $1.2 million from contracts with Nissan Motor (NSANY). In the previous year's quarter, it recorded sales of $2.8 million, comprised principally of $2.5 million recognized upon completion of a development contract with Sanyo Electric (SANYY). As of March 31, total deferred revenue fell to $4 million, compared with $4.2 million a year earlier. The recent quarter's deferred revenue was attributable to the Navy's $2.1 million and a contract from Nissan for $1.7 million. For the fiscal year ending in March, sales soared 90% to $5.5 million.

In addition to the Navy contract, Hoku is working with Nissan to develop fuel cells for cars and trucks using Hoku's products. This $3 million contract, the third in as many years, ends Sept. 30. At that time, Hoku hopes to have a viable product.

"We want to move to the next step of selling product to Nissan in a customer supplier contract," says CFO Nakamoto. "But there is no guarantee that after this contract Nissan will buy something from us."

Also, Sanyo paid Hoku $260,000 to test the smaller company's membranes at its research and development facility in Japan. The company, with a market capitalization of just $86.3 million, said during the March quarter it signed test agreements with four new stationary and automotive fuel cell original equipment manufacturers. Together with the Navy, Nissan and Sanyo agreements it has a total of 11 agreements ongoing.

Hoku held its IPO in August at $6 a share. By the time the stock had come to market, the offering price had been cut twice from a range of $11 to $13, and the share count fell to 3.5 million from the previous offer of 4.2 million.

"Part of the issue for Hoku is that it supplies the components that go into the fuel cell, which are made by another company," says Robert Stone, an analyst at Cowen & Co. "Like any component vendor, their success depends on trying to make the best product they can, which is under their control. But it ultimately depends on the success of their customer, the fuel-cell maker, who is selling the product to the end customer." (Cowen helped underwrite Hoku Scientific's IPO.)

Stone cut his rating on the stock to Neutral from Buy after the May 5 release of the earnings report. But he says he sees increasing interest in the alternative energy and clean technology sector as a result of rising fossil fuel prices and concerns about the environment and energy independence.

"The long-term picture for fuel cells is positive," says Stone. "But it's hard to say when the commercial value will hit because a lot of work is being done behind closed doors. No one will talk until they are ready to launch."