Gushan Environmental Energy Limited Q3 2009 Earnings Call Transcript

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 |  About: Gushan Environmental Energy Limited (GU)
by: SA Transcripts

Operator

Good morning and thank you for participating in the third quarter 2009 Earnings Call of Gushan Environmental Energy. I would now like to turn the call over to Wai Sun Kwong, President of Gushan Environmental Energy.

Wai Sun Kwong

Good morning ladies and gentlemen and welcome to Gushan's third 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 provisions of US 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 our third quarter results.

Gushan's results in the third quarter were significantly impacted by continued uncertainty over potential consumption tax liability and a challenging operating environment. Total revenues for the quarter dropped 74.9% year-to-year, and 34.3% quarter-on-quarter to US$16.4 million. The revenue decline was attributable to drops in the sales volume of biodiesel and average selling prices of both biodiesel and biodiesel byproducts.

Sales volume dropped because of the suspension of production at our Fujian plant beginning in mid-April, at our Shanghai plant from mid-June to mid-August, and at our Hebei plant from mid-September. Production has resumed at Shanghai, where an additional 50,000 tons of capacity came on-stream, but remains suspended at Fujian and Hebei. Production at Hebei is expected to resume at the end of this month.

Another contributing factor to the drop in revenues for the quarter was the continued weakness in diesel prices in China on a year-to-year basis. The average selling price of our biodiesel declined 35.2% year-to-year in the third quarter although it rose 3.8% quarter-on-quarter from the second quarter of 2009, indicating that diesel prices have at least stabilized and may begin to recover as improved economic activity translates into increased demand.

Average selling prices of biodiesel byproducts also appear to have stabilized during the quarter, though a shift in the byproduct mix resulted in a slight decline in the average selling prices of our biodiesel byproducts during Q3. Cost of revenues dropped 43.4% year-to-year and 38.4% quarter-to-quarter to US$23.6 million. These costs included a provision of US$2.8 million or potential consumption tax liability for the third quarter.

Excluding this provision, our cost of revenues dropped 50.1% year-on-year and 22.2% quarter-on-quarter in Q2 as a result of lower sales volume. Although selling prices of biodiesel increased slightly during the quarter, raw material costs rose significantly faster. The average unit cost for our raw material feedstock’s rose 8.8% year-to-year and 16.8% quarter-to-quarter to RMB2,729 per ton in Q3 as suppliers demanded for higher prices.

As a result, the company reported an operating loss of US$11.3 million and a negative gross margin of 43.7% of which 17.2% was attributable to the provision for consumption tax. This compares to an operating loss of US$16.6 million and a negative gross of margin of 53.2% of which 46.4% was attributable to the provision for consumption tax in Q2, 2009. By contrast, the company reported a gross margin for 36.4% in the third quarter of 2008.

Now, we reported a net loss of $11.6 million for the third quarter, representing a basic and diluted loss per ADS of US$0.139. Despite the difficult quarter, our balance sheet remains strong with cash on hand of $86.4 million, and no bank borrowings as at the end of Q3 ’09.

It is clear from this review of our Q3 results that the consumption tax issue and raw material costs remain the two biggest challenges facing the company. We had hoped by now to be able to provide you with more clarity on the consumption tax situation. Unfortunately, we are not able to do so.

The situation remains unchanged from our last call. To recap where things stand, we suspended production at our Fujian plant in mid-April 2009, because of road work in the area, and although that road work was completed at the end of July, production remains suspended at Fujian, because of uncertainty over the plant’s consumption tax liability.

It remains the company’s view and the view of provincial and municipal tax authorities in Fujian that Gushan should be exempt from consumption tax levied on diesel products. However, we are still awaiting a decision by the PRC State Administration of Taxation on whether biodiesel products without petroleum based diesel content are exempted from the consumption tax.

Given the market environment rather than pay consumption tax, on contingent basis for any sales by the Fujian plant pending a decision by PRC SAT, the company decided that it would be prudent to continue to suspend production at the plant to minimize operating cash outflows until the company receives a determination on the tax matter.

In July 2009, our Sichuan plant received similar notices from the local SAT in Sichuan province. However, after discussions with the Sichuan tax authorities in September 2009 the Sichuan SAT agreed to defer assessment of the consumption tax on Gushan until a decision is rendered by the PRC SAT. As a result, there will be no impact on current operating cash flow and production at Sichuan Gushan.

To date, no other plants have received consumption tax assessments, but there is no assurance that it will not happen elsewhere. At this time we still do not have any indication of when we can expect a determination from the PRC SAT on the consumption tax exemption. While we remain hopeful that the PRC SAT will make any determination in our favor, there is no guarantee of this. As a contingency we are continuing with our efforts to expand sales to the chemical industry as such sales are not subject to consumption tax and are working to develop new products for the chemical industry.

On the issue of raw material costs, we have made significant progress during the quarter in diversifying our raw material sources by signing a five-year fixed price supply contract with a supplier of castor bean in Indonesia and a three-year cost-plus supply contract with a castor bean oil supplier in Sichuan. Under the contracts, the company has secured 20,000 to over 100,000 tones of castor bean oil per year over the contract period. We are continuing to seek opportunities to secure similar long-term raw material supply contracts to further diversify our raw material supply, and bring costs down.

Despite two difficult quarters and the continued uncertainty with regards to the consumption tax issue, we expect that the long term outlook for China's biodiesel market and for Gushan will remain positive due to several positive indicators. For example, we believe that China's economy has begun to recover. Diesel prices have begun to stabilize, and have even begun rising again, and the outlook for industrial production and growth in China remains favorable.

Moreover, despite the uncertainty over the consumption tax issue, China continues to demonstrate support for, and promote clean energy sources such as biodiesel through its medium and long-term development plan. We believe our strong cash position provides us with the resources to continue to diversify our raw material sources and install production capacity that will leave us well positioned to take advantage of these positive indicators as and when the markets improve, and once we obtain clarity on the consumption tax issue.

As of the end of the third quarter, Gushan had seven production facilities, with an annual biodiesel production capacity of 450,000 tons, or 135 million gallons. A new second plant in Sichuan with an annual capacity of 50,000 tons using entirely inedible oils as raw materials will be completed by the end of the first half of 2010. The addition of this new Sichuan plant will raise Gushan's total annual production capacity to 500,000 tons or 150 million gallon by the end of the first half of 2010.

Apparently only our Sichuan, Beijing and Shanghai production facilities are in operation. However, we believe, we will be able to quickly ramp up production at our other facilities as and when market conditions improve. The consumption tax issue is resolved or as otherwise appropriate. We will of course continue to closely monitor the situation and adjust our plans accordingly. We will also keep you informed of any material developments with regards to resolution of the consumption tax issue.

At this time, we would be pleased to answer any questions that you may have. I will now 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. Please proceed.

JinMing Liu - Ardour Capital Investments

Can you give us any clarity on the consumption tax issue basically when do you expect a resolution?

Wai Sun Kwong

Yeah, as mentioned in the press release and also what I just told you, we actually do not have any timeline as yet. We are still waiting for response from the central tax bureau.

JinMing Liu - Ardour Capital Investments

Why it has been a dragging for so long? What’s the hold up there, why they haven’t arrived at any decision?

Wai Sun Kwong

Yes. This is a national tax law and needs to go to the highest level, and as you know, changing tax policy or laws require detailed discussions within the government itself and also detailed investigations, and therefore time is needed.

JinMing Liu - Ardour Capital Investments

Okay. You mentioned that you are switching some of your sales into the specialty chemical market. What was the percentage of sales into that market for the third quarter?

Wai Sun Kwong

In the third quarter it’s around 30%.

JinMing Liu - Ardour Capital Investments

30, okay. You mentioned you signed the contracts for castor bean supply. Which plant do you intend to use castor bean oil?

Wai Sun Kwong

I think initially, because our plants are able to use, as long as it’s not 100% being used, I think each of our plant can take up to 30% for the castor bean. Obviously, the one in Sichuan, we signed with Sichuan, obviously it will be used by Sichuan, and for the castor bean being sourced from Indonesia, it would depend on whether Fujian can resume production or else it will be Shanghai and Beijing.

JinMing Liu - Ardour Capital Investments

What is your expected transportation costs associated with shipping castor beans from Indonesia to say either Fujian or Shanghai?

Wai Sun Kwong

We expect the all-in costs for the Indonesia -- Indonesian castor bean oil all the way into China would be roughly around RMB3,000 per ton.

JinMing Liu - Ardour Capital Investments

That’s for the beans, not for the oil.

Wai Sun Kwong

That would be including processing as well.

Operator

(Operator Instructions). Your next question comes from the line of (inaudible). Please proceed.

Unidentified Analyst

Even if we back out the four plants that were not producing this quarter, and you just account for the Beijing, Shanghai and Sichuan plants, that’s still about 55,000 tons of production capacity on quarterly basis and your sales volume was only about 25,000. Were these plants producing at full capacity or were they…

Wai Sun Kwong

No. I think, you can see from last quarter, the plants are not producing at full capacity.

Unidentified Analyst

Then what capacity are they producing at? I mean, a little bit sounds like 50%.

Wai Sun Kwong

Sorry?

Unidentified Analyst

It looks like they're producing at about 50% of capacity?

Wai Sun Kwong

Yes, probably maybe a little bit less than that.

Unidentified Analyst

Is that just due to weaker end market demand or is there another tax issue there or construction?

Wai Sun Kwong

Mainly for the existing plants, because as you know, we are diversifying our sales sources to the chemical industry and we are doing it at a slow pace in a sense because if we push too hard on the chemical side, the prices will drop as well. So in that sense, it is related to the demand, but you see in a way do not want to incur future potential consumption tax issue by producing biodiesel so to speak. In a way, we're sort of transitioning more towards the chemical side. If I give you an example, recently in the current months and so forth, the percentage that we're selling into the chemical industry has now gone up to roughly 50%.

Unidentified Analyst

So then, what are we supposed to forecast for the biodiesel business as this essentially is something that you're transitioning out of, or how do we…?

Wai Sun Kwong

Yes. I think we will need some time to at least complete this transition. It also depends on when we may be able to get some sort of resolution on the consumption tax from the central…

Unidentified Analyst

Is that tax affecting all biodiesel producers in China, or is it just Gushan?

Wai Sun Kwong

Yes it is.

Unidentified Analyst

Do you have any idea why there is that particular tax for biodiesel now? Is the government trying to discourage the production, or…?

Wai Sun Kwong

No. I think what happened was that there are a lot of people who have avoided this consumption tax by just claiming that they are making biodiesel. But really, it's just maybe putting a little bit of so called biodiesel into diesel products and selling it and claiming that they are selling biodiesel, therefore not paying the consumption tax. I think the government is trying to closeout those players, but not realizing that it will be hurting the real biodiesel producers. That’s our reading of it.

Unidentified Analyst

Okay, I see. So then going forward do we assume that the biodiesel production, the capacity will be even will go even lower than 50%. I mean, you could be producing at 25% of capacity next quarter or another plant could shutdown as well.

Wai Sun Kwong

We don’t foresee any shutting down of plants and we foresee similar type of capacity utilization at least for the next quarter. And we will have to see how the whole situation plays out going into 2010?

Unidentified Analyst

Okay, and then could you talk a little bit about what accounted for the jump in the feedstock costs? Could you talk about what accounted for the jump in the feedstock costs?

Wai Sun Kwong

The feedstock costs as you know started going up last quarter. And we basically have been negotiating with our suppliers and they have been trying to get a higher price from us. Now principally, we believe because they believe if they are able to sell some of their products through the so called the [eco] channel because food prices and also edible oil prices have gone up and therefore they are using that to leverage against us, in a sense that trying to get a higher price and unfortunately we are not able to keep that price down, and therefore we have to do what we did, which was to try and find alternative sources to balance that account.

Unidentified Analyst

Can you help us understand the reasoning to transition towards the chemical side from biodiesel when the byproducts ASP was only about RMB2,000 a ton, and your feed stock cost is about a thousand more?

Wai Sun Kwong

Well, firstly the, when we sell to the chemical industry, the prices are slightly better than biodiesel prices, that we sell to the gas station. So that is a plus, and providing that we do not flood the market on the chemical side so we’ll have to pick it relatively slowly, then we are hopeful that as the economy picks up again, pricing will hopefully return to normal.

Yes, you are right. I mean, you look at the byproduct prices, they are weak and that shows that the chemical industry is not doing too great yet and therefore we have to tread very carefully in terms of the pricing.

Operator

(Operator Instructions). Your next question comes from the line of [Steven Hart] with Howard Capital Partners. Please proceed.

Steven Hart - Howard Capital Partners

I was curious if you could talk about a little bit, given what’s going on here with the company. Obviously things have deteriorated pretty rapidly over the past year. Your desires and future desires to remain kind of why you listed in the US and I'm asking the question because management team has not been present in the US and in talking to or meeting with US investors. What are the plans maybe over the next six months as you work through the business issues to maybe come over to the US and meet with investors face-to-face to discuss this stuff?

Wai Sun Kwong

Yes, let me recap a little bit. I certainly have been in the US quite a few times since the listing up to just before the financial crisis happened and obviously when the financial crisis happened it has a substantial impact to our business which has dragged on till now which is sort of or like one-year later. Obviously we are facing very significant challenges and we are in a way quite confident that we are able to resolve these problems and that’s why we believe that it is right for us to continue our expansion plan, which we started end of last year. But obviously we are very conscious of cash flow, operating cash flow especially.

So at the moment we are operating, at least on the operation level we have positive cash flow, and our strategy is to at least maintain that and in the meantime resolving those [sustained] significant issues. I think where it comes to a point I believe where the economy hopefully returning to normal in the coming maybe half a year or six months or so, and once we have been able to get a resolution basically on the consumption tax, and prices are beginning returning to normal, then obviously I certainly will be coming to meet with people and to tell them what we are going to do next and how we are doing, that sort of thing. We have been very busy to try and tackle the sort of challenges that we have been facing, particularly in the last nine months or so.

Steven Hart - Howard Capital Partners

So you haven't been to the US since what late '07?

Wai Sun Kwong

No, '08. Last year. Not late, but it was in the summer of 2008.

Steven Hart - Howard Capital Partners

So it's been almost a year-and-a-half, right?

Wai Sun Kwong

One year. Just over a year. No, actually I also came through in the beginning of, just for two days in the first quarter '09 as well, in March '09.

Operator

(Operator Instruction) There are no additional questions at this time. I would now like to turn the conference over to Mr. Wai Sun Kwong for closing remarks. Please proceed, sir.

Wai Sun Kwong

Thank you again for joining our third quarter 2009 earnings call and we look forward to speaking with you again on our next call. Thank you.

Operator

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

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