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Gushan Environmental Energy Limited (NYSE:GU)

Q1 2009 Earnings Call

May 15, 2009 8:30 am ET

Executives

Wai Sun Kwong - President

Ngai Chi Chan - Principal Financial Officer and Principal Accounting Office

Analysts

JinMing Liu - Ardour Capital Investments

Analyst for Jesse Mitchell - Piper Jaffray

Stephen Hartt - Hiller Capital Partners

Ian Horowitz - Soleil Securities

Operator

Good morning and thank you for participating in the 2009 first quarter earnings conference call of Gushan Environment Energy Limited. (Operator Instructions) I would now like to turn the call over to Mr. Wai Sun Kwong, President of Gushan Environmental Energy Limited, and Mr. Frank Chan, Chief Financial Officer of Gushan Environmental Energy Limited. You may proceed.

Wai Sun Kwong

Good morning, ladies and gentlemen and welcome to Gushan's first quarter 2009 earnings call. Joining me on the call is Frank Chan, Principal Financial Officer of Gushan.

Please note that today’s discussion may contain forward-looking statements made under the Safe Harbor provision of Federal Securities Laws. Please see today’s press release under the section Safe Harbor statement for a discussion of risks and uncertainties that may affect our results.

Before opening the call to questions, I would like to briefly review some of the highlights of the first quarter. Now, the first quarter of 2009 was a difficult one for Gushan and many other companies, as the full impact of China’s economic slow-down, the global recession, and the sharp fall in oil prices was felt. Total revenues for the quarter dropped 18.1% year over year to $39.9 million, as a result of significantly lower diesel prices, even as sales volume increased 22.3% year over year.

On a sequential basis, on a sequential quarterly basis, revenues were down 13.5%, again as a result of lower diesel prices, while sales volume rose 12.9%.

Sales volume of bio-diesel in Q109 increased to over 63,000 tons. That is approximately 18.9 million gallons, reflecting the additional capacity of our new plant in Shanghai, which came on-stream in June 2008. The sequential quarterly increase in the sales volume also reflects resumed production after the temporary shut-down of three of our plants for maintenance and repairs during part of Q4 2008.

In March this year, the 50,000 tons of expanded production capacity at our Beijing plant commenced production, raising Gushan's total annual production capacity as of the end of Q109 to 340,000 tons. That is approximately 102 million gallons.

During the first quarter, diesel prices in China declined dramatically, which was reflected in the sharp decline in our selling prices. The average selling price of our bio-diesel in the first quarter was down 27.4% year over year and 21.4% quarter on quarter, from the fourth quarter of 2008.

The fall in diesel prices in China reflects both the drop in world oil prices and the sharp contraction in China’s industrial production, as a result of the global economic slow-down, which began in Q4 last year.

During the quarter, we were able to negotiate significant reduction in our raw materials costs. Average unit costs for our raw material [feed slots] was RMB2,430 per ton in Q109 -- that is up [6.2%] but down 10.1% from RMB2,704 per ton in Q408.

Overall, our costs of revenues in Q1 was up 26.4% year over year but down 1.7% quarter-on-quarter to 35.9 million.

Despite our success in reducing our raw materials costs, the sharp drop in selling prices have outpaced the fall in raw materials prices and has therefore caused a decline in our gross profit margin to 10.2% for the first quarter of 2009, down from 20.9% in Q408 and 31.8% in Q108.

With the fall in margins, operating income for the quarter dropped 98.6% year over year and 94.7% quarter-on-quarter to 0.2 million. We reported a net loss of 0.3 million for the first quarter, representing a basic and diluted loss per ADS of $0.004.

Despite the difficult quarter, our balance sheet remains strong, with cash on hand of 123 million and no bank borrowings as at the end of the quarter.

By most any measure, it was a difficult quarter and we expect 2009 to be a challenging year operationally.

Now clearly we are most concerned about the [degradation] in margins, but we are cautiously optimistic that the worst may be over in terms of margin pressure.

Towards the end of Q1, world oil prices appear to have stabilized and there are signs that both oil prices and China’s economy are beginning to recover. We will continue to work vigorously with our raw materials suppliers to try and reduce costs.

In terms of our expansion plan, we maintained our target of achieving total annual bio-diesel production capacity of 450,000 tons by the end of 2009. We expect to achieve this target through the addition of the new plant in Chongqing and Hunan, each with 30,000 tons of capacity, which are expected to commence production in the second quarter and the capacity expansion at our Shanghai plant by 50,000 tons in the third quarter this year.

In addition, we maintained our plan to build a 50,000 ton bio-diesel plant in Sichuan, dedicated to the use of inedible oils such as jatropha oil, which is expected to be ready for production in the first half of 2010. However, given the uncertain macro environment as it is and by no means are we certain that economic recovery is on its way, we are closely monitoring the market situation and will adjust our expansion plans as needed.

Nevertheless, we believe that with our financial strength and strong market position, Gushan is well-positioned to benefit from any such recovery.

At this time, we would be pleased to answer any questions you may have, and I will turn the call back over to the operator to begin the Q&A session. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of JinMing Liu with Ardour Capital.

JinMing Liu - Ardour Capital Investments

Good evening. First question is related to your VAT tax refund -- in the news release, you mentioned your Shanghai plant got the certification and you are in the process of [applying for the refund]. Can you give us some clarity on say when do you expect to receive the refund and what the accounting treatment should that be?

Wai Sun Kwong

Okay. We -- VAT for our product is 17%. It is usually not very certain as to when we will get this refund but we will obviously -- when we apply, we will probably will get a better idea because we only just got the certificate and we will be applying for this refund as soon as possible.

And we are still also discussing with our auditors exactly how this VAT, if we get this VAT refund, will be treated but we are of the opinion that it should be reflected in the top line revenue line and also in the cost of revenue line.

JinMing Liu - Ardour Capital Investments

I don’t understand that part -- say if you got the refund, that’s just 17% more of revenue for your --

Wai Sun Kwong

Yeah, both the revenue and also the cost of revenue.

JinMing Liu - Ardour Capital Investments

Why do you put that in the cost of revenue? That’s just a wash.

Wai Sun Kwong

Because our materials, when we purchase the materials, we also pay the VAT as well.

JinMing Liu - Ardour Capital Investments

Oh, okay. So that will be a net gain in terms of --

Wai Sun Kwong

Yes, that will be a net gain.

JinMing Liu - Ardour Capital Investments

Okay, good. The other question is related to your [Sichuan] plant. You are mentioning that plant is currently under construction and intend to use jatropha oil as feedstock. My research shows that in ’07 Sichuan Province has jatropha oil production roughly around 60,000 metric tons and the plant you are building is targeting 50,000 tons annual production. I also know Petrol China and the [Sunok] are also planning to build a bio-diesel plant in Sichuan utilizing jatropha oil. Can you comment on that in terms of this -- the real potential of jatropha oil production from that province and surrounding areas and your competition there?

Wai Sun Kwong

We believe -- well, our plan is to have the plant running in the first half of ‘010 and we believe that the amount that will be available to us in Sichuan and also in the neighboring provinces in the West, Southwest like Yunnan, Guangxi, and Guizhou, these sort of provinces, should be above 100,000 tons. This is what we estimate. And therefore we believe that at least -- I mean, this is to start with and we believe that there should be sufficient, at least for us to start.

We also believe that we are -- we will probably be the first plant to come out using the -- this sort of oil on this sort of scale, 50,000 ton scale. We believe that we will be the first one to come out.

JinMing Liu - Ardour Capital Investments

Okay. All right, thanks.

Operator

Your next question comes from the line of Jesse Mitchell with Piper Jaffray.

Analyst for Jesse Mitchell - Piper Jaffray

Hi, this is Elaine for Jesse. I was hoping you could help me understand something with -- you know, you mentioned the slow-down in the Chinese industrial environment and the decline in oil prices and so we can understand the falling ASPs but it’s still falling much faster than your supply side for feedstock, where you’ve mentioned there’s actually cost inflation from your suppliers. So I was wondering if you could give us a little more color on that disconnect there.

Wai Sun Kwong

Obviously our selling prices are somewhat linked to the Chinese economy and also the world oil prices. But our costs are not exactly related to the end product, [bio-diesel]. And because we are using waste oil, the cost side principally, as mentioned previously, would be the major component of the costs would be labor and transportation and plus the margin to be gained by the suppliers. And therefore the dynamics are very different.

We believe we have made good progress in reducing our average unit costs by 10% but unfortunately the selling price actually dropped a lot more. It was over 20% and therefore we suffered the loss in margins.

Analyst for Jesse Mitchell - Piper Jaffray

But if the economy is slowing down everywhere, then shouldn’t the labor and transportation also be suffering from those same effects as well, if the prices are coming down for everything?

Wai Sun Kwong

Yes, and that’s why we were able to reduce the costs but the dynamics, as I mentioned, are quite different.

Analyst for Jesse Mitchell - Piper Jaffray

Okay. And what is the government’s current target diesel price, if you have that?

Wai Sun Kwong

On average, it is around 4,900.

Analyst for Jesse Mitchell - Piper Jaffray

Okay.

Wai Sun Kwong

That is including the VAT of 17%, which is normally what [inaudible].

Analyst for Jesse Mitchell - Piper Jaffray

So is the bio-diesel now currently selling at a discount to that?

Wai Sun Kwong

Yes.

Analyst for Jesse Mitchell - Piper Jaffray

And is the reason just because of supply and demand?

Wai Sun Kwong

It is generally a market price. As you know, since this sort of reform in the beginning of the year, the so-called guidance price basically sets the ceiling of the diesel price and whatever price that companies can charge would be subject to market and in that sense, our price reflects what the market is, we are able to sell into.

Analyst for Jesse Mitchell - Piper Jaffray

Okay, and are you still able to sell everything you are producing?

Wai Sun Kwong

Yes, we are.

Analyst for Jesse Mitchell - Piper Jaffray

Okay, and just lastly, I noticed that SG&A is quite a bit lower -- I know there was some employee bonus in the fourth quarter but at the same time, you are starting up a new plant so is this kind of a level that we would expect to stay at with the new plant start-up or are there further cost reductions?

Wai Sun Kwong

I would say that there may be some increase because of the new plants but I don’t think that it will be significant -- i.e, there is no significant increase, even though we’ve got two plants coming up.

Analyst for Jesse Mitchell - Piper Jaffray

Okay, great. Thanks so much, Wai Sun.

Operator

(Operator Instructions) Your next question comes from the line of [Stephen Hartt] with [Hiller Capital Partners].

Stephen Hartt - Hiller Capital Partners

I was wondering if you could comment on -- recently reading the 20-F, I see that your audit fees for 2008 were somewhere in the neighborhood of about $600 and in ’07 they were only about $1,000. Have you been fully audited and can you comment on that?

Wai Sun Kwong

Not sure where you got the figures from -- we fully paid our audit fees.

Stephen Hartt - Hiller Capital Partners

I’m getting it from the 20-F that was filed. I don’t have the exact page number in front of me but it shows that you have -- I am assuming that the numbers are in RMB and I think it showed about RMB4,000 or thereabouts.

Wai Sun Kwong

Oh, because it’s in thousands -- it should be 4 million.

Stephen Hartt - Hiller Capital Partners

Okay.

Wai Sun Kwong

It’s all in thousands.

Stephen Hartt - Hiller Capital Partners

Okay, then it makes more sense. I appreciate that. And also, do you have plans to be in the United States any time over the next maybe three to six months to visit with investors?

Wai Sun Kwong

I have no definite plan as yet -- I mean -- but we will, as I mentioned to you previously, I will certainly let you know if any plan is fixed on that.

Stephen Hartt - Hiller Capital Partners

Okay, well, I would strongly encourage that. I think besides the business having its challenging times, I think that the stock price has been reflective of you and the management’s team’s unwillingness to come to the United States to meet with investors, so I just -- it’s more of a comment than a question but do keep me in mind when you do make it over here. Thanks.

Wai Sun Kwong

Absolutely. Okay. Thank you, Stephen.

Operator

Your next question comes from the line of Ian Horowitz with Soleil Securities.

Ian Horowitz - Soleil Securities

Two questions -- in previous quarters you had been selling product, bio-diesel into the intermediary market. Is that still going on? And what percentage are you seeing that occur now?

And the last question is I think what we always ask on these calls, is what are you seeing right now for average selling price for both bio-diesel and the by-products for the quarter?

Wai Sun Kwong

On the intermediary front, we are still selling into that -- into the chemical industry. In fact, the percentage is slightly higher. In the first quarter, is around I believe around 13% into that industry. And the pricing for that, although it has come down but it is slightly higher than the bio-diesel price.

What we are seeing, we are seeing currently bio-diesel pricing is around RMB4,000 per ton. In the first quarter, it did drop a bit below that so we are seeing some uplift from the worst time in the first quarter.

By product wise, it is hard to say. What we -- we suffered in the first quarter. Principally, there are two factors -- one is the general market in terms of by-products which are being sold into the chemical industry, general pricing is down. And secondly, we are producing -- we have been producing less of the higher margin erucic acid and erucic amide. And I think that on that side, the trend is still pretty much the same in the current quarter, I would say, as with the first quarter. So on that front, probably it does look as though things are still pretty much similar.

Ian Horowitz - Soleil Securities

Are you producing less erucic acid and erucic amide or less of -- on a total percentage basis?

Wai Sun Kwong

Less of the erucic acid and erucic amide.

Ian Horowitz - Soleil Securities

And why would you do that, since I thought -- I think it’s the Shanghai plant is the one that produces -- why is there lower volumes there?

Wai Sun Kwong

Because the raw materials we’ve got in the first quarter, there was less [grade C content] and therefore we were not able to produce as much erucic acid and erucic amide as we would have liked.

Ian Horowitz - Soleil Securities

I see. Okay, so it wasn’t a conscious choice or --

Wai Sun Kwong

No, of course not. I mean, we would have -- we would be willing, obviously wanting to produce as much of the higher margin stuff as we can but that was the case.

Ian Horowitz - Soleil Securities

Okay, great. Thanks a lot.

Wai Sun Kwong

Thanks.

Operator

(Operator Instructions) Ladies and gentlemen, this concludes your question-and-answer session. I would now like to hand the call over to management for closing remarks.

Wai Sun Kwong

Thank you all again for joining our call, and we look forward to speaking to you on the next one. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes your presentation and you may now disconnect. Have a great day.

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