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Gushan Environmental Energy Ltd (NYSE:GU)

Q2 2008 Earnings Call

August 15, 2008 8.30 am ET

Executive

Wilson Wai Sun Kwong - President

Frank Chan - Principal Financial Officer and Principal Accounting Officer

Analyst

Joe Gomes - Oppenheimer & Co.

Scott Thomas - Neuberger Berman

Charles Fishman - Piper Jaffray

Jinming Liu - Ardour Capital Investments

Ian Horowitz - Soleil Securities

Leena Blutta - Joho Capital

Joe Gomes - Oppenheimer

Operator

Thank you for participating in the second quarter 2008 earnings conference call of Gushan Environmental Energy. (Operator Instructions) I would now like to turn the call over to Wilson Kwong, President of Gushan Environmental Energy.

Wilson Kwong

Welcome to Gushan’s second quarter 2008 earnings call. Joining me on the call is Frank Chan, Financial Officer of Gushan. Please note that today's discussion may contain forward-looking statements made under the Safe Harbor provisions of Federal Securities Laws and please see today’s press release, under the section Safe Harbor Statement for a discussion of risks that may affect our results.

Before opening the call to questions, I would like to briefly review some of the highlights of our second quarter results. Gushan continued to deliver revenue growth during the second quarter of 2008, both year-over-year and quarter-on-quarter from the first quarter of this year.

Total revenues for the quarter rose 53% year-over-year and 20% quarter-on-quarter to US$58.3 million, reflecting both higher average setting prices and increased sales volume as production at our new Beijing plant operated at full capacity and that more than offset the two week suspension of production at our Sichuan plant in May due to the earthquake.

Now sales volume of biodiesel in Q2, ‘08 was up 22% year-over-year and 16% quarter-on-quarter to nearly 60,000 tons or approximately 18 million gallon. The higher sales volume came from increased production at our Beijing plant, which commenced production in January this year and started operating at full capacity in March.

The year-over-year increase in sale volume was also partly the result of increased production capacity at our Sichuan plant, which expanded its annual production capacity by an additional 20,000 tons in the fourth quarter of 2007. However as a result of the Sichuan earthquake in May, production at the Sichuan plant was suspended for two weeks resulting in a 14% sequential drop in production at Sichuan, so year-over-year production at Sichuan still grew by 17%.

By the end of May Sichuan have resumed production at full operating capacity. Gushan’s total annual production capacity of biodiesel at the end of Q2 ’08 was 290,000 tons or 87 million gallon and that is up from 170,000 tons or 51 million gallon back in Q2 ’07.

The average selling price of our biodiesel was up 33.5% year-over-year and 7.6% quarter-on-quarter. Higher selling prices reflected; firstly, the PRC government increase in the diesel guidance price in November 2007 and again in June 2008; secondly, the continuing shortage of diesel supply in China; and thirdly, increased sales of Gushan’s biodiesel products into the chemical industry, which commenced during the first quarter of this year and continued to grow during the second quarter of ’08.

Selling prices to the chemical industry are on average, higher than selling prices in the diesel market. Our cost of revenues rose 59.4% year-over-year and 21.1% quarter-on-quarter to US$34.2 million in Q2 ’08. The increased costs reflected both higher production volume and an increase in the overall average unit costs for vegetable oil offal and used cooking oil, which rose from RMB 1821 per ton in Q2, ’07 to RMB 2,287 per ton in Q1, ’08 and to RMB 2390, which is $384 in Q2 ’08 as a result of the increased in our suppliers own running costs which are primarily affected by general cost inflation, particularly in labor and transportation.

Going forward we continue expect our feedstock cost to rise inline with general cost inflation in China. Our gross margin was 41.3% in the second quarter down slightly from 43.8% in the second quarter of ’07 and 41.8% in the first quarter of ’08. The slight decline in the margins was largely the result of a decline in the proportion of over sales accounted for by the higher margin by-products; USA asset and USA amide.

The lower proportion of sales accounted for by these products partly reflects the additional biodiesel capacity in Beijing where these products are not produced. In addition sales of USA asset and USA amide dropped during the second quarter because of the temporary shutdown of the Sichuan plant where these by-products are produced.

Operating income for the quarter rose 29.4% year-over-year and 8.3% quarter-on-quarter to $19.3 million. Net income was up 33.1% year-over-year and 8.7% quarter-on-quarter to US$17.6 million.

Excluding share-based compensation expenses, net income for the quarter increased by 41.5% year-over-year and 14.9% quarter-on-quarter to US$19.4 million. Diluted earnings per ADS amounted to US$0.21 for the second quarter and diluted earnings excluding share-based compensation expenses for ADS amounted to US$23.1 for the quarter.

Our balance sheet remains strong with cash on hand of US$168 million as of the end of the second quarter, after payment of a dividend to shareholders totaling US$10 million during the quarter. In June the company had filed a registration statement with the SEC for a follow-on public offering of ADS. That plant offering scrapped in July due to poor market conditions. The proposed and subsequent cancelled offering was limited slowly to existing shares held by certain shareholders and would have no impact on the capital structure of the company.

The company’s ongoing capacity expansion plans will continue to be funded out of our strong cash positions and cash flow. Our expansion plans remained on track. Our new plant in Shanghai, which is our fifth production capacity commenced operations on June 28, adding 50,000 tons or 18 million gallon in annual biodiesel production capacity and raising Gushan's total annual biodiesel production capacity to 290,000 tons or 87 million gallon.

Doubling of capacity at our Beijing plant to 100,000 tons and the opening of new plants now under construction in Chongqing and Hunan, all of which are expected to take place during the fourth quarter of this year. We’ll raise Gushan’s total annual biodiesel production capacity to 400,000 tons which is 120 million gallon by the end of 2008.

In 2009 Gushan plans to add another 200,000 tons or approximately 16 million gallons to our annual biodiesel production capacity bringing the company’s total annual production capacity to 600,000 tons or approximately 180 million gallons by the end of 2009.

On our last earnings call, we estimated that our actual biodiesel production in 2008 would be approximately 270,000 tons or approximately 81 million gallons. However, the company has now temporarily suspended operations at our Beijing plant from August 1 to September 20 as a result of traffic control measures put in place for the Beijing Olympics. This is expected to reduce 2008 production volume at the Beijing plant by approximately 10,000 tons; that combined with the two week suspension of production at Sichuan because of the earthquake and the fact that additional production capacity in Beijing and two new plants are now expected to commence until the end of the fourth quarter means that based on current circumstances and burrowing any unforeseen events, the company now estimate that its total biodiesel production in 2008 will be 250,000 tons or approximately 75 million gallons.

At this time we will be pleased to answer any questions that you may have and I will now turn the call back to the operator to begin the Q&A session; thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Joe Gomes with Oppenheimer.

Joe Gomes – Oppenheimer & Co.

Could you provide maybe some more color on the sale for the chemical companies? In the first quarter I think you said it was roughly 10% of the volume and prices that averaged about 800 RMB above the overall average and I was wonder if you might be able to give us a details for the second quarter and also along the same lines, are you selling to additional customers in the chemical business or just to the same ones you were selling to in the first quarter?

Wilson Wai Sun Kwong

Yes, in terms of percentage of volume, it’s still roughly around 10% for the second quarter and in terms of selling prices, it is still roughly around RMB 800 above the biodiesel selling into the diesel industry prices and in terms of the customers, we are expanding the customer base, there are new customers for the second quarter compared with first quarter.

Joe Gomes – Oppenheimer & Co.

On the by-product production, maybe you could walk me through this, but I know typically as you increase biodiesel production, you get the increase in by-products, but the volume of by-product doesn’t seem to be growing anywhere near as fast as the increase in our biodiesel production. I was just wondering, am I thinking about this wrong or what are we doing with all these by-products of production?

Wilson Wai Sun Kwong

Some of the by-products that we produced, for example plant asphalt are not necessarily all sold and that’s because sometimes we used them as our own field, so that accounts for some of the discrepancy and also the other part is the volume of USA asset and USA amide, which really depends on the amount of waste sea content in raw materials that we received. So, that will also have an impact on the actual volume.

Joe Gomes – Oppenheimer & Co.

Okay and one last question and I’ll get back in queue; could you kind of give us your view of the diesel market and prices in China today? I know there’s been some discussion about grow slowing pretty dramatically in China after the Olympics and I just wanted to kind of get your view of the market and the prices in China?

Wilson Wai Sun Kwong

Currently, we are still seeing increase in pricing, although the crude oil prices have dropped quite dramatically in recent week. So, going forward we may see a slightly slower increase and that’s what we think will happen in terms of the diesel prices, but at the moment we’re not seeing any difference in the trend in terms of supply demand situation for our market.

Operator

And our next question will come from the line of Scott Thomas with Neuberger Berman; please proceed.

Scott Thomas - Neuberger Berman

Two quick questions I guess; one is just around the average selling prices of the by-products that you talked about. I was confused a little bit; in the press release you talked about the average selling prices of all the by-products going up, but as a group, the average selling price went down. Can you maybe explain that and then talk about what should we expect going forward for those, for the pricing in those by-products?

Wilson Wai Sun Kwong

Because we have a number of by-products and we don’t split it out particularly in terms of separating each of the by-product itself. Unfortunately, some by-products have much higher selling prices and a higher margin, which these one were as I mentioned in the call the USA asset and USA amide and because the production of these two products, firstly only being made at our Sichuan plant, and that’s because they require a sufficient amount of rate sea content and only in Sichuan where we have the raw materials that we receive will have sufficient rate sea content and so depending on how much we produced of the USA asset and USA amide that tend to distort the average selling price of the by-products.

Scott Thomas - Neuberger Berman

Can you just talk maybe about; since those are the margin drivers, those by-product, is there a reason to expect a circular growth in demand for those or is it difficult to say?

Wilson Wai Sun Kwong

In terms of demand it has been pretty stable, in the sense that we’ve never seen sort of demand for such by-products. The key is how much we are able to produce. It is somewhat not 100% under our control because as I mentioned when we received the raw materials that will really depend on how much rate sea content there is for us to produce a certain amount of those high margin by-product of USA asset and USA amide.

So as a result you might see the by-product average selling prices to fluctuate a bit, but in general by-product prices have been going up along with the general sort of cost inflation in China.

Scott Thomas - Neuberger Berman

Thank you, just one another question, maybe a little broader if I may. As I understand, the feedstocks that you guys use, generally speaking there’re not a lot of alternative uses for that, they don’t go back in the food chain and generally have to be disposed of. I understand that in some other places, maybe in the U.S, some parts of that are different; I don’t know whether it’s because of rules and regulations or just a demand for putting it back into the animal food chain for instance. Can you just provide some prospective on what do you think that has the possibility of changing in China and evolving overtime; is it possible to rules to change or the demand for that could change for other uses.

Wilson Wai Sun Kwong

Actually for the moment we are not seeing any sort of real change to that, because we see firstly the abundant supply of such raw materials and I would say it would be a very, very large exercise for the government to put a measure in place to ensure that those waste oil our property dealt with, ensuring that the quality is as the same as in the U.S. for example and so for us we don’t think the situation will change very much at all in the foreseeable future.

Operator

And our next question will come from the line of Charles Fishman with Piper Jaffray; please proceed.

Charles Fishman - Piper Jaffray

Wilson, can you give us any more detail on the ’09 expansion plan? Will that be at existing facilities, new plants, size of plants anymore color you can provide would be appreciated?

Wilson Wai Sun Kwong

For the moment, in terms of play between existing and new plants, we are considering that roughly around 90,000 tons will come from existing plant expansion and the rest will come from new locations. At the moment, we are still deciding on the exact locations for the new facility and therefore are not able to give too much detail on that, but the plan is to have 90,000 tons coming from existing facilities and the rest coming from new facilities.

Charles Fishman - Piper Jaffray

So, 100,000 tons of new plant…

Wilson Wai Sun Kwong

110,000.

Charles Fishman - Piper Jaffray

And what will be the driver? Will it be just the availability of feedstock? Will it be the distribution system for biodiesel? How would you think about that, when you do make those decisions?

Wilson Wai Sun Kwong

Generally, we do think about the stock and indirectly related to that would be sort of government support in a sense when we decided to build a plant in Chongqing for example, we received or we bought what we thought is a very, very reasonably priced piece of land from the government. So, the government depending on how much of the benefit or how much indirect help they’re giving us, that is also a factor coupled with the general availability of feedstock within a certain parameter, those are the key conservations. In terms of selling side, I think that is not so much a consideration.

Charles Fishman - Piper Jaffray

How much influence does the government have on the new site location?

Wilson Wai Sun Kwong

In terms of effecting our decision or…?

Charles Fishman - Piper Jaffray

Yes, I mean how much are they involved in the decision making of the new site location?

Wilson Wilson Wai Sun Kwong

We tend to talk with them and obviously because they will have certain sites available and then we will talk with them and seek out what we think is the best site for us and then see whether that is going to be available and whether they are able to put it out for us to tender for it, so that’s the way we go around for that.

Operator

And your next question will come from the line of Jinming Liu with Ardour Capital; please proceed.

Jinming Liu - Ardour Capital Investments

What is the current biodiesel selling price, because I noticed that there are some recent drops in terms of the diesel prices in China; should we look at exactly the government guidance price which is along the RMB 6,400?

Wilson Wai Sun Kwong

Our current biodiesel selling price is around 6,300. I think the number for the guidance price for diesel on average is actually 6,000. So, at the moment we’re still selling above guidance.

Jinming Liu - Ardour Capital Investments

Also in terms of your kinds of the secondary offering, are you going to do another on there in later this year or next year?

Wilson Wai Sun Kwong

We have no plans for any follow-on offering.

Jinming Liu - Ardour Capital Investments

My last question; can you help me breakout your production expenses. What was the direct material expense for second quarter ’08?

Wilson Wai Sun Kwong

Direct materials that would be the oil cost and also the methanol, about 94%.

Operator

And our next question will come from the line of Ian Horowitz with Soleil Securities; please proceed.

Ian Horowitz - Soleil Securities

A couple of questions that kind of start on Jinming’s questions; you saw about 2,390 per ton for the feedstock; are we seeing significant price increase since the end of the quarter or...?

Wilson Wai Sun Kwong

I would say we are seeing some increase after the quarter. I wouldn’t say its significant.

Ian Horowitz - Soleil Securities

Would you say it’s inline with CTI?

Wilson Wai Sun Kwong

Yes, I think its inline generally inline with the inflation.

Ian Horowitz - Soleil Securities

The second question, we saw a sequential decline in the by-product price per ton due to the Sichuan plant coming down. Now that that’s back online, should we expect basically a recovery back to kind of the first quarter pricing?

Wilson Wai Sun Kwong

Yes, I think so, yes.

Ian Horowitz - Soleil Securities

The next question I had and to go off Charles questions, I mean you are not ready to kind of talk about the 2009 calendar; do you have any idea when -- I mean should we be waiting again to the next earnings call or do you expect something any NRM?

Wilson Wai Sun Kwong

We hope to have something before the next earnings call, but in any case we will have something for the next earnings call.

Ian Horowitz - Soleil Securities

So, I mean if you look out, you’re usually about 10 months on a Greenfield location. This capacity I would assume then is going to be very much backend loaded to the second?

Wilson Wai Sun Kwong

Not, necessarily because some of the existing plant expansion can happen earlier, I mean say in the first quarter.

Ian Horowitz - Soleil Securities

I guess that was my question; how long did it take to do an existing plant expansion?

Wilson Wai Sun Kwong

That is normally very fast, so it can be done, much, much shorter than the 8 months to 9 months required for Greenfield.

Ian Horowitz - Soleil Securities

Are all of the regulatory processes in place that you can just do the expansion without having to go through the whole process again?

Wilson Wai Sun Kwong

Yes, yes.

Ian Horowitz - Soleil Securities

So, then I would kind of say the potential first half volume expansion would be coming out of the existing plants and then the 110,000 new tonnage and new locations would definitely be a second half opportunity then, correct?

Wilson Wai Sun Kwong

Yes, I think you can assume that, yes.

Ian Horowitz - Soleil Securities

Which will be almost a 50/50 split throughout the year?

Wilson Wai Sun Kwong

Yes, I mean that’s what we expect to be.

Ian Horowitz - Soleil Securities

And the lat question I have and I’ll get back in queue. Beijing, September 20, is the start date, is it a gradual process to turn the plant back on and can we expect to get the full utilization rates within the several days or how will this process kind of workout mechanically?

Wilson Wai Sun Kwong

In terms of getting back up to speed normally it takes a week.

Operator

And our next question will come from the line of [Leena Blutta] with Joho Capital. Please proceed.

Leena Blutta - Joho Capital

I just had a question on the feedstock cost, so you guys list of bunch of suppliers in your filing and we tried to talk to a few of them and the prices that we were getting from them, the ASP for the feedstock were a little bit different from what you guys saw in the quarter so the range that we got was from suppliers of anywhere from like RMB 2,800 to RMB 4000 and so I don’t know if you could explain that?

Wilson Wai Sun Kwong

I think the main difference is you are not a biodiesel producer.

Leena Blutta - Joho Capital

Right; no, but I mean I guess as we ask them like what is the average doing side?

Wilson Wai Sun Kwong

They would not tell you. I mean why would they tell you.

Leena Blutta - Joho Capital

And then related to that does the availability of feedstock going forward for your expansion plans at all were here because checks also indicate that there is a problem in many provinces of shortage of feedstock. So, are you fairly confident of going up to 400,000 on a timely basis? It sounds like you are, but I just want to confirm that.

Wilson Wai Sun Kwong

Yes, we don’t see a problem in supply of our feedstock. As I always mentioned, it’s a matter of costs and our costs do continue to rise and the rising costs are more a function of the higher costs of our suppliers running costs, which is basically linked to the inflationary environment in China.

Leena Blutta - Joho Capital

Got it and then lastly when would the Q1 ’08 numbers be audited externally?

Wilson Wai Sun Kwong

I think the audit gets done annually.

Leena Blutta - Joho Capital

Okay. So, we won’t see audited numbers until March ’09 or something?

Wilson Wai Sun Kwong

Yes, the end of the year.

Operator

And our next question is a follow-up question, from the line of Jinming Liu with Ardour Capital; please proceed.

Jinming Liu - Ardour Capital Investments

I just have one follow-up question. I know that diesel price increased in June ’08 and can you give us some details regarding, how much, the increase in diesel price that have an impact on your feedstock prices?

Wilson Wai Sun Kwong

It’s a hard question because the element for our feedstock costs, basically there’s labor and also transportation and also when diesel prices go up, transportation costs for our suppliers also go up. If I give you a number I don’t think, it is that credible to put it this way, but as you can see, we got the sort of average costs for the quarter of 2,390 for the second quarter and that should give you some sort of perspective of the general cost of the feedstock.

Jinming Liu - Ardour Capital Investments

Last time in the first quarter ‘07, when the trends coming increase, diesel guidance price in you’re feedstock cost jumped a little bit; should we expect a similar expense increase or a little bit lower in this time?

Wilson Wai Sun Kwong

I would say that if that could be similar, but mind you the last time we were also hit by this snow storm in January, so the impact I would expect would be larger last year than this time around. That’s obviously an impact on the feedstock cost.

Operator

And our next question will come from the line of Joe Gomes with Oppenheimer; please proceed.

Joe Gomes - Oppenheimer

Wilson there’s been some speculation that you guys are looking for some employees in Burma and Indonesia and I was wondering would that be more for scouting out say to Tropo farm locations or are you planning on looking into biodiesel expansion in those areas; thanks.

Wilson Wai Sun Kwong

Yes, we actually are wanting to have people to scout around. We know that there is Tropo being grown in Southeast Asian countries and also castor bean being grown as well and we are actually trying to find out how much there is and to just get an overall picture as to development of these alternative feedstock and how that is going.

Operator

At this time we have no questions in queue.

Wilson Wai Sun Kwong

Well thank you very much for joining our second quarter earnings call and we do look forward to speaking with you again on our next call. Thanks very much.

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