Item 1. Business.
Introduction
We manufacture and trade bromine and crude salt, and manufacture and sell chemical products used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals. To date, our products have been sold only within the People’s Republic of China. As used in this report, the terms "we," "our," "Company" and "Gulf Resources" refers to Gulf Resources, Inc. and its wholly-owned subsidiaries, and the terms “ton” and “tons” refers to metric tons, in each case, unless otherwise stated or the context requires otherwise. All information in this report gives retroactive effect to a 4-for-1 reverse stock split of our common stock effected on October 12, 2009.
The functional currency of the Company’s operating foreign subsidiaries is the Renminbi (“RMB”), which had an average exchange rate of $0.14661, $0.14787 and $0.15482 during fiscal year 2009, 2010 and 2011, respectively. The functional and reporting currency of the Company is the United States dollar (“USD” or $”).
Our Corporate History
We were incorporated in Delaware on February 28, 1989. From November 1993 through August 2006, we were engaged in the business of owning, leasing and operating coin and debit card pay-per copy photocopy machines, fax machines, microfilm reader-printers and accessory equipment under the name “Diversifax, Inc.”. Due to the increased use of internet services, demand for our services declined sharply, and in August 2006, our Board of Directors decided to discontinue our operations.
Upper Class Group Limited, incorporated in the British Virgin Islands in July 2006, acquired all the outstanding stock of Shouguang City Haoyuan Chemical Company Limited ("SCHC"), a company incorporated in Shouguang City, Shandong Province, the People's Republic of China (the “PRC”), in May 2005. At the time of the acquisition, members of the family of Mr. Ming Yang, our president and former chief executive officer, owned approximately 63.20% of the outstanding shares of Upper Class Group Limited. Since the ownership of Upper Class Group Limited and SCHC was then substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Upper Class Group Limited recognized the assets and liabilities transferred at their carrying amounts.
On December 12, 2006, we, then known as Diversifax, Inc., a public "shell" company, acquired Upper Class Group Limited and SCHC. Under the terms of the agreement, the stockholders of Upper Class Group Limited received 13,250,000 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of voting common stock of Gulf Resources, Inc. in exchange for all outstanding shares of Upper Class Group Limited. Members of the Yang family received approximately 62% of our common stock as a result of the acquisition. Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class Group Limited for the net assets of Gulf Resources, Inc., accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange is identical to that resulting from a reverse acquisition, except no goodwill is recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class Group Limited. Share and per share amounts stated have been retroactively adjusted to reflect the share exchange. On February 20, 2007, we changed our corporate name to Gulf Resources, Inc.
On February 5, 2007, we acquired Shouguang Yuxin Chemical Industry Co., Limited ("SYCI"), a company incorporated in the People's Republic of China, in October 2000. Under the terms of the acquisition agreement, the stockholders of SYCI received a total of 8,094,059 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of common stock of Gulf Resources, Inc. in exchange for all outstanding shares of SYCI's common stock. Simultaneously with the completion of the acquisition, a dividend of $2,550,000 was paid to the former stockholders of SYCI. At the time of the acquisition, approximately 49.1% of the outstanding shares of SYCI were owned by Ms. Yu, Mr. Yang’s wife, and the remaining 50.9% of the outstanding shares of SYCI were owned by SCHC, all of whose outstanding shares were owned by Mr. Yang and his wife. Since the ownership of Gulf Resources, Inc. and SYCI are substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Gulf Resources, Inc. recognized the assets and liabilities of SYCI at their carrying amounts. Share and per share amounts have been retroactively adjusted to reflect the acquisition.
To satisfy certain ministerial requirements necessary to confirm certain government approvals required in connection with the acquisition of SCHC by Upper Class Group Limited, all of the equity interest of SCHC were transferred to a newly formed Hong Kong corporation named Hong Kong Jiaxing Industrial Limited (“Hong Kong Jiaxing”) all of the outstanding shares of which are owned by Upper Class Group Limited. The transfer of all of the equity interest of SCHC to Hong Kong Jiaxing received approval from the local State Administration of Industry and Commerce on December 10, 2007.
As a result of the transactions described above, our corporate structure is linear. That is Gulf Resources owns 100% of the outstanding shares of Upper Class Group Limited, which owns 100% of the outstanding shares of Hong Kong Jiaxing, which owns 100% of the outstanding shares of SCHC, which owns 100% of the outstanding shares of SYCI. Further, as a result of our acquisitions of SCHC and SYCI, our historical financial statements, as contained in our Condensed Consolidated Financial Statements and Management's Discussion and Analysis, appearing elsewhere in the report, reflect the accounts of SCHC and SYCI.
On October 12, 2009 we completed a 1-for-4 reverse stock split of our common stock, such that for each four shares outstanding prior to the stock split there was one share outstanding after the reverse stock split. All shares of common stock referenced in this report have been adjusted to reflect the stock split figures. On October 27, 2009 our shares began trading on the NASDAQ Global Select Market under the ticker symbol “GFRE” and on June 30, 2011 we changed our ticker symbol to “GURE” to better reflection of our corporate name.
Our current corporate structure chart is set forth in the following diagram:
Our executive offices are located in China at Chenming Industrial Park, Shouguang City, Shandong, People's Republic of China. Our telephone number is +86 (536) 5670008. Our website address is www.gulfresourcesinc.com. The information contained on or accessed through our website is not intended to constitute and shall not be deemed to constitute part of this Form 10-K.
Acquisitions of Production Facilities
On January 7, 2009, we acquired substantially all of the assets owned by Qiufen Yuan, Han Wang and Yufen Zhang in the Shouguang City Renjiazhuangzi Village North Area (the “Qiufen Yuan, Han Wang & Yufen Zhang property” or “Factory No. 7”). The Qiufen Yuan, Han Wang and Yufen Zhang property includes a 50-year (as of acquisition date) mineral rights and land lease covering 1,611 acres of real property as well as the related production facility, the pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was $10,615,000, consisting of $10,000,000 in cash and 375,000 shares of the Company’s Common Stock valued at $615,000 (fair value).
On September 7, 2009, we acquired substantially all of the assets owned by Yuliang Gao, Han Wang and Qing Yang in the Shouguang City Yingli Township Beishan Village (the “Yuliang Gao, Han Wang & Qing Yang property” or “Factory No. 8”). Fengxia Yuan acted as Attorney-in-Fact for one of the owners of Factory 8, Yuliang Gao, and entered into the acquisition agreement relating to Factory 8 on behalf of Yuliang Gao. The FengxiaYuan, Han Wang and Qing Yang property includes a 50-year (as of acquisition date) mineral rights and land lease covering 2,723 acres of real property as well as the related production facility, the pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was $ 16,930,548, consisting of $11,516,960 in cash and 1,057,342 shares of the Company’s Common Stock valued at $5,413,588 (fair value).
On June 7, 2010, we acquired substantially all of the assets owned by Jinjin Li and Qiuzhen Wang in the Shouguang City Yangkou Township Yangzhuang Village (the “Jinjin Li and Qiuzhen Wang property” or “Factory No. 9”). Jinjin Li was acting individually and as Attorney-in-Fact for four other owners of Factory 9, Yueliang Wang, Kunming Tian, Gaoming Tian and Zhiqiang Wei. The Jinjin Li and Qiuzhen Wang property includes a 50-year mineral rights (as of acquisition date) and land lease covering 759 acres of real property, with the related production facility, the pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was $13,905,719, consisting of $13,297,492 in cash and 70,560 shares of the Company’s Common Stock valued at $608,227 (fair value).
On December 30, 2010, we acquired all right, title, and interest in and to all fixtures and facilities owned by the State-Operated Shouguang Qingshuibo Farm (the “Crude Salt Field”). The Crude Salt Field includes a 30-year land lease covering 568 acres of crude salt field, as well as the related fixtures and facilities located on the crude salt field. The total purchase price for the Crude Salt Field was $11,023,000 in cash consideration. Pursuant to the purchase agreement, SCHC signed a 30-year land lease agreement for the Crude Salt Field on January 18, 2011 with an annual leasing fee payable of approximately $26,048.
On December 22, 2011, we acquired substantially all of the assets owned by Liangcai Zhang in the Shouguang City Yangkou Township Area (the “Liangcai Zhang property” or “Factory No. 10”). The Liangcai Zhang property includes a 10-year land lease covering 1,700 acres of real property, with the related production facility, the wells, pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was approximately $9,998,730 in cash. The production line of Factory No. 10 was resumed in February 2012 after certain repair and adjustments.
Each of the bromine factories and Crude Salt Field acquisitions described above was not in operation when the Company acquired the asset. The owners of each of the bromine factories did not hold the proper license for the exploration and production of bromine, and production at each of the bromine factories acquired had been previously halted by the government. With respect to Factory No. 7, the assets had not been operational for twelve months; with respect to Factory No. 8, the assets had not been operational for thirteen months; and with respect to Factory No. 9 and Factory No. 10, the assets had not been operational for six months. The Crude Salt Field had not been in operation for six months. The Company recorded the above transactions as purchase of assets.
We also enhanced the new plant and machinery leased in the first quarter of 2011 by making capital improvement in reconstruction and renovation work at a cost of approximately $3,050,400, which was recorded as buildings and plant and machinery, for the operation of the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings located on the property.
In the second quarter of 2011, we carried out enhancement projects to its existing bromine extraction and crude salt production facilities. In particular, we incurred reconstruction and renovation works at a cost of approximately $12,379,153 for its crude salt fields in Factory No. 1, 5 to 9, and at a cost of approximately $20,087,600 for its extraction wells and transmission channels and ducts in Factory No. 1 to 9. The above enhancement projects have estimated useful lives of 5 to 8 years and are capitalized as buildings and plant and machinery.
Leased Facility
On November 5, 2010, SCHC entered into a Lease Contract (the “Lease Contract”) with State-Operated Shouguang Qingshuibo Farm (the “Lessor”). Pursuant to the Lease Contract, SCHC shall lease certain property with an area of 3,192 square meters and buildings adjacent to the Company’s Factory No. 1. There are currently non-operating bromine production facilities on the property which have not been in production for more than 12 months. The annual lease payment for the property is RMB5 million, approximately US$755,000, per year and shall be paid by SCHC no later than June 30th of each year. The term of the Lease Contract is for twenty years commencing from January 1, 2011 and the Lease Contract may be renewed by SCHC for an additional twenty-year period on the same terms. The Lessor has agreed to permit SCHC to reconstruct and renovate the existing bromine production facilities on the property.
Our Business Segments
Our business operations are conducted in three segments, bromine, crude salt, and chemical products. We manufacture and trade bromine and crude salt, and manufacture and sell chemical products used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals. We conduct all of our operations in China, in close proximity to China’s petrochemical and oil refinery manufacturing base and its rapidly growing market.
Bromine and Crude Salt
We manufacture and distribute bromine through our wholly-owned subsidiary, Shouguang City Haoyuan Chemical Company Limited, or SCHC. Bromine (Br2) is a halogen element and it is a red volatile liquid at standard room temperature which has reactivity between chlorine and iodine. Elemental bromine is used to manufacture a wide variety of bromine compounds used in industry and agriculture. Bromine is also used to form intermediates in organic synthesis, in which it is somewhat preferable over iodine due to its lower cost. Our bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines and disinfectants.
The extraction of bromine in the Shandong Province is limited by the Provincial Government to licensed operations. We hold one of such licenses. As part of our business strategy, it is our plan to continue acquiring smaller scaled and unlicensed producers and to use our bromine to expand our downstream chemical operations.
Location of Production Sites
Our production sites are located in the Shandong Province in northeastern China. The productive formation (otherwise referred to as the “working region”), extends from latitude N 36°56’ to N 37°20’ and from longitude E 118°38’ to E 119°14’, in the north region of Shouguang city, from the Xiaoqing River of Shouguang city to the west of the Dan River, bordering on Hanting District in the east, from the main channel of “Leading the Yellow River to Supply Qingdao City Project” in the south to the coastline in the north. The territory is classified as coastal alluvial - marine plain with an average height two to seven meters above the sea level. The terrain is relatively flat.
Geological background of this region
The Shandong Province working region is located to the east of Lubei Plain and on the south bank of Bohai Laizhou Bay. The geotectonic location bestrides on the North China Platte (I) and north three-level structure units, from west to east including individually the North China Depression, Luxi Plate, and Jiaobei Plate. Meanwhile, 4 V-level structure units including the Dongying Sag of Dongying Depression (IV) of North China Depression, the Buried Lifting Area of Guangrao, Niutou sag and Buried Lifting Area of Shuanghe and are all on two V-level structure units including Xiaying Buried Lifting Area of Weifang Depression (IV) of Luxi Plate and Chuangyi Sag, as well as on a V-level structure units of Jiaobei Buried Lifting Area of Jiaobei Plate.
Processing of Bromine
Natural brine is a complicated salt-water system, containing many ionic compositions in which different ions have close interdependent relationships and which can be reunited to be many dissolved soluble salts such as sodium chloride, potassium chloride, calcium sulfate, potassium sulfate and other similar soluble salts. The goal of natural brine processing is to separate and precipitate the soluble salts or ions away from the water. Due to the differences in the physical and chemical characteristics of brine samples, the processing methods are varied, and can result in inconsistency of processing and varied technical performance for the different useful components from the natural brine.
Bromine is the first component extracted during the processing of natural brine. In natural brine, the bromine exists in the form of bromine sodium and bromine magnesium and other soluble salts.
The bromine production process is as follows:
1.natural brine is pumped from underground through extraction wells by subaqueous pumps;
2.the natural brine then passes through transmission pipelines to storage reservoirs;
3.the natural brine is sent to the bromine refining plant where bromine is extracted from the natural brine. In neutral or acidic water, the bromine ion is easily oxidized by adding the oxidative of chlorine, which generates the single bromine away from the brine. Thereafter the extracted single bromine is blown out by forced air, then absorbed by sulfur dioxide or soda by adding acid, chlorine and sulfur. Extracted bromine is stored in containers of different sizes; and
4.the wastewater from this refining process is then transported by pipeline to brine pans.
Our production feeds include (i) natural brine; (ii) vitriol; (iii) chlorine; (iv) sulfur; and (v) coal.
Crude Salt
We also produce crude salt, which is produced from the evaporation of the wastewater after our bromine production process. Once the brine is returned to the surface and the bromine is removed, the remaining brine is pumped to on-site containing pools and then exposed to natural sunshine. This causes the water to evaporate from the brine, resulting in salt being left over afterwards. Crude salt is the principal material in alkali production as well as chlorine alkali production and is widely used in the chemical, food & beverage, and other industries.
Chemical Products
We produce chemical products through our wholly-owned subsidiary, Shouguang Yuxin Chemical Industry Company Limited, or SYCI. The products we produce and the markets in which they are sold include, among others:
Product name Application sector
Hydroxyl guar gum Oil Exploration & Production
Demulsified agent Oil Exploration & Production
Corrosion inhibitor for acidizing Oil Exploration & Production
Bactericide Oil Exploration / Agricultural
Chelant Paper Making
Iron ion stabilizer Oil Exploration & Production
Clay stabilizing agent Oil Exploration & Production
Flocculants agent Paper Making
Remaining agent Paper Making
Expanding agent with enhanced gentleness Paper Making
Bromopropane Oil Exploration / Agricultural
Environmental friendly additive products Oil Exploration & Production
Solid lubricant Oil Exploration & Production
Polyether lubricant Oil Exploration & Production
SYCI concentrates its efforts on the production and sale of chemical products that are used in oil and gas field explorations, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents, and inorganic chemicals. SYCI also engages in research and development of commonly used chemical products as well as medicine intermediates. Currently, SYCI's annual production of oil and gas field exploration products and related chemicals is over 26,000 tons, and its production of papermaking-related chemical products is over 5,000 tons. These products are mainly distributed to large domestic papermaking manufacturers and major oilfields such as Shengli Oilfield, Daqing Oilfield, Zhongyuan Oilfield, Huabei Oilfield, and Talimu Oilfields.
In June 2010, SYCI completed the construction of a new production line for wastewater treatment chemical additives, which is located in our Yuxin Chemical Plant, at a total cost of $8,838,000. The new production line started operation in April 2011 and was switched to the production of pharmaceutical and agricultural chemical intermediates at a cost of $153,426 as we experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives.
SYCI’s headquarters are located in Shouguang City at 2nd Living District, Qinghe Oil Factory, Shouguang City, Shandong Province, China. The company has been certified as ISO9001-2000 compliant and received the Quality Products and Services Guarantee Certificate from China Association for Quality. SYCI has been accredited by Shandong as a Provincial Credit Enterprises and is a Class One supplier for both China Petroleum & Chemical Corporation (“SINOPEC”) and Petro China Company Limited. SYCI has been engaged in product innovation and research and development projects with Shandong University, Shandong Institute of Light Industry, Southeast University and other higher education institutions. SYCI has hired three college professors and three professionals who hold PhD degrees to lead its Research and Development Department.
Segment disclosure
We have three reportable segments: bromine, crude salt and chemical products.
The amounts set forth below are based upon on an average RMB to USD exchange rates of $0.15482 and $0.14787 during fiscal year 2011 and 2010, respectively.
Sales and Marketing
We have in-house sales staff of 8 persons. Our customers send their orders to us, usually with cash paid in advance. Our in-house sales staff then attempts to satisfy these orders based on our actual production schedules and inventories on hand. Many of our customers have a long term relationship with us, and while we expect this to continue due to continuing high demand for mineral products, this relationship could not be guaranteed in the future.
Principal Customers
We sell a substantial portion of our products to a limited number of PRC customers. Our principal customers during 2011 were Shandong Morui Chemical Company Limited, Shouguang City Rongyuan Chemical Company Limited, Shandong Brother Technology Limited, Kuerle Xingdong Trading Limited, Shouguang Shen Runfa Ocean Chemical Company Limited, Shouguang Weidong Chemical Company Limited and Shandong Yijia Chemical Company Limited. We have ongoing policies in place to ensure that sales are made to these customers who are credit-worthy. We are not aware of any allowances for doubtful debts required for each of the years ended December 31, 2011 and 2010.
During each of the years ended December 31, 2011 and 2010, sales to our three largest bromine customers, based on net revenue from such customers, aggregated $36,117,419 and $33,187,054, respectively, or approximately 33.5% and 33.5% of total net revenue from sale of bromine; and sales to our largest customer represented approximately 12.9% and 13.2%, respectively, of total net revenue from the sale of bromine.
During each of the years ended December 31, 2011 and 2010, sales to our three largest crude salt customers, based on net revenue from such customers, aggregated $11,736,677 and $10,181,361, respectively, or approximately 73.7% and 67.7% of total net revenue from sale of crude salt; and sales to our largest customer represented approximately 31.1% and 25.1%, respectively, of total net revenue from the sale of crude salt.
During each of the years ended December 31, 2011 and 2010, sales to our three largest chemical products customers, based on net revenue from such customers, aggregated $17,612,488 and $23,194,994, respectively, or approximately 42.7% and 52.5% of total net revenue from sale of chemical products; and sales to our largest customer represented approximately 25.0% and 26.4%, respectively, of total net revenue from the sale of chemical products.
This concentration of customers for all three segments makes us vulnerable to an adverse near-term impact, should one or more of these relationships be terminated.
Principal Suppliers
Our principal external suppliers are Shandong Haihua Chlorine & Alkali Colophony Chemicals Company Limited, Shouguang Hongye Trading Company Limited, Shouguang City Rongguang Trading Company Limited and Zibo Linzi Xinlong Chemical Company Limited.
During each of the years ended December 31, 2011 and 2010, we purchased 59.2% and 84.5%, respectively, of raw materials for our bromine production from three suppliers.
During each of the years ended December 31, 2011 and 2010, we purchased 95.8% and 85.1%, respectively, of raw materials for our chemical products production from three suppliers. Internally, we a portion of the bromine produced, at costs totaling $2,979,826 and $3,973,624, for the years ended December 31, 2011 and 2010, for the production of chemical products.
This supplier concentration makes us vulnerable to a near-term adverse impact, should the relationships be terminated.
Business Strategy
Expansion of Production Capacity to Meet Demand
▼ Bromine and Crude Salt
In view of the keen competition and the trend of a decrease in bromine contraction of brine water being extracted in Shouguang City, Shandong Province, in recent years, the Company has announced its intent to access more bromine and crude salt resources by finding new underground brine water resources in Sichuan Province. In 2011, the Company incurred exploration costs in the amount of $7,034,153, in Daying County, Sichuan Province, for the drilling of exploratory wells and their associated facilities in order confirm and measure the natural brine resources. The Company completed the drilling of the first exploratory well in December 2011 and announced in mid-January 2012 that the Company discovered underground brine water resources in Daying County, and it has provided preliminary concentration results after the testing by a third-party independent testing expert. According to the third-party independent testing report, the bromine concentration in the underground brine water resources is 1.53 grams per liter, which is approximately six to seven times higher than the average bromine concentration from its brine water resources at our bromine factories in Shouguang City. The Company expects to continue to cooperate with Daying County in 2012 continue and drilling in order to further determine the total brine water resources reserve and exploitable amount in the area. The Company expects that the capital expenditure required in 2012 to be in a range of $30 million to $40 million and will be funded by a combination of cash on hand, and the issuance of debt or equity securities, including securities issued to the developers.
In view of the trend of a decrease in the bromine concentration of the brine water being extracted at the Company’s production facilities, the Company engaged a professional appraisal firm in late October 2011 to reassess the optimal annual production capacity of all of our factory facilities. Based on the appraisal report, the Company’s optimal annual production capacity of bromine and crude salt is 41,547 tons and 861,143 tons, respectively. In order to improve the bromine and crude salt production capacity, the Company will continue to enhance its existing bromine and crude salt production facilities. From March through mid-June 2011, the Company carried out such enhancement projects at a cost of approximately $15.5 million for its crude salt fields in Factories No. 1 (including Branch 1 of Factory No. 1), No. 5 to No. 9 and at a cost of approximately $20.1 million for its extraction wells and transmission channels and ducts in Factories No. 1 to No. 9. Enhancements of protective shells to the crude salt fields, extraction wells and transmission channels and ducts are carried out every 5 to 8 years, depending on the need to do so, that is, when regular repair and maintenance work identifies the replacement needs. The erosion rate of protection shells is affected by different weather conditions and the change in acid components of brine water over time. The Company expects the future enhancement expenditures will be funded by the Company’s cash on hand.
In addition, the Company plans to continue to acquire crude salt fields and bromine properties to increase its production capacity. Prior to 2011, the Company acquired eight such crude salt field and bromine properties at purchase prices totaling $87.4 million in form a combination of cash and shares of our common stock, expanded our overall annual production capacity to 41,547 metric tons of bromine and 861,143 metric tons of crude salt. In late December 2011, the Company acquired another bromine property for $10 million in cash. This property further expanded our annual production capacity by 3,000 metric tons of bromine. The Company expects that it will continue its acquisition program in 2012 and that these acquisitions will be funded by a combination of cash on hand, and the issuance of debt or equity securities, including securities issued to the sellers.
▼ Chemical Products
In April 2011, SYCI switched the production line for wastewater treatment chemical additives, with carrying value of $8.3 million, to the production of pharmaceutical and agricultural chemical intermediates at a cost of $0.15 million as the Company experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. To expand its chemical production capacity, the Company intends to acquire chemical product producers. These acquisitions will be funded by a combination of cash on hand, and the issuance of debt or equity securities.
Competition
The markets for our products have been experiencing increased levels of demand as China continues its recent pace of accelerated growth. Nevertheless, the markets for our products are highly competitive. To date, our sales have been limited to customers within the PRC and we expect that our sales will remain primarily in domestic for the immediate future. Our marketing strategy involves developing long term ongoing working relationships with customers based on large multi-year agreements which foster mutually advantageous relationships.
We compete with PRC domestic private companies and state-owned companies. Certain state-owned and state backed competitors are more established and have more control of certain resources in terms of pricing than we do. We compete in our business based on price, our reputation for quality and on-time delivery, our relationship with suppliers and our geographical proximity to natural brine deposits in the PRC for bromine, crude salt and chemical productions. Management believes that our stable quality, manufacturing processes and plant capacity for the production of bromine, crude salt and chemical products are key considerations in the awarding of contracts in the PRC.
Our principal competitors in the bromine business are Shandong Yuyuan Group Company Limited, Shandong Haihua Group Company Limited, Shandong Dadi Salt Chemical Group Company Limited and Shandong Haiwang Chemical Company Limited, all of which produce bromine principally for use in their chemicals businesses and sell part of the bromine produced to customers. These companies may switch to selling bromine to the market if they no longer use bromine in their chemical business.
Our principal competitors in the crude salt business are Shandong Haiwang Chemical Company Limited, Shandong Haihua Group Company Limited, Shandong Weifang Longwei Industrial Company Limited, Shandong Yuyuan Group Company Limited and Shandong Caiyangzi Saltworks.
Our principal competitors in the chemical business are Beijing Tianqing Chemical Company Limited, Shandong Weifang Shuangxing Pesticides Company Limited, Zibo Dacheng Pesticides Company Limited, Befar Group Company Limited, China Eastar (Group) Chemical Industry Company Limited and Pecome Technologies Limited.
Government Regulation
The following is a summary of the principal governmental laws and regulations that are or may be applicable to our operations in the PRC. The scope and enforcement of many of the laws and regulations described below are uncertain. We cannot predict the effect of further developments in the Chinese legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement of laws.
In the natural resources sector, the PRC and the various provinces have enacted a series of laws and regulations over the past 20 years, including laws and regulations designed to improve safety and decrease environmental degradation. The "China Mineral Resources Law" declares state ownership of all mineral resources in the PRC. However, mineral exploration rights can be purchased, sold and transferred to foreign owned companies. Mineral resource rights are granted by the Central Government permitting recipients to conduct mineral resource activities in a specific area during the license period. These rights entitle the licensee to undertake mineral resource activities and infrastructure and ancillary work, in compliance with applicable laws and regulations, within the specific area covered by the license during the license period. The licensee is required to submit a proposal and feasibility studies to the relevant authority and to pay the Central Government a natural resources fee in an amount equal to a percent of annual sales. Shandong Province has determined that bromine is to be extracted only by licensed entities and we hold one of such licenses. Despite the province desire to limit extraction to licensed entities hundreds of smaller operations continue to extract bromine without licenses.
The Ministry of Land and Resources (“MLR”) is the principal regulator of mineral rights in China. The Ministry has authority to grant licenses for land-use and exploration rights, issue permits for mineral rights and leases, oversee the fees charged for them and their transfer, and review reserve evaluations.
All of our operating activities in China have been authorized by or obtained written consent from land and resources departments of local governments. In addition, all of our operations are subject to and have passed government safety inspections. We also have been granted environmental certification from the PRC Bureau of Environmental Protection.
Employees
As of December 31, 2011, we employed approximately 519 full-time employees, of whom about 77% are with SCHC and 21% are with SYCI. Approximately 6% of our employees are management personnel, 3% are sales and procurement staff. 11% of our employees have a college degree or higher. None of our employees is represented by a union.
Our employees in China participate in a state pension arrangement organized by Chinese municipal and provincial governments. We are required to contribute to the arrangement at the rate of 17% of the average monthly salary. In addition, we are required by Chinese law to cover employees in China with other types of social insurance. Our total contribution may amount to 26% of the average monthly salary. We have purchased social insurance for almost all of our employees. Expense related to social insurance was approximately $431,428 for fiscal year 2011.
Research and Development
On September 6, 2007, SYCI and East China University of Science and Technology formally opened a Co-Op Research and Development Center. The research center is equipped with state of the art chemical engineering instruments for the purpose of pursuing targeted research and development of new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry. Professor Ji of East China University is the Center’s manager. He will provide his expertise in chemical applications and medicine engineering. All research findings and patents developed by this Center will belong to Gulf Resources. At the outset, SYCI agreed to make an annual payment of $500,000 to the center through the original expiration date of June 14, 2012. On June 7, 2011, the Company and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for the Company.
The Company completed the research, the testing of manufacturing routine and samples, and started normal production for the new production line of wastewater treatment additives in April 2011. However, the Company switched the aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as the Company experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. The research and development expense incurred for the new production line of wastewater treatment additives from outside parties and the consumption of bromine produced by the Company during the year ended December 31, 2011 were $56,286 and $105,739, respectively.
Available Information
We make available free of charge on or through our internet website, www.gulfresourcesinc.com, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, if any, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. The information contained on our website is not intended to be incorporated into this Annual Report on Form 10-K.
Item 1A.
Item 1A. Risk Factors.
You should consider carefully each of the following business and investment risk factors and all of the other information in this report. If any of the following risks and uncertainties develops into actual events, the business, financial condition or results of our operations could be materially adversely affected. If that happens, the trading price of our shares of common stock could decline significantly. The risk factors below contain forward-looking statements regarding our business. Actual results could differ materially from those set forth in the forward-looking statements. See "Special Note Regarding Forward-Looking Information".
Risks Relating to Our Business
The unsuccessful integration of a business or business segment we acquire could have a material adverse effect on our results.
As part of our business strategy, we expect to acquire assets and businesses relating to or complementary to our operations. These acquisitions will involve risks commonly encountered in acquisitions. These risks include exposure to unknown liabilities of the acquired assets, right, additional acquisition costs and unanticipated expenses. Our quarterly and annual operating results could fluctuate due to the costs and expenses of acquiring and integrating new assets and businesses. We may also experience difficulties in assimilating the operations of acquired businesses. Our ongoing business may be disrupted and our management's time and attention diverted from existing operations. Our acquisition strategy will likely require additional equity or debt financing, resulting in additional leverage or dilution of ownership. We cannot assure you that any future acquisition will be consummated, or that if consummated, that we will be able to integrate such acquisition successfully.
We depend on revenues from a few significant relationships, and any loss, cancellation, reduction, or interruption in these relationships could harm our business.
In general, we have derived a material portion of our revenue from a limited number of customers. If sales to such customers were terminated or significantly reduced, our revenues and net income could significantly decline. Our success will depend on our continued ability to develop and manage relationships with significant customers and suppliers. Any adverse change in our relationship with our customers and suppliers may have a material adverse effect on our business. Although we are attempting to expand our customer base, we expect that our customer concentration will not change significantly in the near future. We cannot be sure that we will be able to retain our largest customers and suppliers or that we will be able to attract additional customers and suppliers, or that our customers and suppliers will continue to buy our products in the same amounts as in prior years. The loss of one or more of our largest customers or suppliers, any reduction or interruption in sales to these customers or suppliers, our inability to successfully develop relationships with additional customers or suppliers or future price concessions that we may have to make could significantly harm our business.
Attracting and retaining key personnel is an essential element of our future success.
Our future success depends to a significant extent upon the continued service of our executive officers and other key management and technical personnel and on our ability to continue to attract, retain and motivate executive and other key employees, including those in managerial, technical, marketing and information technology support positions. Experienced management and technical, marketing and support personnel are in demand and competition for their talents is intense. The loss of the services of one or more of our key employees or our failure to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition and results of operations.
If we lose the services of our chairman and chief executive officer, our business may suffer.
We are dependent on Mr. Ming Yang, our chairman and Mr. Liu Xiaobin, our chief executive officer. The loss of their services could materially harm our business because of the cost and time necessary to retain and train a replacement. Such a loss would also divert management attention away from operational issues.
If we do not pass the review and approval for renewing our bromine and salt production license, our bromine business may suffer.
We are required to hold a bromine and salt production license in order to operate our bromine and salt production business in the PRC. Our bromine and salt production license is subject to a yearly audit. If we do not successfully pass the yearly approval by relevant government authorities, our bromine and salt production operations may be suspended until we are able to comply with the license requirements which could have a material adverse effect on our business, financial condition and results of operations.
Because we do not have any proven or probable reserves of brine water, we may not be able to continue to produce bromine and crude salt at existing levels in the future which could harm our business, results or operations and financial condition
The SEC’s Industry Guide 7, which relates to businesses with mining operations such as ours defines “reserves” as: “that part of a mineral deposit which could be economically and legally extracted or produced at the time of the reserve determination.” In addition, Industry Guide 7 provides the following definitions with respect to the classification of reserves for mining companies:
l“Proven (Measured) Reserves” - Reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and/or quality are computed from the results of detailed sampling and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth and mineral content of reserves are well-established.
l“Probable (Indicated) Reserves” - Reserves for which quantity and grade and/or quality are computed form information similar to that used for proven (measure) reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven (measured) reserves, is high enough to assume continuity between points of observation.
We do not have any proven or probable reserves of brine water on our mining properties. Therefore, we cannot provide investors with any assurance that there will be adequate volume or concentration of brine water on our mining properties to continue our bromine and crude salt operations at existing levels or to expand our production capacity of bromine and crude salt. If we experience decreases in the volume and/or concentration of brine water we are able to extract from our mining properties, our business, results of operations and financial condition may be adversely affected.
We do not have mining permits for some of our bromine factories which we have acquired. Our operations depend on our existing permits and approvals already obtained from government authorities.
We hold government permits or operations permits and for each of our bromine factories. However, we do not currently hold valid mining permits issued by the State Land and Resources Bureau for our Factories No. 5, 6, 7, 8 and 9. We have already filed applications for these mining permits, however we are not able to confirm when such mining permits will be issued, if at all.
We have received a letter from the Shouguang Municipal State Land and Resources Bureau on March 10, 2011, stating that these five bromine factories “are permitted to continue with the mining and can operate in a standard manner and carry out mining activities in a reasonable way pursuant to the requirements of the relevant mineral resources authorities, and are free of any illegal acts of exceeding layer or boundary limits and any violations of relevant laws and regulations of the State.”
A decision made by relevant government agency(ies) to reject or delay the issuance of a new permit or to repeal or modify an existing permits or approval could prevent or limit our ability to continue operations at the affected facilities and harm our business, financial condition and operating results. Expansion of our existing operations would also require securing the necessary permits and approvals which we may not be able to obtain in a timely manner, if at all.
We do not have a certificate of land use rights for the land relating to certain bromine assets and crude salt production. We will not be able to obtain the property certificates for the relevant buildings attached to the land.
We do not have certificates of land use rights for land leased by SCHC. As a result, we have not been able to obtain the relevant property certificates for buildings on such leased land which are normally required as security in obtaining financing from financial institutions. Although we believe that this is a common occurrence with respect to property leases in the PRC, the property certificates confirm legal ownership of the buildings. Because we do not have certificate of land use rights for the leased land, we might be required by the government to demolish our buildings and/or restore the land back to its original state. If such event occurs, it will have major impact on our operations, financial status and performance results.
Because we have not been able to obtain property certificates to certain of our properties we may not be able to borrow money from banks in the PRC and as a result, could face liquidity problems.
As discussed above, we have not been able to obtain property certificates for certain of our properties. In the PRC banks normally require a company’s property certificates to be pledged as security before they will provide a loan to a company. In the past several years we have financed our operations with loans from third-party companies, cash from operations and equity financing. However, if these sources of funds are not available in the future and we need to find an alternate source of financing to maintain our operations, we may not be able to borrow money from a bank to meet our cash needs. This could materially harm our business and have a major impact on our operations, financial status and performance results.
Our inability to successfully manage the growth of our business may have a material adverse effect on our business, results or operations and financial condition.
We expect to experience growth in the number of employees and the scope of our operations as a result of internal growth and acquisitions. Such activities could result in increased responsibilities for management. Our future success will be highly dependent upon our ability to manage successfully the expansion of operations. Our ability to manage and support our growth effectively will be substantially dependent on our ability to implement adequate improvements to financial, inventory, management controls, reporting, order entry systems and other procedures, and hire sufficient numbers of financial, accounting, administrative, and management personnel.
Our future success depends on our ability to address potential market opportunities and to manage expenses to match our ability to finance operations. The need to control our expenses will place a significant strain on our management and operational resources. If we are unable to control our expenses effectively, our business, results of operations and financial condition may be adversely affected.
Our management is comprised almost entirely of individuals residing in the PRC with very limited English skills.
Our management is comprised almost entirely of individuals born and raised in the PRC. As a result of differences in culture, educational background and business experiences, our management may analyze, evaluate and present business opportunities and results of operations differently from the way they are analyzed, evaluated and presented by management teams of public companies in Europe and the United States. In addition, our management has very limited skills in English. Consequently, it is possible that our management team will emphasize or fail to emphasize aspects of our business that might customarily be emphasized in a different manner by comparable public companies from different geographical and political areas.
We will face many of the difficulties that companies in the early stage may face.
We have a limited operating history as a bromine produce and chemical processing company, which may make it difficult for you to assess our ability to identify merger or acquisition candidates and our growth and earnings potential. Therefore, we may face many of the difficulties that companies in the early stages of their development in new and evolving markets often face. We may continue to face these difficulties in the future, some of which may be beyond our control. If we are unable to successfully address these problems, our future growth and earnings will be negatively affected.
We cannot accurately forecast our future revenues and operating results, which may fluctuate.
Our short operating history and the rapidly changing nature of the markets in which we compete make it difficult to accurately forecast our revenues and operating results. Furthermore, our revenues and operating results may fluctuate in the future due to a number of factors, including the following:
lthe success of identifying and completing mergers and acquisitions;
lthe introduction of competitive products by different or new competitors;
lreduced demand for any given product;
ldifficulty in keeping current with changing technologies;
lincreased or uneven expenses, whether related to sales and marketing, product development or administration;
ldeferral of recognition of our revenue in accordance with applicable accounting principles due to the time required to complete projects; and
lcosts related to possible acquisitions of technology or businesses.
Due to these factors, forecasts may not be achieved, either because expected revenues do not occur or because they occur at lower prices or on terms that are less favorable to us. In addition, these factors increase the chances that our results could be lower than the expectations of investors and analysts. If so, the market price of our stock would likely decline.
Mr. Ming Yang, our Chairman and a substantial shareholder, has potential conflicts of interest with us, which may adversely affect our business.
Mr. Ming Yang, our chairman, was a substantial owner of SCHC and SCYI before their acquisition by us, and remains, with the shares held by him, both individually and through Shandong Haoyuan Industry Group Ltd., and by his wife and son, Wenxiang Yu and Zhi Yang, a substantial owner of our securities. There may have been conflicts of interest between Mr. Yang and our Company as a result of such ownership interests. The terms on which we acquired SCHC and SCYI may have been different from those that would have been obtained if SCHC and SCYI were owned by unrelated parties. In addition, conflicts of interest between Mr. Yang’s dual roles as our shareholder and our director may arise. We cannot assure you that, when conflicts of interest arise, Mr. Yang will act in the best interests of the Company or that conflicts of interest will be resolved in our favor.
Currently, we do not have existing arrangements to address potential conflicts of interest between Mr. Yang and us. We rely on these Mr. Yang to abide by the laws of the State of Delaware, which provide that directors owe a fiduciary duty to the Company, and which require them to act in good faith and in the best interests of the Company, and not use their positions for personal gain. If we cannot resolve any conflicts of interest or disputes between us and Mr. Yang, we would have to rely on legal proceedings, which could result in disruption of our business and substantial uncertainty as to the outcome of any such legal proceedings.
Because of the uncertainties regarding the feasibility of producing bromine from brine water resources in Sichuan province, there may not be a return on our investment in certain related exploration costs.
For the year ended December 31, 2011, we incurred exploration costs in the amounts of $7,034,153 in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. Although we announced that we have discovered underground brine water resources in Daying County with high concentration, to date there has be no bromine produced from the brine water resources in Sichuan province. We cannot be certain that that there will be sufficient brine water resources reserve and exploitable amount in the brine water in the area where we are drilling in Sichuan province to make the production of bromine there feasible. In addition, we cannot be certain that the local authorities in Sichuan province will issue a mining permit to us. As a result of these uncertainties, we cannot assure you that there will be a return on our investment in such exploration costs.
Risks Related to Doing Business in the People's Republic of China.
Our business operations take place primarily in the People's Republic of China. Because Chinese laws, regulations and policies are changing, our Chinese operations will face several risks summarized below.
-Limitations on Chinese economic market reforms may discourage foreign investment in Chinese businesses.
The value of investments in Chinese businesses could be adversely affected by political, economic and social uncertainties in China. The economic reforms in China in recent years are regarded by China’s central government as a way to introduce economic market forces into China. Given the overriding desire of the central government leadership to maintain stability in China amid rapid social and economic changes in the country, the economic market reforms of recent years could be slowed, or even reversed.
Any change in policy by the Chinese government could adversely affect investments in Chinese businesses.
Changes in policy could result in imposition of restrictions on currency conversion, imports or the source of supplies, as well as new laws affecting joint ventures and foreign-owned enterprises doing business in China. Although China has been pursuing economic reforms, events such as a change in leadership or social disruptions that may occur upon the proposed privatization of certain state-owned industries, could significantly affect the government's ability to continue with its reform.
-We face economic risks in doing business in China.
As a developing nation, China’s economy is more volatile than that of developed Western industrial economies. It differs significantly from that of the U.S. or a Western European country in such respects as structure, level of development, capital reinvestment, legal recourse, resource allocation and self-sufficiency. Only in recent years has the Chinese economy moved from what had been a command economy through the 1970s to one that during the 1990s encouraged substantial private economic activity. In 1993, the Constitution of China was amended to reinforce such economic reforms. The trends of the 1990s indicate that future policies of the Chinese government will emphasize greater utilization of market forces. For example, in 1999 the Government announced plans to amend the Chinese Constitution to recognize private property, although private business will officially remain subordinate to state-owned companies, which are the mainstay of the Chinese economy. However, we cannot assure you that, under some circumstances, the government's pursuit of economic reforms will not be restrained or curtailed. Actions by the central government of China could have a significant adverse effect on economic conditions in the country as a whole and on the economic prospects for our Chinese operations.
-We are subject to comprehensive regulation by the PRC legal system, which is uncertain. As a result, it may limit the legal protections available to you and us and we may not now be, or remain in the future, in compliance with PRC laws and regulations.
SCHC and SYCI, our PRC operating companies, are incorporated under and are governed by the laws of the PRC; all of our operations are conducted in the PRC; and our suppliers and customers are all located in the PRC. The PRC government exercises substantial control over virtually every sector of the PRC economy, including the production, distribution and sale of bromine, brominated chemical products and crude salt. In particular, we are subject to regulation by local and national branches of the Ministry of Land and Resources, as well as the State Administration of Foreign Exchange, and other regulatory bodies. In order to operate under PRC law, we require valid licenses, certificates and permits, which must be renewed from time to time. If we were to fail to obtain the necessary renewals for any reason, including sudden or unexplained changes in local regulatory practice, we could be required to shut down all or part of our operations temporarily or permanently.
SCHC and SYCI are subject to PRC accounting laws, which require that an annual audit be performed in accordance with PRC accounting standards. The PRC foreign-invested enterprise laws require that our subsidiary, SCHC, submit periodic fiscal reports and statements to financial and tax authorities and maintain its books of account in accordance with Chinese accounting laws. If PRC authorities were to determine that we were in violation of these requirements, we could lose our business license and be unable to continue operations temporarily or permanently.
The legal and judicial systems in the PRC are still rudimentary. The laws governing our business operations are sometimes vague and uncertain and enforcement of existing laws is inconsistent. Thus, we can offer no assurance that we are, or will remain, in compliance with PRC laws and regulations.
-The Chinese legal and judicial system may negatively impact foreign investors.
In 1982, the National People’s Congress amended the Constitution of China to authorize foreign investment and guarantee the "lawful rights and interests" of foreign investors in China. However, China's system of laws is not yet comprehensive. The legal and judicial systems in China are still under development, and enforcement of existing laws is inconsistent. Many judges in China lack the depth of legal training and experience that would be expected of a judge in a more developed country. Because the Chinese judiciary is relatively inexperienced in enforcing the laws that exist, anticipation of judicial decision-making is more uncertain than would be expected in a more developed country. It may be impossible to obtain swift and equitable enforcement of laws that do exist, or to obtain enforcement of the judgment of one court by a court of another jurisdiction. China's legal system is based on written statutes; a decision by one judge does not set a legal precedent that is required to be followed by judges in other cases. In addition, the interpretation of Chinese laws may shift to reflect domestic political changes.
The promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors. However, the trend of legislation over the last 20 years has significantly enhanced the protection of foreign investment and allowed for more control by foreign parties of their investments in Chinese enterprises. We cannot assure you that a change in leadership, social or political disruption, or unforeseen circumstances affecting China's political, economic or social life, will not affect the Chinese government's ability to continue to support and pursue these reforms. Such a shift could have a material adverse effect on our business and prospects.
The practical effect of the People’s Republic of China’s legal system on our business operations in China can be viewed from two separate but intertwined considerations. First, as a matter of substantive law, the Foreign Invested Enterprise laws provide significant protection from government interference. In addition, these laws guarantee the full enjoyment of the benefits of corporate articles and contracts to Foreign Invested Enterprise participants. These laws, however, do impose standards concerning corporate formation and governance, which are not qualitatively different from the general corporation laws of the several states. Similarly, the accounting laws and regulations of the People’s Republic of China mandate accounting practices which are not consistent with U.S. Generally Accepted Accounting Principles. China's accounting laws require that an annual "statutory audit" be performed in accordance with People’s Republic of China’s accounting standards and that the books of account of Foreign Invested Enterprises are maintained in accordance with Chinese accounting laws. Article 14 of the People’s Republic of China Wholly Foreign-Owned Enterprise Law requires a Wholly Foreign-Owned Enterprise to submit certain periodic fiscal reports and statements to designated financial and tax authorities, at the risk of business license revocation. Second, while the enforcement of substantive rights may appear less clear than United States procedures, Foreign Invested Enterprises and Wholly Foreign-Owned Enterprises are Chinese registered companies, which enjoy the same status as other Chinese registered companies in business-to-business dispute resolution. Generally, the Articles of Association provide that all business disputes pertaining to Foreign Invested Enterprises are to be resolved by the Arbitration Institute of the Stockholm Chamber of Commerce in Stockholm, Sweden, applying Chinese substantive law. Any award rendered by this arbitration tribunal is, by the express terms of the respective Articles of Association, enforceable in accordance with the "United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958)". Therefore, as a practical matter, although no assurances can be given, the Chinese legal infrastructure, while different in operation from its United States counterpart, should not present any significant impediment to the operation of Foreign Invested Enterprises.
Because our principal assets are located outside of the United States and some of our directors and all of our executive officers reside outside of the United States, it may be difficult for you to enforce your rights based on the United States Federal securities laws against us and our officers and directors in the United States or to enforce judgments of United States courts against us or them in the People's Republic of China.
In addition, our operating subsidiaries and substantially all of our assets are located outside of the United States. You will find it difficult to enforce your legal rights based on the civil liability provisions of the United States Federal securities laws against us in the courts of either the United States or the People's Republic of China and, even if civil judgments are obtained in courts of the United States, to enforce such judgments in the courts of the People's Republic of China. In addition, it is unclear if extradition treaties in effect between the United States and the People's Republic of China would permit effective enforcement against us or our officers and directors of criminal penalties, under the United States Federal securities laws or otherwise.
-Issues associated with increased rate of inflation as a result of economic reform
Although the Chinese government owns the majority of productive assets in China, during the past several years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent or ineffectual, we are unable to assure you that:
lWe will be able to capitalize on economic reforms;
lThe Chinese government will continue its pursuit of economic reform policies;
lThe economic policies, even if pursued, will be successful;
lEconomic policies will not be significantly altered from time to time; and
lBusiness operations in China will not become subject to the risk of nationalization.
Since 1979, the Chinese government has reformed its economic systems. Because many reforms are unprecedented or experimental, they are expected to be refined and improved. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or in the disparities in per capita wealth between regions within China, could lead to further readjustment of the reform measures. This refining and readjustment process may negatively affect our operations.
Over the last few years, China's economy has registered a high growth rate. Recently, there have been indications that rates of inflation have increased. In response, the Chinese government recently has taken measures to curb this excessively expansive economy. These measures have included revaluations of the Chinese currency, the RMB, restrictions on the availability of domestic credit, and limited re-centralization of the approval process for purchases of some foreign products. These austerity measures alone may not succeed in slowing down the economy's excessive expansion or control inflation, and may result in severe dislocations in the Chinese economy. The Chinese government may adopt additional measures to further combat inflation, including the establishment of freezes or restraints on certain projects or markets.
To date, reforms to China's economic system have not adversely impacted our operations and are not expected to adversely impact operations in the foreseeable future; however, there can be no assurance that the reforms to China's economic system will continue or that we will not be adversely affected by changes in China's political, economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations, measures which may be introduced to control inflation, changes in the rate or method of taxation, imposition of additional restrictions on currency conversion and remittance abroad, and reduction in tariff protection and other import restrictions.
-Fluctuations in the value of the RMB may reduce the value of your investment
The value of the RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China's political and economic conditions and China's foreign exchange policies. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on exchange rates set by the People's Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB solely to the U.S. dollar. Under this revised policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. Following the removal of the U.S. dollar peg, the RMB appreciated more than 20% against the U.S. dollar over the following three years. However, the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate and achieve policy goals. For almost two years after July 2008, the RMB traded within a narrow range against the U.S. dollar. As a consequence, the RMB fluctuated significantly during that period against other freely traded currencies, in tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase RMB exchange rate flexibility. However, it remains unclear how this flexibility might be implemented. There remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar.
Because substantially all of our revenues and expenditures are denominated in RMB and our cash is denominated in U.S. dollars, fluctuations in the exchange rate between the U.S. dollar and RMB will affect the relative purchasing power of such amounts and our balance sheet and earnings per share in U.S. dollars. In addition, we report financial results in U.S. dollars, and appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollars terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of earnings from and the value of any U.S. dollar-denominated investments we make in the future.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedging transactions may be limited and we may not be able to successfully hedge our exposure at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currency.
-Failure of our PRC resident shareholders to comply with regulations on foreign exchange registration of overseas investment by PRC residents could cause us to lose our ability to contribute capital to SCHC and remit profits out of the PRC as dividends
The Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents to Engage in Overseas Financing and Round Trip Investment via Overseas Special Purpose Vehicles (“Circular 75”), issued by the SAFE and effective on November 1, 2005, regulates the foreign exchange matters in relation to the use of a “special purpose vehicle” by PRC residents to seek offshore equity financing and conduct a ‘‘round trip investment’’ in China. Under Circular 75, a “special purpose vehicle” refers to an offshore entity directly established or indirectly controlled by PRC resident natural or legal persons (“PRC residents”) for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents in onshore companies, while “round trip investment” refers to the direct investment in China by such PRC residents through the “special purpose vehicles,” including, without limitation, establishing foreign-invested enterprises and using such foreign-invested enterprises to purchase or control onshore assets through contractual arrangements. Circular 75 requires that, before establishing or controlling a “special purpose vehicle”, PRC residents and PRC entities are required to complete a foreign exchange registration with the competent local branches of the SAFE for their overseas investments. After the completion of a round-trip investment or the overseas equity financing, the PRC residents are required to go through foreign exchange registration alteration formalities of overseas investment in respect of net assets of special purpose vehicles that such PRC residents hold and the variation thereof.
In addition, an amendment to the registration is required if there is a material change in the “special purpose vehicle,” such as increase or reduction of share capital and transfer of shares. Failure to comply with the registration procedures set forth in Circular 75 may result in restrictions on the foreign exchange activities of the relevant foreign-invested enterprises, including the payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate and the capital inflow from the offshore parent, and may also subject the relevant PRC residents to penalties under PRC foreign exchange administration regulations.
We have requested our current PRC resident shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the scope of the Circular 75 and urges PRC residents to register with the local SAFE branch as required under the Circular 75. Our affiliates subject to the SAFE registration requirements, including Mr. Ming Yang, our Chairman, Ms. Wenxiang Yu, the wife of Mr. Yang, and Mr. Zhi Yang, Mr. Yang’s son, have informed us that they have not made their initial registrations with SAFE. The failure of our PRC resident shareholders and/or beneficial owners to timely furnish or amend their SAFE registrations pursuant to the Circular 75 or the failure of our future shareholders and/or beneficial owners who are PRC residents to comply with the registration requirement set forth in the Circular 75 may subject such shareholders, beneficial owners and/or SCHC to fines and legal sanctions. Any such failure may also limit our ability to contribute additional capital into SCHC, limit SCHC’s ability to distribute dividends to us or otherwise adversely affect our business.
The PRC government could restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain expenses as they come due or may restrict which limit the payment of dividends from the Company.
-We may be treated as a resident enterprise for PRC tax purposes under the currently effective EIT Law, which may subject us to PRC income tax on our taxable global income
On March 16, 2007, the National People’s Congress approved and promulgated a new tax law, the PRC Enterprise Income Tax Law (“EIT Law”). On November 28, 2007, the PRC State Council passed the implementing rules of the EIT Law. Both the EIT Law and the implementing rules of the EIT Law took effect on January 1, 2008. Under the EIT Law, enterprises are classified as “resident enterprises” and “non-resident enterprises.” An enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define “de facto management bodies” as a managing body that in practice exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise; however, it remains unclear whether the PRC tax authorities would deem our managing body as being located within China. Due to the short history of the EIT Law and lack of applicable legal precedents, the PRC tax authorities determine the PRC tax resident treatment of a foreign (non-PRC) company on a case-by-case basis.
If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our global taxable income, as well as PRC enterprise income tax reporting obligations. Second, under the EIT Law and its implementing rules, dividends paid between “qualified resident enterprises” are exempt from enterprise income tax. It is unclear whether the dividends we receive will constitute dividends between “qualified resident enterprises” and would therefore qualify for tax exemption, because the definition of qualified resident enterprises is unclear and the relevant PRC governmental authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes.
In addition to the uncertainty as to the application of the “resident enterprise” classification, there can be no assurance that the PRC governmental authorities will not amend or revise the taxation laws, rules and regulations to impose stricter tax requirements, higher tax rates or retroactively apply the EIT Law, or any subsequent changes in PRC tax laws, rules or regulations. If such changes occur and/or if such changes are applied retroactively, such changes could materially and adversely affect our results of operations and financial condition.
-Restricted power supply could disrupt our production and have an adverse effect on our business, financial position and results of operations
All of our products are produced at our manufacturing facilities in Shouguang, Shandong province, China. A significant disruption at those facilities, such as electricity power control, even on a short-term basis, could impair our ability to timely produce and deliver products, which could have an adverse effect on our business, financial position and results of operations. We have encountered power shortages historically due to restrictions on the power supply provided to industrial users when the usage of electricity is high and the supply is limited or as a result of damage to the electricity supply network. Interruptions of electricity supply could result in lengthy production shutdowns, increased costs associated with restarting production and the loss of production in progress. Any major suspension or termination of electricity or other unexpected business interruptions could have an adverse impact on our business, financial condition and results of operations.
Risks Associated with Bromine Extraction
We are subject to risks associated with our operations which may affect our results.
The resource industry in the PRC has drawbacks that the resource industry does not have within the United States. For instance:
lIn China, insurance coverage is a relatively new concept compared to that of the United States and for certain aspects of a business operation, insurance coverage is restricted or expensive. Workers compensation for employees in the PRC may be unavailable or, if available, insufficient to adequately cover such employees.
lThe environmental laws and regulations in the PRC set various standards regulating certain aspects of health and environmental quality, including, in some cases, the obligation to rehabilitate current and former facilities and locations where operations are or were conducted. Violation of those standards could result in a temporary or permanent restriction by the PRC of our bromine operations.
We cannot assure you that we will be able to adequately address any of these or other limitations.
Our earnings and, therefore our profitability, may be affected by price volatility.
We anticipate that the majority of our future revenues will be derived from the sale of bromine and products derived from bromine and, as a result, our earnings are directly related to the prices of these products. There are many factors influencing the price of these products including expectations for inflation; global and regional demand and production; political and economic conditions; and production costs. These factors are beyond our control and are impossible for us to predict. As a result, price changes may adversely affect our operating results.
We may become subject to numerous risks and hazards associated with our chemical processing business.
Bromine is highly corrosive and must be handled carefully in order to avoid leakage and damage to containers, transportation equipment and other facilities. The risks associated with bromine include:
lenvironmental hazards; and
lindustrial accidents, including personal injury.
Such risks could result in:
ldamage to or destruction of properties or production facilities;
lpersonal injury or death;
lenvironmental damage;
lmonetary losses; and
llegal liability.
Our business operations and related activities may be subject to PRC government regulations concerning environmental protection.
We may have to make a significant financial commitment for the construction of environmental protection facilities and the establishment of a sound environmental protection management and monitoring system. Compliance with existing and future environmental protection regulations may increase our operating costs and may adversely affect our operating results.
Our operations and business activities may involve dangerous materials.
Although we may establish stringent rules relating to the storage, handling and use of dangerous materials, there is no assurance that accidents will not occur. Should we be held liable for any such accident, we may be subject to penalties and possible criminal proceedings may be brought against our employees.
We may have to reduce our bromine production volumes based on guidelines issued by the Shouguang Bromine Professional Association.
We are a member of the Shouguang Bromide Professional Association (the “Association”), whose members are bromine producers in the Shouguang region of Shandong province. Members of the Association are required to follow production guidelines recommended by the Association. If the Association asks its members to reduce production volumes in the future, we may be required to limit our bromine production volume which could adversely affect our business, financial condition and results of operations.
We may have to temporarily halt production at our facilities in order to prepare for environmental inspections made by the local government.
In the past two years we have experienced an increase in the number of environmental inspections of our factories made by the local government in order to renew our mining licenses, which we have successfully passed. As a result of these inspections, we may be required to temporarily halt production at our factories in order to prepare for and pass the inspections made by the local government. If we are required to close some or all of our factories in order to prepare for these inspections, our business, financial condition and results of operations could be adversely affected.
Decreases in the bromine yield from our brine water could have an adverse effect on our business, financial position and results of operations.
In recent years, we have been able to extract less bromine from brine water during the production process due to a decrease in the bromine concentration of brine water being extracted. In an effort to address this issue, we carried out enhancement projects to our extraction wells in June 2011 by increasing the depth of our brine water wells to extract brine water from a lower second layer which we believe will have a higher bromine concentration. However, we can not be certain that this will improve the bromine yield from our production facilities in the long run. If we are not able to improve the bromine yield at our production facilities or if the bromine concentration in the brine water we extract continues to decline, our business, financial condition and results of operations could be adversely affected.
Taking of leased land by the Chinese government could disrupt our production facilities and capacity, and have a material adverse effect on our business, financial position and results of operations.
Most of our bromine and crude salt manufacturing facilities are located on land leased by SCHC. Any taking of leased land by the Chinese government could impair our carrying value of production facilities and our ability to timely produce and deliver products, which could have an adverse effect on our business, financial position and results of operations. In mid-May 2011, one of our leased parcels of land was taken by the Chinese government for civil redevelopment, which caused suspension of the operations of Factory No. 4 in early July 2011 for relocation, which took four months. Any future taking of our leased lands will adversely affect our existing business and productivity.
Risks Relating to our Common Stock and our status as a Public Company
The price of our common stock may be affected by a limited trading volume and may fluctuate significantly.
There has been a limited public market for our common stock and we cannot assure you that an active trading market for our stock will develop or if developed, will be maintained. The absence of an active trading market may adversely affect our stockholders' ability to sell our common stock in short time periods, or possibly at all. In addition, we cannot assure you that you will be able to sell shares of common stock that you have purchased without incurring a loss. The market price of our common stock may not necessarily bear any relationship to our book value, assets, past operating results, financial condition or any other established criteria of value, and may not be indicative of the market price for the common stock in the future. In addition, the market price for our common stock may be volatile depending on a number of factors, including business performance, industry dynamics, and news announcements or changes in general economic conditions.
We have not and do not anticipate paying any dividends on our common stock; because of this our securities could face devaluation in the market.
We have paid no dividends on our common stock to date and it is not anticipated that any dividends will be paid to holders of our common stock in the foreseeable future. While our dividend policy will be based on the operating results and capital needs of the business, it is anticipated that any earnings will be retained to finance our future expansion and for the implementation of our business plan. As an investor, you should take note of the fact that a lack of a dividend can further affect the market value of our stock, and could significantly affect the value of any investment in our Company.
We will continue to incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance requirements.
As a public company we incur significant legal, accounting and other expenses under the Sarbanes-Oxley Act of 2002, together with rules implemented by the Securities and Exchange Commission and applicable market regulators. These rules impose various requirements on public companies, including requiring certain corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.
Currently, none of our employees have significant experience or training in U.S. GAAP and we primarily rely on outside consultants to prepare our U.S. GAAP financial statements. Until such time that our employees gain sufficient experience or we hire additional employees with relevant U.S. GAAP experience, we will continue to incur costs related to these outside consultants.
In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, commencing in 2007, we must perform system and process evaluations and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Compliance with Section 404 may require that we incur substantial accounting expenses and expend significant management efforts. If we are not able to comply with the requirements of Section 404 in a timely manner, or if our accountants later identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other applicable regulatory authorities.
Lack of management control by purchasers of our common stock
As of the date of this report, Mr. Ming Yang, our chairman and former chief executive officer, and his affiliates, beneficially owned approximately 38.6% of our common stock. As a result of this concentration of ownership, our public stockholders, acting alone, may not have the ability to influence the outcome of matters requiring stockholder approval, including the election of our directors or significant corporate transactions. In addition, this concentration of ownership, which is not subject to any voting restrictions, may discourage or thwart efforts by third parties to take-over or effect a change in control of our Company that may be desirable for our stockholders, and may limit the price that investors are willing to pay for our common stock.
Our Board of Directors has the authority, without stockholder approval, to issue preferred stock with terms that may not be beneficial to common stock holders and with the ability to adversely affect stockholder voting power and perpetuate the board's control over the Company.
Our certificate of incorporation authorizes the issuance of up to 1,000,000 shares of preferred stock. Our Board of Directors by resolution may authorize the issuance of up to 1,000,000 shares of preferred stock in one or more series with such limitations and restrictions as it may determine, in its sole discretion, with no further authorization by security holders required for the issuance thereof. The Board may determine the specific terms of the preferred stock, including: designations; preferences; conversions rights; cumulative; relative; participating; and optional or other rights, including: voting rights; qualifications; limitations; or restrictions of the preferred stock.
The issuance of preferred stock may adversely affect the voting power and other rights of the holders of common stock. Preferred stock may be issued quickly with terms calculated to discourage, make more difficult, delay or prevent a change in control of our company or make removal of management more difficult. As a result, the Board of Directors' ability to issue preferred stock may discourage the potential hostile acquirer, possibly resulting in beneficial negotiations. Negotiating with an unfriendly acquirer may result in terms more favorable to us and our stockholders. Conversely, the issuance of preferred stock may adversely affect any market price of, and the voting and other rights of the holders of the common stock. We presently have no plans to issue any preferred stock.
Future sales of our common stock, or the perception that such sales could occur, could have an adverse effect on the market price of our common stock.
We have approximately 34,735,912 shares of our common stock outstanding as of March 14, 2011. There are a limited number of holders of our common stock. Future sales of our common stock, pursuant to a registration statement or Rule 144 under the Securities Act, or the perception that such sales could occur, could have an adverse effect on the market price of our common stock. The number of our shares available for sale pursuant to registration statements or Rule 144 is very large relative to the trading volume of our shares. Any attempt to sell a substantial number of our shares could severely depress the market price of our common stock. In addition, we may use our capital stock in the future to finance acquisitions and to compensate employees and management, which will further dilute the interests of our existing shareholders and could also depress the trading price of our common stock.
Techniques employed by manipulative short sellers in Chinese small cap stocks may drive down the market price of our common stock.
Short selling is the practice of selling securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is therefore in the short seller’s best interests for the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short. While traditionally these disclosed shorts were limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research reports that mimic the type of investment analysis performed by large Wall Street firm and independent research analysts. These short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base. Issuers with business operations based in China and who have limited trading volumes and are susceptible to higher volatility levels than U.S. domestic large-cap stocks, can be particularly vulnerable to such short attacks.
These short seller publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not subject to the certification requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst Certification) and, accordingly, the opinions they express may be based on distortions of actual facts or, in some cases, fabrications of facts. In light of the limited risks involved in publishing such information, and the enormous profit that can be made from running just one successful short attack, unless the short sellers become subject to significant penalties, it is more likely than not that disclosed shorts will continue to issue such reports.
While we intend to strongly defend our public filings against any such short seller attacks, oftentimes we are constrained, either by principles of freedom of speech, applicable state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceed against the relevant short seller. You should be aware that in light of the relative freedom to operate that such persons enjoy - oftentimes blogging from outside the U.S. with little or no assets or identity requirements - should we be targeted for such an attack, our stock will likely suffer from a temporary, or possibly long term, decline in market price should the rumors created not be dismissed by market participants.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties .
FIGURE 2.1 - REGIONAL MAP OF MINING PROPERTIES
FIGURE 2.2 - DETAILED MAP OF MINING PROPERTIES
We do not own any land, though we do own some of the buildings on land we lease. Our executive offices are located in China at Chenming Industrial Park, Shouguang City, Shandong Province, People's Republic of China, which also is the headquarters of SCHC. These offices are located on approximately 17,342 square meters of land owned by Shouguang City Wo Pu Town Ba Mian He Village. The lease for the land expires on November 1, 2054. The annual rent for the land is RMB4,000, or approximately US$619. The building on this land has approximately 3,335 square meters of usable space and is owned by SCHC.
SYCI's headquarters are located in the 2nd Living District, Shouguang City, Shandong Province, People's Republic of China. SYCI's headquarters are located on approximately 18,768 square meters of land owned by Shouguang City Houxin village. There are three buildings owned by SYCI located on the property. Two of the buildings are operational plants of steel structure with an aggregate of approximately 1,560 square meters of production space and a total of 4,000 square meters for pump rooms, boiler rooms, finished products and raw materials storage. The third building is primarily for administration and has approximately 795 square meters. The company has a 50 year lease on the land from April 1, 1998 to March 31, 2048 at an annual rent of RMB4,000 or $619.
The Company operates its bromine and crude salt production facilities through its wholly-owned subsidiary SCHC. SCHC has land use rights to one property (10,790 square meters, or approximately 3 acre) as bromine production area for Factory No. 1 and land lease contracts to nine properties (approximately 25,086 acre), totaling nearly 25,089 acre, located on the south bank of Laizhou Bay on the Shandong Peninsula of the People’s Republic of China (“China”). Each of the properties is accessible by road. The Yiyang railway line is within 50 kilometers and the Yangkou port is five kilometers away.
Each of the ten properties contains natural brine deposits which are extracted through wells and are used to extract bromine and produce crude salt. Bromine is a simple molecular element which is produced by extracting the bromine ion from natural brine. Crude salt is sodium chloride. Bromine is an important chemical raw material in flame retardants, fire extinguishing agents, refrigerants, photographic materials, pharmaceuticals, pesticides, and oil and other industries. Crude salt, also known as industrial salt, is used in a wide range of chemical industries, is the major raw material in the soda and chlor-alkali industries and can be widely used in agricultural, animal husbandry, fisheries and food processing industries. Crude salt is also the main raw material for edible salt.
Nature of Ownership Interest in the Properties
All land in PRC is owned by the State. Individuals and companies are permitted to acquire rights to use land or land use rights for specific purposes at no cost. In the case of land used for industrial purposes, the land use rights are granted for a period of fifty (50) years. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations. The Company does not own any land but has entered into contracts with the local government and original owners of the land use rights to acquire their rights for a period of 50 years. The contracts required us to pay a one-time fee plus an annual rent.
Mineral Rights
The Chinese and provincial governments have enacted a series of laws and regulations relating to the natural resources sector over the past 20 years, including laws and regulations designed to improve safety and decrease environmental degradation. The “China Mineral Resources Law” declares state ownership of all mineral resources in China. However, mineral exploration rights can be purchased, sold and transferred to both domestic and foreign owned companies. Mineral resource rights are granted by the central government permitting recipients to conduct mineral resource activities in a specific area during the license period. These rights entitle the licensee to undertake mineral resource activities and infrastructure and ancillary work, in compliance with applicable laws and regulations, within the specific area covered by the license during the license period. The licensee is required to submit a proposal and feasibility studies to the relevant authority and to pay the central government a natural resources fee in an amount equal to 2% of annual bromine sales. The Company was exempt from paying the fee prior to January 1, 2008. Shandong province has determined that bromine is to be extracted only by licensed entities.
Our mineral rights are issued by the local government and allow for a one year period of mining. The rights provide us with the exclusive rights to explore and extract natural brine under the leased land and produce bromine and crude salt. The government performs an annual inspection of the company’s previous year’s state of production & operations at beginning of each year. The annual inspection reviews: (1) whether the production is safe and if any accidents occurred during the previous year; (2) whether the mineral resources compensation fees and other taxes were timely paid; (3) whether employees’ salary and welfare benefits were timely paid; and (4) whether the Company meets environment protection meet standards. Only those companies who pass the inspection receive mineral rights for another one year term. For those companies who do not pass the inspection, additional mineral rights are not allocated until they can meet the requirements. If there is major safety accident, the government may revoke the mining permit. All of the relevant documentation to apply for renewal of mining rights must be filed with the Land and Resources Bureau before March 31st each year.
All of our bromine and crude salt production facilities have been authorized by the local land and resources departments, of which Factories No. 1 to No. 4 are included under a single permit, which was originally issued in January 2005. For Factories No. 5 to No. 10, the related mining permit applications are under review by the local land and resources departments, nevertheless we have obtained written consent from the local land and resources department to commence the production for Factories No. 5 to No. 9. In addition, all of our operations are subject to and have passed government safety inspections. We also have been granted environmental certification from the PRC Bureau of Environmental Protection.
Factories No. 1 to No. 9 are in their production stage and operates bromine extraction and crude salt production facilities. The facilities each include wells, which are used to extract natural brine from underground, natural brine transmission pipelines, natural brine storage reservoirs, bromine refining equipment, wastewater transport pipes, and drying brine drying pans. For the newly acquired Factory No. 10, the assets and facilities are now under repair and adjustments, the Company expected to resume the production by the end of first quarter 2012.
The equipment and facilities described above were constructed within three months after the acquisition of each of our respective properties using the latest technology and equipment and do not currently require modernization. Because bromine is a highly corrosive liquid, the equipment undergoes inspection and maintenance each year, especially the subaqueous pumps which need to be regularly inspected and maintained or replaced. Also, enhancement works for certain protective shells to the crude salt fields, extraction wells and transmission channels and ducts are carried out every 5 to 8 years, depends on the erosion rate, which is affected by different weather conditions and the change in acid components of brine water over time.
As of December 31, 2011, the Company had invested approximately $87.6 million in its ten production factories and facilities, paid approximately $6.7 million in prepaid land lease payments and mineral rights, and incurred approximately $32.5 million in enhancement works for protection shells to crude salt fields (approximately 12.4 million), extraction wells (approximately 12.4 million) and transmission channels and ducts (approximately $7.7 million). None of the existing extraction wells were impaired or in need of replacement as a result of the enhancement work. However, certain eroded protection shells for crude salt fields and transmission channels and ducts, with net carrying value of $1,632,004 (original cost of $1,939,288) and $1,315,476 (original cost of $2,274,700), respectively, were replaced and impaired in 2011 as part of our enhancement work. In light of the increased labor and raw materials costs of construction projects in recent years, the cost to replace those eroded parts increased the overall cost of the enhancement project to its current level.
As mentioned hereinbefore, the expected life of protective shells for the crude salt fields, extraction wells and transmission channels and ducts are 5 to 8 years. When we acquired production factories No. 2 to 9, their protective shells for crude salt fields, extraction wells and transmission channels and ducts were already under a certain degree of corrosion. In 2011, we decided to carry out large scale enhancement work to replace all these protective shells within a four year timeframe. The priority of the enhancement work depends upon the rate of corrosion at each factory. The enhancement work for all of our crude salt fields’ protective shells was completed in 2011, and the Company is not expected to carry out such enhancement works to the fields during the course of the next 5 years. The tables below demonstrate the schedule for each factory’s enhancement work to extraction wells and transmission channels and ducts in the next three years.
Extraction wells
Transmission channels and ducts
In addition, the Company estimates that it will invest approximately $20 million in enhancement projects to our extraction wells and transmission channels and ducts in Factory No. 1 to 9 in each of the 2012 to 2014. The Company also estimates that equipment maintenance will cost approximately $1.5 million in 2012, which is higher than the cost incurred in 2011 in view of the increased no. of factories and crude salt fields we owned and increasing level of wages and salaries and the cost of equipment’s spare parts.
Each of the ten bromine production facilities is provided with electricity and water by local government utilities.
Following is a description of the land use and mineral rights related to each of the ten properties held by SCHC as of December 31, 2011.
Property
Factory No. 1 - Haoyuan General Factory
Area
6,442 acres
Date of Acquisition
February 5, 2007
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
2054 (for mining areas only)
The number of remaining years to expiration of the of the land lease as of December 31, 2011
42.25 Years
Prior fees paid for land use rights
RMB8.6 million
Annual Rent
RMB186,633
Mining Permit No.:
C3707002009056220022340
Date of Permission:
January 2005, subject to annual renewal
Period of Permission:
One year
Property
Factory No. 2 - Yuwenbo
Area
1,846 acres
Date of Acquisition
April 7, 2007
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
41 Years
Prior Fees Paid For Land Use Rights
RMB7.5 million
Annual Rent
RMB162,560
Mining Permit No.:
C3707002009056220022340
Date of Permission:
January 2005, subject to annual renewal
Period of Permission:
One year
Property
Factory No. 3 - Yangdonghua
Area
2,318 acres
Date of Acquisition
June 8, 2007
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
40.3 Years
Prior Fees Paid For Land Use Rights
RMB5 million
Annual Rent
RMB111,317
Mining Permit No.:
C3707002009056220022340
Date of Permission:
January 2005, subject to annual renewal
Period of Permission:
One year
Property
Factory No. 4 - Liuxingji
Area
2,310 acres
Date of Acquisition
October 26, 2007
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
42.83 Years
Annual Rent
RMB139,255
Prior Fees Paid For Land Use Rights
RMB6.5 million
Mining Permit No.:
C3707002009056220022340
Date of Permission:
January 2005, subject to annual renewal
Period of Permission:
One year
Property
Factory No. 5 - Wangjiancai
Area
2,165 acres
Date of Acquisition
October 25, 2007
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
43 Years
Annual Rent
RMB176,441
Prior Fees Paid for Land Use Rights
RMB8.3 million
Mining Permit No.:
Under application, written consent obtained from local land and resources departments
Property
Factory No. 6 - Yangxiaodong
Area
2,641 acres
Date of Acquisition
January 8, 2008
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
43.5 Years
Prior Fees Paid for Land Use Rights
RMB9.1 million
Annual Rent
RMB191,295
Mining Permit No.:
Under application, written consent obtained from local land and resources departments
Property
Factory No. 7 - Qiufen Yuan
Area
1,611 acres
Date of Acquisition
January 7, 2009
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
47.17 Years
Prior Fees Paid for Land Use Rights
Not applicable
Annual Rent
RMB171,150
Mining Permit No.:
Under application, written consent obtained from local land and resources departments
Property
Factory No. 8 - Fengxia Yuan
Area
2,723 acres
Date of Acquisition
September 7, 2009
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
47.66 Years
Prior Fees Paid for Land Use Rights
Not applicable
Annual Rent
RMB347,130
Mining Permit No.:
Under application, written consent obtained from local land and resources departments
Property
Factory No. 9 - Jinjin Li
Area
759 acres
Date of Acquisition
June 7, 2010
Land Use Rights Lease Term
Fifty Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
48.5 Years
Prior Fees Paid for Land Use Rights
Not applicable
Annual Rent
RMB184,000
Mining Permit No.:
Under application, written consent obtained from local land and resources departments
Property
Factory No. 10 - Liangcai Zhang
Area
1,700 acres
Date of Acquisition
December 22, 2011
Land Use Rights Lease Term
Ten Years
Land Use Rights Expiration Date
The number of remaining years to expiration of the of the land lease as of December 31, 2011
10.0 Years
Prior Fees Paid for Land Use Rights
Not applicable
Annual Rent
RMB688,000
Mining Permit No.:
Under application, written consent obtained from local land and resources departments
Leased Facility
On November 5, 2010, SCHC entered into a Lease Contract (the “Lease Contract”) with State-Operated Shouguang Qingshuibo Farm (the “Lessor”). Pursuant to the Lease Contract, SCHC shall lease certain property with an area of 3,192 square meters (or 0.8 acres) or and buildings adjacent to the Company’s Factory No. 1. There are currently non-operating bromine production facilities on the property which have not been in production for more than 12 months. The annual lease payment for the Property is RMB 5 million, approximately $794,550, per year and shall be paid by SCHC no later than June 30th of each year. The term of the Lease Contract is for twenty years commencing from January 1, 2011 and the Lease Contract may be renewed by SCHC for an additional twenty year period on the same terms. The Lessor has agreed to permit SCHC to reconstruct and renovate the existing bromine production facilities on the property.
The chart below represents the annual production capacity and annualized utilization ratios for our bromine producing properties currently leased by the Company, which are all located in Shouguang City, Shandong Province, China. There are no proven and probable reserves located on our properties.
*Bromine production for Factory No. 5 and Factory No. 7 were combined in early 2010 as both factories are located adjacent to each other.
#Except for Factory No. 10, which was acquired after the assessment performed, annual production capacities for other factories were reassessed by Grant Sherman Appraisal Limited on October 28, 2011.
Each of the properties described above was not in operation when the Company acquired the asset. The owners of each of the properties did not hold the proper license for the exploration and production of bromine, and production at each of the assets acquired had been previously halted by the government. With respect to Factory No. 2, the property had not been operational for nine months; with respect to Factory No. 3, the property had not been operational for eleven months; with respect to Factory No. 4 and No. 5, the property had not been operational for fifteen months; and with respect to Factory No. 6, the property had not been operational for eighteen months; with respect to Factory No. 7, the property had not been operational for thirteen months; with respect to Factory No. 8, the property had not been operational for fourteen months; and with respect to Factory No. 9 and No. 10, the assets had not been operational for six months.
The following table shows the annual bromine produced and sold for each of our production facilities and the weighted average price received for all products sold for the last three years.
*Bromine production for Factory No. 5 and Factory No. 7 were combined in early 2010 as both factories are located adjacent to each other.
The following table shows the annual crude salt produced and sold for each of our production facilities and the weighted average price received for all products sold for the last three years.
*Bromine production for Factory No. 5 and Factory No. 7 were combined in early 2010 as both factories are located adjacent to each other.
# 	Factory No. 2 commenced the production of crude salt in 2011 after the acquisition of a nearby crude salt field in late December 2010.
The following table shows the chemical products produced and sold for our SYCI’s production facilities and the weighted average price received for all products sold for the last three years.
Item 3.
Item 3. Legal Proceedings.
The Company and certain of its officers and directors (Ming Yang, Xiaobin Liu, and Min Li, collectively, the “Individual Defendants”) have been named as defendants in a putative securities class action lawsuit alleging violations of the federal securities laws. That action, which is now captioned Lewy, et al. v. Gulf Resources, Inc., et al., No. 11-cv-3722 ODW (MRWx), was filed on April 29, 2011 in the United States District Court for the Central District of California. The lead plaintiffs, who seek to represent a class of all purchasers and acquirers of the Company’s common stock between March 16, 2009 and April 26, 2011 inclusive, filed an amended complaint on September 12, 2011. Lead plaintiffs assert claims for violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. The amended complaint alleges the defendants made false or misleading statements in the Company’s Annual Reports on Form 10-K for the years ended December 31, 2008, 2009, and 2010, and in interim quarterly reports by, among other things, overstating revenue and net income and failing to disclose material related party transactions and certain facts about the CEO’s prior employment at another company. The amended complaint also asserts claims against the Individual Defendants for violations of Section 20(a) of the Securities Exchange Act of 1934. The amended complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. On December 30, 2011, lead plaintiffs filed an opposition to the Company’s motion to dismiss the amended complaint. The Company filed a reply in further support of its motion to dismiss on February 6, 2012. In response to the Company’s reply in further support of its motion to dismiss, lead plaintiffs filed an objection on February 17, 2012, to certain documents filed by the Company in support of its motion to dismiss. The Company opposed the objection on February 22, 2012, to which lead plaintiffs replied in further support of their objection on February 23, 2012. The Court has not yet ruled on the motion to dismiss nor the objections raised by lead plaintiffs. The Company intends to defend vigorously against the lawsuit. The Company currently cannot estimate the amount or range of possible losses from this litigation.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market for Our Common Stock
Our common stock is listed for trading on the NASDAQ Global Select Market, or NASDAQ, under the symbol “GURE”. The prices set forth below reflect the quarterly high and low sales prices per share for our common stock, as reported by the NASDAQ:
Holders
As of March 9, 2012, our common stock was held of record by approximately 39 stockholders, some of whom may hold shares for beneficial owners and have not been polled to determine the extent of beneficial ownership.
Dividends
We have never paid cash dividends on our common stock. Holders of our common stock are entitled to receive dividends, if any, declared and paid from time to time by the Board of Directors out of funds legally available. We intend to retain any earnings for the operation and expansion of our business and do not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon future earnings, results of operations, future expansion of bromine and crude salt business and other, capital requirements, our financial condition and other factors that our Board of Directors may consider.
Our Equity Compensation Plans
The following table provides information as of December 31, 2011 about our equity compensation plans and arrangements.
Equity Compensation Plan Information - December 31, 2011
Stock Price Performance Graph
The following chart compares the cumulative total shareholder return on the Company’s shares of common stock with the cumulative total shareholder return of (i) the NASDAQ Composite Index and (ii) S&P Chemicals Index.
COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE
COMPANIES, PEER GROUPS, INDUSTRY INDEXES AND/OR BROAD MARKETS
The material in this chart is not soliciting material, is not deemed filed with the SEC and is not incorporated by reference in any filing of the Company under the Securities Act of 1933, as amended or the Exchange Act, whether made before or after the date of this proxy statement and irrespective of any general incorporation language in such filing.
Purchases of Equity Securities by the Company and Affiliated Purchasers
The authorization for the stock purchase program expired on September 22, 2011. As a result the fourth quarter of our fiscal year ended December 31, 2011, neither we nor any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) purchased any shares of our common stock, the only class of our equity securities registered pursuant to section 12 of the Exchange Act.
Recent Sales of Unregistered Securities
We have reported all sales of our unregistered equity securities that occurred during 2011 in our Reports on Form 10-Q or Form 8-K, as applicable.
Item 6.
Item 6. Selected Financial Data.
You should read the following selected financial data together with our financial statements and the related notes contained in Item 8 of Part II of this Annual Report on Form 10-K. We have derived the statements of operations data for each of the three years ended December 31, 2009, 2010 and 2011 and the balance sheets data as of December 31, 2010 and 2011 from the audited financial statements contained in Item 8 of Part II of this Form 10-K. The selected balance sheet data as of December 31, 2007, 2008 and 2009 and the statement of operations data for the year ended 2007 and 2008 have been derived from the audited financial statements for such years not included in this Form 10-K.
The historical financial information set forth below may not be indicative of our future performance and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical financial statements and notes to those statements included in Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
We are a holding company which conducts operations through our wholly-owned China subsidiaries. Our business is conducted and reported in three segments, namely, bromine, crude salt and chemical products.
Through our wholly-owned subsidiary, SCHC, we produce and trade bromine and crude salt. We are one of the largest producers of bromine in China, as measured by production output. Elemental bromine is used to manufacture a wide variety of bromine compounds used in industry and agriculture. Bromine also is used to form intermediary chemical compounds such as T.M.B. Bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines and disinfectants. Crude salt is the principal material in alkali production as well as chlorine alkali production and is widely used in the chemical, food & beverage, and other industries.
Through our wholly-owned subsidiary, SYCI, we manufacture and sell chemical products used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals.
On December 12, 2006, we acquired, through a share exchange, Upper Class Group Limited, a British Virgin Islands holding corporation which then owned all of the outstanding shares of SCHC. Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction in substance, rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class for the net assets of our company, accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange was identical to that resulting from a reverse acquisition, except no goodwill was recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, our company, are those of the legal acquiree, Upper Class Group Limited, which is considered to be the accounting acquirer. Share and per share amounts reflected in this report have been retroactively adjusted to reflect the merger.
On February 5, 2007, we, acting through SCHC, acquired SYCI. Since the ownership of Gulf Resources, Inc. and SYCI was then substantially the same, the transaction was accounted for as a transaction between entities under common control, whereby we recognized the assets and liabilities of SYCI at their carrying amounts. Share and per share amounts stated in this report have been retroactively adjusted to reflect the merger.
On August 31, 2008, SYCI completed the construction of a new chemical production line. It passed the examination by Shouguang City Administration of Work Safety and local fire department. This new production line focuses on producing environmental friendly additive products, solid lubricant and polyether lubricant, for use in oil and gas exploration. The line has an annual production capacity of 5,000 tons. Formal production of this chemical production line started on September 15, 2008.
On October 12, 2009 we completed a 1-for-4 reverse stock split of our common stock, such that for each four shares outstanding prior to the stock split there was one share outstanding after the reverse stock split. All shares of common stock referenced in this report have been adjusted to reflect the stock split figures. On October 27, 2009 our shares began trading on the NASDAQ Global Select Market under the ticker symbol “GFRE” and on June 30, 2011 we changed our ticker symbol to “GURE” to better reflection of our corporate name.
As a result of our acquisitions of SCHC and SYCI, our historical financial statements and the information presented below reflects the accounts of SCHC and SYCI. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.
RESULTS OF OPERATIONS
Year ended December 31, 2011 as compared to year ended December 31, 2010
Net Revenue Net revenue for the fiscal year 2011, was $164,980,453, representing an increase of $6,645,430 or 4% over the same period in 2010. This increase was primarily attributable to (i) the growth in our bromine segment, in which revenue increased from $99,211,812 for the fiscal year 2010 to $107,849,304 for the same period in 2011, an increase of approximately 9%; and (ii) the strong growth in our crude salt segment, in which revenue increased from $14,971,774 for the fiscal year 2010 to $15,918,655 for the same period in 2011, an increase of approximately 6%. The increase in net revenue was partially offset by the decrease in our chemical products segment, in which net revenue decreased from $44,151,437 for fiscal year 2010 to $41,212,494 for fiscal year 2011, a decrease of approximately 7%.
Bromine segment
The increase in net revenue from our bromine segment was mainly due to the increase in the average selling price of bromine. The average selling price of bromine increased from $2,972 per tonne for fiscal year 2010 to $4,082 per tonne for the same period in 2011, an increase of 37%. The increase in the average selling price was a result of (i) strong demand in the China market following the recovery of business and economic conditions and reforms in the medical industry in China, and (ii) expansion of bromine applications in a variety of industries. However, we noted that the effect of the increase in the average selling price was diminished due to the macro-economic tightening policy imposed by the PRC government which weakened the demand of bromine beginning in the second half of 2011. The average selling of bromine decreased from a high in the first quarter of 2011 ($4,596 per tonne) to the lowest in the third quarter of 2011 ($3,597 per tonne), and kept stable in the fourth quarter of 2011 ($3,716 per tonne). We expect the average selling price of bromine will remain at current levels (around $3,716 per tonne) through the first half of 2012 should the PRC government’s macro-economic tightening policy remain in place.
The favorable effect of the increase in the average selling price of bromine was almost offset by a decrease in the sales volume of bromine from 33,386 tonnes for fiscal year 2010 to 26,418 tonnes for fiscal year 2011, a decrease of approximately 37%. Despite an increase in the number of our bromine production plants in recent years, sales volume of bromine decreased. The reasons for the decrease in the sales volume of bromine was mainly attributable to (i) the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy; (ii) less bromine being extracted from brine water during the production process due to the trend of a decrease in the bromine concentration of brine water being extracted at our facilities; and (iii) the suspension of operations of our original Factory No. 4 in early July 2011 to cooperate with the demolition of the factory and construction of new factory, which resumed normal production in late November 2011. The table below showed the changes in the average selling price of bromine and changes in the sales volume of bromine for fiscal year 2011 from 2010.
In an effort to address the trend of a decrease in the bromine concentration of brine water being extracted at our facilities, we carried out enhancement projects to our extraction wells in June 2011 by increasing the depth of our brine water wells to extract brine water from a lower second layer which we believe will have a higher bromine concentration. Yet, the result of the enhancement projects was not reflected in fiscal year 2011 as the overall demand of bromine decreased due to the macro-economic tightening policy imposed by the PRC government.
Crude salt segment
The increase in net revenue from our crude salt segment was mainly due to the increase in the average selling price of crude salt. The average selling price of crude salt increased from $40.42 per tonne for fiscal year 2010 to $44.72 per tonne for fiscal year 2011, an increase of 11%. The increase in the average selling price was a result of increased demand for crude salt and the increase in our production capacity was a result of the additional crude salt field we acquired in late 2010.
The favorable effect of the increase in the average selling price of crude salt was partially offset by a decrease in the sales volume of crude salt from 370,437 tonnes for fiscal year 2010 to 355,962 tonnes for fiscal year 2011, a decrease of approximately 3.9%. The decrease in average selling price was a result of the macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy, which decreased the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. The decrease in sales volume also was a result of the decrease in sales volume of bromine in fiscal year 2011, which reduced the wastewater available for the production of crude salt. The table below shows the changes in the average selling price and changes in the sales volume of crude salt for fiscal year 2011 from 2010.
Despite the above increasing factor, we noted a trend of decrease in the average selling price of crude salt for fiscal year 2011. The average selling price decreased from $50.10 per tonne in the first quarter of 2011 to $37.67 per tonne in the fourth quarter of 2011. We expect the average selling price of crude salt will remain at current levels through the first half of 2012 should the PRC government’s macro-economic tightening policy remain in place.
Chemical products segment
Revenues from our chemical products segment decreased from $44,151,437 for fiscal year 2010 to $41,212,494 for fiscal year 2011, a decrease of approximately 7%. The decrease was mainly attributable to the drop in demand for our oil and gas exploration additives and paper manufacturing additives. Our oil and gas exploration chemicals are the most popular products within our chemical products segment and contributed $26,234,497 (or 64%) and $32,110,313 (or 73%) of our chemical segment revenue for fiscal years 2011 and 2010, respectively, a decrease of $5,875,816, or 18%. Net revenue from our agricultural intermediates increased from $6,302,231 for fiscal year 2010 to $9,679,768 for fiscal year 2011, an increase of approximately 54%. We believe that as result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, the overall demand for chemical products was reduced, which resulted in a decrease in our volume of chemical products sold. The sales volume of chemical products decreased by 29% from 30,560 tonnes for fiscal year 2010 to 21,799 tonnes for fiscal year 2011.
However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price for all of our chemical products due to the continuing high level of oil prices. The average selling price per tonne for our chemical products increased by a range of 18% (paper manufacturing additives) to 59% (pesticides manufacturing additives) for fiscal year 2011 as compared with fiscal year 2010. In particular, the PRC government continued to support expansion of agricultural related products, which supported the growth in sales of our pesticides manufacturing additives. Also, in June 2011 we stopped production of our wastewater treatment chemical additive and in July we successfully converted the production equipment from this wastewater treatment chemical additive to pharmaceutical and agricultural chemical additives which have higher profit margins. The table below shows the changes in the average selling price and changes in the sales volume of our major chemical products, other than wastewater treatment chemical additive, for fiscal years 2011 and 2010.
Cost of Net Revenue
Cost of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $89,538,212 for fiscal year 2011, an increase of $9,283,453 (or approximately 12%) compared to fiscal year 2010. The increase was primarily due to the increase in the purchase price of raw materials, depreciation and amortization of manufacturing plant and machinery, mineral resource compensation fees paid for extraction of brine water in our bromine segment and price adjustment fund imposed by the local PRC government to our bromine and crude salt segments.
Bromine production capacity and utilization of our factories
The table below represents the annual capacity and utilization ratios for our all of our bromine producing properties:
# Annual production capacities for 2010 were estimated by management, and the annual production capacity for 2011 was extracted from an appraisal report carried out by an international appraisal firm, Grant Sherman Appraisal Limited, in October 2011.
* Utilization ratio is calculated based on the annualized actual production volume in tonnes for the year divided by the annual production capacity in tonnes.
Since 2007, we continued to acquire bromine properties to increase the production capacity to meet demand. However, the cost of obtaining additional production capacity in recent years increased significantly due to the limited availability of suitable bromine facilities. Prior to 2009, we acquired production facilities at costs of approximately $34.6 million (or $1,460 per ton production capacity), with annual production capacity increased by 23,700 tons (from initially 12,000 tons). In 2009 and 2010, we acquired further production facilities at costs of approximately $27.5 million and $13.9 million for additional 7,600 tons (or $3,620 per ton production capacity) and 3,000 tons (or $4,630 per ton production capacity) annual production capacity, respectively.
In 2011, we acquired another facility and incurred capital improvement for bromine and crude salt production in 2011 at costs of $6.2 million with additional bromine annual production capacity of 3,200 tons (or $1,930 per ton production capacity). The cost per ton production capacity acquired in 2011 is comparatively lower than the factories acquired prior to 2011 because the term of lease for the newly acquired facility only lasts for 20 years, where the lease term for factories acquired before 2011 were all 50-year lease terms. The latest acquired cost per ton production capacity would be increased to $4,825 if the lease term would have been 50 years.
In view of the recent trend of a decrease in bromine concentration of brine water being extracted in Shandong areas, we determined that the existing annual production capacity information previously estimated by the management at the time of acquisition of the respective factory may not accurately reflect the current production and information available. As a result, we hired an international appraisal firm, Grant Sherman International Limited, to reassess all of our bromine facilities in October 2011 and concluded that our optimal annual production capacity in given our current situation was 41,547 tons, a decrease of 7,953 tons annually as compared to the annual production capacity in 2010, which included additional 3,200 tons’ production capacity acquired in early 2011. The decrease in our overall annual bromine production capacity was mainly attributable to (1) active aging of bromine facilities, in particular, certain protective shells for the crude salt fields, extraction wells and transmission channels and ducts, which increased the leakage rate and directly reduced the volume of brine water available to flow into the bromine production cycle, and (2) a trend of decrease in the bromine concentration of brine water being extracted from our existing extraction wells.
In order to reduce the leakage rate and attempt to recover the annual production capacity of bromine and crude salt to a higher level in the future, we decided to carry out large scale enhancement work to replace all the eroded protective shells within a four year timeframe, which work commenced in the second quarter of 2011. The priority of the enhancement work depends upon the rate of corrosion at each factory. In fiscal year 2011, we incurred costs of $32.5 million for such enhancement projects, which included (1) drilling certain existing extraction wells into deeper underground for higher bromine concentration of brine water at a cost of approximately $12.4 million, and (2) replacing certain eroded protective shells to the crude salt fields, and transmission channels and ducts with new ones at costs of approximately $12.4 million and $7.7 million. The enhancement work for all of our crude salt fields’ protective shells was completed in 2011, and the Company is not expected to carry out such enhancement works to the fields during the course of the next 5 years.
The table below summarizes the schedule for enhancement work to the protective shells to extraction wells and transmission channels and ducts in the next three years.
The optimal annual bromine production capacity of 41,547 tons for 2011, as reassessed by the international appraisal firm in October 2011, only partially reflected the enhancement work for the extraction wells, protective shells for transmission channels and ducts performed in the second quarter of 2011. Nevertheless, our annual production capacity still recorded a decrease of 7,953 tons as compared with management’s prior estimates. Although this decline is not insignificant, we believe that the situation would have been worse if we have not started to carry out the enhancement work in the second quarter of 2011, as we anticipated that this trend in bromine concentration of brine water in the Shandong areas will continue and the leakage rate of our aged protective shells for transmission channels and ducts would continue to adversely affect our bromine production capacity in the future. To remedy and recover our annual bromine production capacity, we will continue to carry out the remaining enhancement work to the extraction wells, and protective shells for transmission channels and ducts in the next three years at expected annual costs of $20 million.
The management considered that the protective shells for the crude salt fields, extraction wells and transmission channels and ducts are individual components that can be separately identified for replacement, while the enhancement costs incurred increases the future service potential of the extraction wells, crude salts fields and transmission channels and ducts. The original eroded protective shells were replaced and removed from the fixed assets. The management estimated that the enhancement projects for extraction wells and protection shells for the crude salt fields, extraction wells and transmission channels and ducts will have useful lives of 8 and 5 years, respectively. As such, the Company capitalized the enhancement components as separate fixed asset items and depreciated with their useful lives of 5 to 8 years.
Our utilization ratio decreased by 12% for fiscal year 2011 as compared with fiscal year 2010. The decrease in utilization and hence the sales volume of bromine was mainly attributable to (i) the suspension of operations of our original Factory No. 4 in early July 2011 to cooperate with the demolition of the factory and construction of a new factory, which was completed its construction and resumed normal operations in late November 2011; and (ii) intermittent suspension of operations of some of our factories in the first half of 2011 due to the annual scheduled repair and maintenance, the increased number of environmental inspections by the local government and the restriction of the supply of electricity to all industrial factories by the local government. We estimated that the amount of ordinary repair and maintenance expense will be $1.5 million in 2012.
As normal operations of our bromine and crude salt, most of our fixed assets require less daily repair and maintenance. These kinds of plant and equipment include the crude salt fields, channels and ducts, and extraction wells. Without altering the foundation of these assets, the protective shells attached to the foundation are required to be replaced with their life cycle, which is around every 5 to 8 years. The ordinary repairs and maintenance costs incurred during each year represents mainly the costs of spare parts of manufacturing machinery and pumps for bromine extraction, and salaries for repair and maintenance department.
Bromine segment
For the fiscal year 2011, the cost of net revenue for our bromine segment was $56,468,761, an increase of $7,937,939 (or 16%) compared to $48,530,822 for the fiscal year 2010. The most significant components of our cost of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $34,844,710 (or 62%), depreciation and amortization of manufacturing plant and machinery of $10,786,076 (or 19%) and electricity of $4,198,738 (or 7%) for fiscal year 2011. The major components of the cost of revenue for fiscal year 2010 were cost of raw materials and finished goods consumed of $31,707,281 (or 65%), depreciation and amortization of manufacturing plant and machinery of $7,330,200 (or 15%) and electricity of $4,881,580 (or 10%), a similar cost structure as compared with the same in 2011. The increase in cost of net revenue was attributable to the increase in raw material prices and depreciation and amortization of manufacturing plant and machinery. The table below represents the major production cost component of bromine per ton for respective periods:
Our production cost of bromine per ton was $2,138 for the fiscal year 2011, an increase of 47% (or $684) as compared to the fiscal year 2010, which attributable mainly to the components of raw material and depreciation and amortization of manufacturing plant and machinery. The cost of raw material consumed per ton increased by 39% as compared to last comparison period mainly attributable to the increase in the purchase price of raw materials. The significant percentage increase in depreciation and amortization per ton by 85% was due to the enhancement projects in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery. Since January 2011, included in our others production cost was a price adjustment fund, a levy charged by PRC government, of $32 per tonne.
Crude salt segment
For the fiscal year 2011, the cost of net revenue for our crude salt segment was $4,776,283, representing an increase of $1,480,442, or 45%, over the same period in 2010. The increase in cost was mainly due to the increase in the number of crude salt fields and enhancement projects performed in late June 2011, which in turn increased the depreciation and amortization of manufacturing plant and machinery. The significant costs were depreciation and amortization of $2,546,780 (or 53%), resource tax calculated based on the crude salt sold of $935,333 (or 20%) and electricity of $501,005 (or 10%) for the fiscal year 2011. The major cost components were depreciation and amortization of $1,030,264 (or 31%), resource tax calculated based on the crude salt sold of $947,576 (or 29%) and electricity of $741,451 (or 23%) for fiscal year 2010. The table below represents the major production cost component of crude salt per ton for respective periods:
Our production cost of crude salt per ton was $13.4 for the fiscal year 2011, an increase of 51% (or $4.5) as compared to the same period in 2010, which attributable mainly to the components of depreciation and amortization of manufacturing plant and machinery and introduction of price adjustment fund since January 2011. The significant percentage increase in depreciation and amortization per ton by 157% was due to the enhancement projects period in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery. Since January 2011, included in our others production cost was a price adjustment fund, a levy charged by PRC government, of $0.4 per tonne. Other production costs represented mainly salaries and welfare of labor worked in the crude salt fields.
Chemical products segment
For the fiscal year 2011, the cost of net revenue for our chemical products segment was $28,293,168, representing a decrease of $134,928 or 0.47% over the same period in 2010. The rate of decrease for the cost of net revenue for our chemical products segment was similar to that of net revenue. The significant costs were cost of raw material and finished goods consumed of $24,731,108 (or 87%) and $25,458,672 (or 90%) and depreciation and amortization of manufacturing plant and machinery of $2,325,050 (or 8%) and $1,673,358 (or 6%) for each of the fiscal years 2011 and 2010, respectively. As the components of our cost of net revenue are fixed levels of depreciation and amortization of manufacturing plant and machinery and the inflated purchase price of raw materials, the overall cost of net revenue for chemical products segment remained at a same level for the fiscal year 2011 compared to the fiscal year 2010.
Gross Profit Gross profit was $75,442,241, or 46%, of net revenue for fiscal year 2011 compared to $78,080,264, or 49%, of net revenue for fiscal year 2010. The decrease in gross profit percentage was primarily attributable to a drop in margin percentage to all of our three segments.
Bromine segment
For the fiscal year 2011, the gross profit margin for our bromine segment was 48% compared to 51% for the fiscal year 2010. The average selling price of bromine increased from $2,972 per tonne for fiscal year 2010 to $4,082 per tonne for fiscal year 2011, an increase of 37%. We do not expect that the selling price for bromine will continue to increase in 2012. As mentioned before, due to a decrease in the bromine concentration of brine water being extracted and the PRC government’s macro-economic tightening policy, our production level and sales volume for the second half of 2011 was adversely affected. In order to improve the quality of brine water being extracted from our wells, we completed enhancements of our facilities during the second quarter of 2011 to pump brine water from deeper underground. We expect that the production capacity of bromine will improve in the near future as a result of these enhancements and that the gross profit margin of bromine will remain at current level through the first half of 2012 should the PRC government’s macro-economic tightening policy remains in place.
Crude salt segment
For the fiscal year 2011, the gross profit margin for our crude salt segment was 70% compared to 78% for the fiscal year 2010. This 8% decrease in our gross profit margin is attributable to (i) the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects performed in late June 2011 to our crude fields, extraction wells and transmission channels and ducts; and (ii) the change in the estimated useful life of certain protective shells and transmission channels and ducts from 8 years to 5 years. For the fiscal year 2011, the average selling price of crude salt increased to $44.72 per ton, as compared from $40.42 per ton in the fiscal year 2010, an increase of 11%. As mentioned hereinbefore, the increase in average selling price was a result of increased demand of crude salt which was offset by the increase in cost of net revenue.
Chemical products segment
The gross profit margin for our chemical products segment for the fiscal year 2011 was 31% compared to 36% for the fiscal year 2010, a decrease of 5%. As mentioned hereinbefore, the decrease in gross profit margin was a result of the decrease in demand for our oil and gas exploration additives and paper manufacturing additives which in turn reduced the sales volume of these chemical products. As sales of oil and gas exploration additives contributed more than 64% of our total chemical products segment’s net revenue, the decrease in demand largely reduced the gross profit margin of our chemical products segment. However, our factory is capable of producing diversified chemical products, the selling price fluctuation of individual chemical products is not expected to have an impact on our gross profit margin for overall chemical products.
Research and Development Costs The total research and development costs incurred for the fiscal years 2011 and 2010 were $398,842 and $2,200,291, respectively, with a decrease of 82%.
Included in research and development costs are costs paid to East China University of Science and Technology for the establishment of a Co-Op Research and Development Center in June 2007 to develop new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry. On June 7, 2011, SYCI and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for us. The research and development costs paid pursuant to this agreement amounted to $236,816 and $503,382 for the fiscal years 2011 and 2010, respectively.
Since the second quarter of 2010, SYCI conducted research for the new production line of wastewater treatment additives, the purpose of which is for the testing the manufacturing routine and samples. The research and development expenses incurred for the new production line of wastewater treatment additives during the fiscal years 2011 and 2010 were $162,025 and $1,696,909, respectively. The new production line began operations in April 2011. However, we switched the aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as we experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. The converted new production line was started operation and normal production in late July 2011 with positive cash from operations.
Exploration Costs To explore natural brine resources in Sichuan Province, SCHC incurred exploration costs in the amount of $7,034,153 for the fiscal year 2011. These costs consisted of the drilling of exploratory wells and associated facilities in order to confirm and measure the brine water resources in the province. We charged the exploration costs to the income statement as incurred. We completed the drilling of the first exploratory well in December 2011 and announced in mid-January 2012 that we have discovered underground brine water resources in Daying County, and provided preliminary concentration results after the testing by a third-party independent testing expert. According to the third-party independent testing report, the bromine concentration in the underground brine water resources is 1.53 grams per liter, which is approximately six to seven times higher than the average bromine concentration from its brine water resources at our bromine factories in Shouguang City. We expects to continue to cooperate with Daying County in 2012 and drilling in order to further determine the total brine water resources reserve and exploitable amount in the area.
Write-off/Impairment on property, plant and equipment The write-off and impairment on property, plant and equipment represented (i) the write-off on property, plant and equipment that could not be relocated to the new Factory No. 4 in the amount of $1,384,443; (ii) the impairment loss on property, plant and equipment related to the conversion of our production line from wastewater treatment chemical additives to the production of pharmaceutical and agricultural chemical intermediates in the amount of $1,805,598; (iii) the impairment loss on property, plant and equipment under capital leases for idle plant and machinery in the amount of $683,046; and (iv) the write-off of certain crude salt field protective shells and transmission pipelines replaced during renovation work in the amounts of $1,632,004 and $2,065,475, respectively.
General and Administrative Expenses General and administrative expenses were $17,874,296 in fiscal year 2011, an increase of $11,003,205 (or 160%) compared to $6,871,091 for the same period in 2010. The significant increase was primarily due to non-cash expenses of $7,481,400 for the fiscal year 2011 related to options granted to our employees in the amount of $2,731,400, recognition of non-vested options which were cancelled in late September 2011 in the amount of $4,298,000, and a warrant issued to our investor relations firm in the amount of $452,000 related to a the service agreement signed in February 2011. The non-cash expenses related to options and a warrant granted for the fiscal year 2010 amounted to $1,282,428, which resulted in an increase of $6,198,972, or 483%, as compared with the fiscal year 2011. The increase in stock options was primarily for the purpose of incentivizing our employees. Other reasons for the increase in general and administrative expenses were due to (i) demolition and re-installation expense in the amount of $626,272 for relocating Factory No. 4 due to the Chinese government taking the leased land, where our original Factory No. 4 was situated, for civil redevelopment; (ii) $229,052 of depreciation of property, plant and equipment for Factory No. 4 which were temporarily suspended operations due to the relocation; (iii) $1,398,574 of unrealized exchange loss in relation to the translation difference of inter-company balances in USD and RMB; and (iv) $3,154,400 of consultancy fee paid to an unrelated PRC agent for the purpose of searching suitable crude salt fields and bromine properties for acquisition.
Other Operating Income Other operating income was $1,821,010 for the fiscal year 2011, a significant increase of $1,597,295 from $223,715 for the fiscal year 2010. Such increase was primarily due to (i) a sum of $1,340,026 received from the local PRC government in third quarter of 2011 as compensation for the demolition of our original Factory No. 4; and (ii) a sum of $300,000 for compensation received from a legal case. Included in other operating income for the fiscal years 2011 and 2010 were $180,984 and $223,715 income from sales of wastewater to some of our customers. Not all of our bromine production plants have sufficient area on the property to allow for evaporation of wastewater to produce crude salt. Certain of our customers who have facilities located adjacent to our bromine production plants have agreed to channel our wastewater into brine pans on their properties for evaporation. These customers then are able to sell the resulting crude salt themselves. We have signed agreements with three of our customers to sell them our wastewater at market prices.
Income from Operations Income from operations was $44,298,458 for the fiscal year 2011 (or 26.9% of net revenue), a decrease of $24,797,775 (or approximately 36%) over income from operations for the fiscal year 2010. The decrease resulted primarily from the decrease in net revenue as a result of (i) the macro-economies tightening policy imposed by the PRC government to slow down the economy, which in turn decrease the demand and selling price of our products; and (ii) a non-cash expense of $4,298,000 related to cancellation of all non-vested stock options in late September 2011 as explained hereinbefore.
Bromine segment
Income from operations from our bromine segment was $37,023,963 for the fiscal year 2011, a decrease of $11,450,648 (or approximately 24%) compared to the same period in 2010. Despite the effect of increase in bromine’s selling price which contributed an increase of approximately $33 million in income from operations, the overall decrease in income from operations bromine segment resulted primarily from (i) the decrease in sales volume (contributed a decrease of approximately $25 million) as a result of the PRC government’s macro-economies tightening policy which decrease the demand of bromine; (ii) the increase in cost of net revenue, in particular, cost of raw material and depreciation and amortization of manufacturing plant and machinery (contributed a decrease of approximately $6 million); (iii) the impairment losses and write-off of certain property, plant and equipment (contributed a decrease of approximately $4 million); and (iv) the increase in exploration costs to explore natural brine resources in Sichuan province (contributed a decrease of approximately $6 million).
Crude salt segment
Income from operations from our crude salt segment was $7,688,190 for the fiscal year 2011, a decrease of $3,672,286 (or approximately 32%) compared to the fiscal year 2010. This decrease was mainly due to (i) the impairment losses and write-off of certain property, plant and equipment of approximately $2 million; and (ii) the increase in exploration costs to explore natural brine resources in Sichuan province of approximately $1 million, which outweighed the increase in net revenue of approximately $1 million.
Chemical segment
Income from operations from our chemical products segment was $10,237,586 for the fiscal year 2011, a decrease of $1,981,027 (or approximately 16%) compared to the fiscal year 2010. This decrease resulted primarily from (i) the decrease in net revenue of our oil and gas exploration chemicals and paper manufacturing additives of approximately $6.9 million due to the decreased demand; and (ii) the impairment losses and write-off of certain property, plant and equipment of approximately $1.8 million, which was partially offset by (i) the increase in net revenue of our agricultural intermediates of approximately $3.4 million; (ii) the net revenue from wastewater treatment chemical products of approximately $0.5 million; and (iii) the decrease in our research and development costs incurred and paid to East China University of Science and Technology of approximately $1.8 million as explained hereinbefore.
Other Income, Net Other income represented bank interest income, net of the capital lease interest expense. The decrease in net other income was primarily due to the charge of capital lease interest expense since January 2011 for the acquisition of fixed assets under capital lease.
Net Income Net income was $30,952,760 for the fiscal year 2011, a decrease of $20,330,560 (or approximately 40%) compared to the fiscal year 2010. This decrease was primarily attributable to the impairment losses recognized for and the write-off of certain property, plant and equipment of approximately $7.6 million, exploration costs related to the drilling of exploratory wells in Sichuan province of approximately $7 million and recognition of non-vested options which cancelled in late September 2011 of approximately $4.3 million.
Effective tax rate Our effective tax rate for the fiscal year 2011 was 30%, represented an increase of 4% as compared to the same periods in 2010. The significant increase in the effective tax rate was due to the US federal net operating loss incurred by Gulf during 2011 in respect of the non-cash expenses of $4,298,000 for the fiscal year 2011 related to the recognition of non-vested options granted to employees which were cancelled in late September 2011. We considered that such non-cash expense is a one-off item and did not anticipate this will be a recurring item in the future.
Year ended December 31, 2010 as compared to year ended December 31, 2009
Net Revenue Net revenue was $158,335,023 in fiscal year 2010, an increase of approximately $48 million (or 44%) as compared to fiscal year 2009. This increase was primarily attributable to (i) the strong growth in our bromine segment, in which revenue increased from $63,679,888 for fiscal year 2009 to $99,211,812 for fiscal year 2010, an increase of approximately 56%; (ii) the strong growth in our crude salt segment, in which revenue increased from $10,650,698 for fiscal year 2009 to $14,971,774 for fiscal year 2010, an increase of approximately 41%; and (iii) strong demand in our chemical products segment, in which revenue increased from $35,946,322 for fiscal year 2009 to $44,151,437 for fiscal year 2010, an increase of approximately 23%.
Bromine segment
The increase in net revenue from our bromine segment was mainly due to the increase in the average selling price of bromine. The average selling price of bromine increased from $1,854 per ton for the fiscal year 2009 to $2,972 per ton for fiscal year 2010, an increase of 60%. The increase in average selling price was a result of (i) strong demand for brominated flame retardants, fumigants, water purification compounds, dyes, medicines, and disinfectants in the China market following the recovery of business and economic conditions and reforms in the medical industry in China; (ii) expansion of bromine applications in a variety of industries for cleaning up sulfur and mercury from polluted areas and wastewater treatment; (iii) no major cost effective substitute for bromine in the pharmaceutical area; (iv) strong domestic consumption as historically limited bromine was imported into China; and (v) no new bromine reserves were discovered in 2009 and 2010.
However, the sales volume of bromine decreased from 34,342 tonnes for fiscal year 2009 to 33,386 tonnes for fiscal year 2010, a decrease of approximately 2.8%. Despite an increase in the number of our bromine production plants in recent years, sales volume of bromine decreased. The decrease in the sales volume of bromine was attributable to less bromine being extracted from brine water during the production process due to a trend of a decrease in bromine concentration of brine water being extracted. In addition, during 2010, the local government also restricted the supply of electricity to our factories and there was an increase in the number of environmental inspections of our factories made by the local government. The table below shows the changes in the average selling price of bromine and changes in the sales volume of bromine for fiscal year 2010 from 2009.
Crude salt segment
The increase in net revenue from our crude salt segment was mainly due to the increase in both the average selling price and sales volume of crude salt. The sales volume of crude salt slightly increased by 3.8%, from 356,839 tonnes for fiscal year 2009 to 370,437 tonnes for fiscal year 2010, and the average selling price of crude salt increased from approximately $29.9 per ton to above $40.4 per ton, an increase of approximately 35%. The increase in average selling price was a result of increased demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. Before 2010, our sales volume was restricted by our limited production capacity. We acquired 3 factories (Factories no. 7, 8 & 9) between mid-2009 and mid-2010, which increased our productivity, and increased the volume of crude salt we sold.
The table below showed the changes in the average selling price of crude salt and changes in the sales volume of crude salt for fiscal year 2010 from 2009.
Chemical products segment
Revenues from our chemical products segment increased from $35,946,322 for fiscal year 2009 to $44,151,437 for the same period in 2010, an increase of approximately 23%. The increase was mainly due to the strong demand for environmentally friendly oil and gas exploration chemicals and agricultural intermediaries. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $32,110,313 (or 73%) and $28,081,921 (or 78%) of our chemical segment revenue for fiscal year 2010 and 2009, respectively, with an increase of $4,028,392, or 14%. As result of the recent macro-economic tightening policy imposed by the PRC government in second half of 2010 to slow down the economy, our overall demand for chemical additives was reduced, which slowed down our increase of revenue in oil and gas exploration additives and paper manufacturing additives for the whole year in 2010. However, revenue from our agricultural intermediates increased from $2,877,806 for fiscal year 2009 to $6,302,231 for the same period in 2010, an increase of $3,424,424, or approximately 119%. The PRC government continues to support expansion of agricultural related products, which supported the growth in sales of pesticides manufacturing additives in 2010. The table below showed the changes in the average selling price of major chemical products and changes in the sales volume of crude salt for fiscal year 2010 from 2009.
Although net revenue in all segments grew, the growth of sales of bromine and crude salt was much higher than that of our chemical products operations mainly due to the outweighed increase in average selling price of bromine and crude salt.
Cost of Net Revenue
Cost of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $80,254,759 in fiscal year 2010, an increase of approximately $17.6 million (or approximately 28%) from the cost of net revenue in fiscal year 2009. This increase resulted primarily from the increase in purchase price in raw materials, depreciation and amortization of manufacturing plant and machinery and mineral resources compensation fees paid for extraction of brine water in bromine segment. The rate of increase for cost of net revenue was lower than that of net revenue because (i) the rate of inflation relating to cost of net revenue was lower than the percentage increase in selling price of our products and (ii) the leverage of bulk purchases of raw materials which partially lowered the percentage of increase in price of raw materials.
Bromine production capacity and utilization of our factories
The table below represents the annual capacity and utilization ratios for our bromine producing properties:
Utilization ratio is calculated based on the annualized actual production volume in tonnes for the year divided by the annual production capacity in tonnes.
Despite the fact that we acquired Factory No. 9 in 2010 which increased our annual bromine production capacity by 3,000 tones, our utilization decreased by 8% in 2010. The decrease in utilization and hence the sales volume of bromine was mainly attributable to less bromine being extracted from brine water during the production process due to a trend of decrease in bromine concentration of brine water being extracted. In addition, during 2010, the local government also restricted the supply of electricity to our factories and there was an increase in the number of environmental inspections of our factories made by the local government.
Bromine segment
For the fiscal year 2010, the cost of net revenue for the bromine segment was $48,530,822, representing an increase of $11,611,159 or 31% over the same period in 2009. The most significant components of our cost of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $31,707,281 (or 65%), depreciation and amortization of manufacturing plant and machinery of $7,330,200 (or 15%) and electricity of $4,881,580 (or 10%) for the fiscal year 2010. For the fiscal year 2009, the major components of the cost of net revenue were cost of raw materials and finished goods consumed of $25,412,625 (or 69%), depreciation and amortization of manufacturing plant and machinery of $5,104,703 (or 14%) and electricity of $3,617,262 (or 10%), a similar cost structure as compared with the same in 2010. The increase in cost of net revenue was attributable to the increase in raw material prices. The table below represents the major production cost component of bromine per ton for respective periods:
Our production cost of bromine per ton was $1,454 for the fiscal year 2010, an increase of 38% (or $397) over the same period in 2009, which attributable mainly to the components of raw materials and depreciation and amortization of manufacturing plant and machinery. The cost of raw materials consumed per ton increased by 30% as compared to last comparison period mainly due to increase in the purchase price of raw materials. The rate of increase for cost of net revenue was lower than that of net revenue because (i) the supply of raw materials is relatively stable and the rate of increase in the price of raw materials was lower compared with the rate of increase in the selling price of bromine and (ii) bulk purchases of raw materials partially lowered the percentage of increase in the price of raw materials. The increase in electricity consumed and depreciation and amortization reflected our expansion of the number of production plants of bromine through acquisitions in 2009 and 2010.
Crude salt segment
The cost of net revenue for the crude salt segment for the fiscal year 2010 was $3,295,841, an increase of $251,195 (or 8%) compared to $3,044,646 for the same period in 2009. The increase was mainly attributable to an increase in the number of our crude salt fields for evaporation of crude salt, which increased the corresponding variable costs, such as resource taxes paid and depreciation and amortization of manufacturing plant and machinery. The significant cost components for the fiscal year 2010 were depreciation and amortization of $1,030,264 (or 31%), resource tax calculated based on the crude salt sold of $947,576 (or 29%) and electricity of $741,451 (or 23%). The significant cost components for the fiscal year 2009 were depreciation and amortization of $853,781 (or 28%), resource tax calculated based on the crude salt sold of $1,295,051 (42%) and electricity of $605,000 (20%). The table below represents the major production cost component of crude salt per ton for respective periods:
Our production cost of crude salt per ton was $8.9 for the fiscal year 2010, an increase of 5% (or $0.4) as compared to the same period in 2009, which attributable mainly to the components of depreciation and amortization of manufacturing plant and machinery and electricity. The increase in electricity consumed and depreciation and amortization reflected our expansion of the number of crude salt fields through acquisitions in 2009 and 2010. Other production costs represented mainly salaries and welfare of labor worked in the crude salt fields.
Chemical products segment
Cost of net revenue for the fiscal year 2010, was $28,428,096, representing an increase of $5,694,534 or 25% over the same period in 2009. The significant costs were cost of raw materials and finished goods consumed of $25,458,672 (or 90%) and $20,690,656 (91%) and depreciation and amortization of manufacturing plant and machinery of $1,673,358 (or 6%) and $1,118,478 (or 5%) for each of the fiscal years 2010 and 2009, respectively. Our raw materials consumed mainly composed of chemical elements, including bromine, and their costs were increased over this year due to the strong in demand. The rate of increase for the cost of net revenue for chemical products segment was similar to that of net revenue.
Gross Profit Gross profit was $78,080,264, or 49%, of net revenue for fiscal year 2010 compared to $47,579,037, or 43%, of net revenue for fiscal year 2009. The increase in gross profit percentage was primarily attributable to a rise of margin percentage in our bromine and crude salt
segments.
Bromine segment
For the fiscal year 2010, the gross profit margin for our bromine segment was 51% compared to 42% for fiscal year 2009. The increase in gross profit margin is mainly attributable to the increase in average selling price, which is partially offset by an increase in cost of raw materials and a decrease in the bromine concentration of brine water being extracted. For the fiscal year 2010, the average selling price of bromine increased from $1,854 per ton to $2,972 per ton compared to the fiscal year 2009, an increase of 60%. As mentioned before, due to a decrease in the bromine concentration of brine water being extracted limited our production capacity for 2010. We expect the trend will continue in 2011.
Crude salt segment
For the fiscal year 2010, the gross profit margin for our crude salt segment was 78% compared to 71% for the same period in 2009. For the fiscal year 2010, the average selling price of crude salt increased to $40.4 per ton, as compared from $29.9 per ton in the fiscal year 2009, an increase of 35%. As mentioned hereinbefore, the increase in average selling price was a result of increased demand of crude salt and the increase in the gross profit margin of crude salt was mainly due to the acquisition of a crude salt field in 2010 and three factories between mid-2009 and mid-2010 (Factories no. 7 to 9) which increased our productivity of crude salt and economies of scale.
Chemical products segment
The gross profit margin for chemical products segment remained stable for the fiscal year 2010 as compared to the fiscal year 2009. As our factory is capable of producing diversified chemical products, the selling price fluctuation of individual chemical products is not expected to have an impact on our gross profit margin for overall chemical products.
Research and Development Costs Research and development costs result from the agreement that SYCI and East China University of Science and Technology entered in June 2007 to establish a Co-Op Research and Development Center to develop new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry. All research findings and patents developed by this center will belong to Gulf Resources.
Since the second quarter of 2010, SYCI conducted research for the new production line of wastewater treatment additives, the purpose of which is for the testing the manufacturing routine and samples. The research and development expense incurred for the aforesaid new production line from outside parties and the use of SCHC’s products during the fiscal year 2010 were $847,919 and $848,990, respectively. The total research and development costs incurred for the year ended December 31, 2010 and 2009 was $2,200,291 and $500,406, respectively.
General and Administrative Expenses General and administrative expenses were $6,871,091 in fiscal year 2010, an increase of $1,526,258, or approximately 29%, from the general and administrative expenses of $5,344,833 during fiscal year 2009. This increase in general and administrative expenses was primarily due to (i) the loss on disposal of property, plant and equipment of approximately $1.3 million for the fiscal year 2010, as compared to approximately $0.5 million for fiscal year 2009; and (ii) the increase in salary and welfare payments, depreciation, and land duty and franchise tax by approximately $1.2 million. During the year ended December 31, 2010, we incurred a loss on disposal of property, plant and equipment of approximately $1.3 million (fiscal year 2009 $0.5 million) as the equipment being disposed of was specialized equipment used in the bromine and chemical production industry which has few suppliers and an inactive second-hand market, which resulted in low second-hand price. In order to take advantage of the increasing demand for environmentally friendly chemical products produced from bromine, we intend to focus our future chemical production on environmentally friendly products, and therefore, have disposed of certain machinery and equipment that has been used for other products. Also, in order to enhance our bromine production process, we disposed of certain outdated auxiliary machinery. Such increment was partly offset by the decrease in non-cash expenses related to stock options granted to our employees and a warrant granted to our investor relations firm by approximately $740,000.
Other Operating Income Other operating income was $223,715 for the fiscal year 2010, which represented the income from sales of wastewater to some of our customers since March 2010. Wastewater is generated from the production of bromine which eventually becomes crude salt when it evaporates. Not all of our bromine production plants have sufficient area on the property to allow for evaporation of wastewater to produce crude salt. Certain of our customers who have facilities located adjacent to our bromine production plants have agreed to channel our wastewater into brine pans on their properties for evaporation. These customers then are able to sell the resulting crude salt themselves. We have signed agreements with three of our customers to sell them our wastewater at market prices.
Income from Operations Income from operations was $69,096,233 in fiscal year 2010 (or 43.6% of net revenue), an increase of $27,384,147 (or approximately 65.7%) over income from operations in fiscal year 2009. This increase resulted primarily from the increase in net revenue and relatively lower increase in cost of net revenue as explained hereinbefore.
Bromine segment
Income from operations of bromine segment was $48,474,611 for the fiscal year 2010 (or 69% of the segment’s income from operations), an increase of $23,376,576 (or approximately 93%) compared with the fiscal year 2009. This increase resulted primarily from the increase in average selling price of bromine (contributed approximately $37.8 million), which was partially offset by (i) the increase in costs of net revenue, mainly raw material costs, of approximately $11.6 million and (ii) the decrease in sales volume of approximately $2.3 million due to the decreased concentration of brine water extracted.
Crude salt segment
Income from operations of crude salt segment was $11,360,476 for the fiscal year 2010 (or 16% of the segment’s income from operations), an increase of $4,032,431 (or approximately 55%) compared with the fiscal year 2009. The increase in the income from operations of crude salt was mainly due to (i) the increase in the selling price of crude salt, which contributed an increase of $3.8 million, and (ii) the increase in sales volume, which contributed an increase of another $0.5 million.
Chemical segment
In fiscal year 2010, income from operations in the chemical products segment was $12,218,613, a slight decrease of 2.5% from $12,530,417 in fiscal year 2009. The decrease in income from operations of our chemical products was due to the extensive research and development costs incurred for the new production line of wastewater treatment additives for fiscal year 2010 which offset increases in revenue from our environmentally friendly oil and gas exploration chemicals and agricultural intermediaries
Other Income, Net Other income was $241,936 for fiscal year 2010, an increase of $178,209 as compared to fiscal year 2009. Such increase in other income was primarily due to the increase in interest income of approximately $162,000.
Net Income Net income was $51,283,320 in fiscal year 2010, an increase of $20,691,905 (or approximately 68%) as compared to fiscal year 2009. This increase was primarily attributable to the increase in selling price of bromine and crude salt.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2011, cash and cash equivalents were $78,576,060 as compared to $68,494,480 as of December 31, 2010. The components of this increase of $10,081,580 are reflected below.
Statement of Cash Flows
For the fiscal years 2011, 2010 and 2009, we met our working capital and capital investment requirements mainly by using cash flows from operations and cash on hand. The Company intends to continue to explore opportunities relating to bromine asset purchases and new bromine resource development.
Net Cash Provided by Operating Activities
During the years ended December 31, 2011, 2010 and 2009, we had positive cash flow from operating activities of $59.0 million, $58.0 million and $39.8 million respectively, primarily attributable to net income.
During the year ended December 31, 2011, cash flow from operating activities of $59.0 million exceeded our net income of $31.0 million, which is caused by (i) cash used in working capital of $2.8 million for the fiscal year 2011, mainly consisted of inventory and tax paid; and (ii) our net income included substantial non-cash charges of $30.9 million, mainly in form of stock-based compensation, depreciation and amortization of property, plant and equipment and writ-off/impairment loss on property, plant and equipment.
During the year ended December 31, 2010, cash flow from operating activities of $58.0 million exceeded our net income of $51.3 million, which is caused by (i) cash used in working capital of $7.0 million for the fiscal year 2011, mainly consisted of inventory and accounts receivable; and (ii) our net income included substantial non-cash charges of $13.7 million, mainly in form of stock-based compensation, depreciation and amortization of property, plant and equipment and loss on disposal of property, plant and equipment.
During the year ended December 31, 2009, cash flow from operating activities of $39.8 million exceeded our net income of $30.6 million, which is caused by (i) cash used in working capital of $0.5 million for the fiscal year 2011, mainly consisted of inventory and accounts receivable; and (ii) our net income included substantial non-cash charges of $9.7 million, mainly in form of stock-based compensation, depreciation and amortization of property, plant and equipment and loss on disposal of property, plant and equipment.
Accounts receivable
Cash collections on our accounts receivable had a major impact on our overall liquidity. The following table presents the aging analysis of our accounts receivable as of December 31, 2011 and 2010.
The overall accounts receivable balance as of December 31, 2011 increased by $377,599 (or 1.8%), as compared to those as of December 31, 2010. Such increase is mainly attributable to the extended settlement days by customers due to the macro-economic tightening policy imposed by PRC government to slow down the economy, which in turn lengthened the turnover days of accounts receivable from customers from 42 days for the fiscal year 2010 to 48 days for the fiscal year 2011. Normally, a 90-days credit period is granted to customers with a good repayment history. We are not aware of any allowances for doubtful debts required for the fiscal year 2011 as we have policies in place to ensure that sales are made to customers with an appropriate credit history. We perform ongoing credit evaluation on the financial condition of our customers.
Inventory
Our inventory consists of the following:
The gross inventory level as of December 31, 2011 increased by $1,766,251 (or 65.7%), as compared to the gross inventory level as of December 31, 2010.
Raw materials slightly increased by 10% as of December 31, 2011 as compared to December 31, 2010. All of the raw materials are basic chemical industry materials, few of which have a possibility of loss over time, or major fluctuations in their prices. So, we concluded that all of our raw materials as of December 31, 2011 are fully realizable for production of finished goods without any impairment.
Our finished goods are mainly composed of bromine, crude salt and chemical products. Our chemical products are similar to raw materials, as there is no loss over time and a stable market price with a positive gross profit margin of 31% for the fiscal year 2011. Therefore, we believe that the realization of the chemical products is 100%. Similarly, as there is no depletion of bromine, we believe that the realization of it is also 100%. Although the gross profit margin for the fiscal year 2011 decreased to 48%, as compared with 51% in fiscal year 2010, we anticipated that the price in the next six months will not fluctuate significantly to impair the cost of bromine.
The annual loss of crude salt due to evaporation is around 3%. As the market price of crude salt is stable and the gross margin is high (70% for the fiscal year 2011), we believe that there will be no realizability problem for crude salt and its selling price should not be lower than its cost.
Net Cash Used In Investing Activities
Higher capital investments partially offset by compensation received from the PRC government for demolition of factory in 2011 drove the increase in cash used in investing activities compared to 2010. Higher capital investments and lower proceeds from asset sales in 2010 drove the increase in cash used in investing activities compared to 2009. The table below detailed the cash capital investments for the fiscal years 2011, 2010 and 2009:
In the fiscal year 2011, we carried out improvement and upgrade of bromine wells, transmission pipelines and aqueducts, and conversion of SYCI’s production line, in particular, we used (i) approximately $3 million cash to reconstruct and renovate a subdivision of Factory No. 1 which included bromine production facilities and brine water channels acquired under a capital lease; (ii) approximately $32.5 million cash to carry out enhancement projects to our existing bromine extraction and crude salt production facilities; and (iii) approximately $0.2 million cash for the conversion of a chemical production line from wastewater treatment chemical production line to bromopropane.
We also used (i) approximately $6.2 million cash for the construction of our new Factory No. 4 due to the taking of leased land by the PRC local government for redevelopment; (ii) approximately $10 million cash for acquisition of Factory No. 10; and (iii) approximately $1.1 million for other new plant and machinery.
These projects were financed by opening cash balances as of December 31, 2010 and cash generated from operations during fiscal year 2011.
Net Cash (Used In) Provided by Financing Activities
In the fiscal year 2011, we repaid approximately $0.3 million cash for our capital lease obligation and used another $0.5 million to repurchase 184,599 shares of common stock of the Company under the approval of the Board of Directors.
In the fiscal year 2010, we obtained cash of approximately $2.2 million from a private placement for settlement of assets acquisition.
In the fiscal year 2009, we raised cash of approximately $21.3 million from private placements for settlement of note and loan payable, and repayment to related parties.
We believe that our available funds and cash flows generated from operations will be sufficient to meet our anticipated ongoing operating needs for the next twelve (12) months. However we will likely need to raise additional capital in order to fund the ongoing program of acquiring unlicensed bromine properties, increasing our chemical production capacity and developing new bromine and crude salt production line in Sichuan Province, PRC. We expect to raise those funds through credit facilities obtained with lending institutions. There can be no guarantee that we will be able to obtain such funding, whether through the issuance of debt or equity, on terms satisfactory to management and our board of directors.
Working capital was approximately $93.3 million at December 31, 2011 as compared to approximately $79.8 million at December 31, 2010. The increase was mainly attributable to the cash provided by operating activities during fiscal year 2011.
We had available cash of approximately $78.6 million at December 31, 2011, most of which are in highly liquid current deposits with no or little interest rate. We intend to retain the cash for future expansion of our bromine and crude salt businesses through acquisition, enhancement works to our existing bromine and crude salt business, and exploration cost of new brine water resources in Sichuan Province, and we do not anticipate paying cash dividends in the foreseeable future.
In the future we intend to focus our efforts on the activities of SCHC and SYCI as these segments continue to expand within the Chinese market. We also intend to explore the possibility of cooperation with overseas large-scale bromine manufacturers for expansion into overseas markets. As a result, we may issue additional shares of our capital stock and incur new debt in order to raise cash for acquisitions and other capital expenditures during the next twelve months.
We may not be able to identify, successfully integrate or profitably manage any businesses or business segment we may acquire, or any expansion of our business. An expansion may involve a number of risks, including possible adverse effects on our operating results, diversion of management attention, inability to retain key personnel, risks associated with unanticipated events and the financial statement effect of potential impairment of acquired intangible assets, any of which could have a materially adverse effect on our condition and results of operations. In addition, if competition for acquisition candidates or operations were to increase, the cost of acquiring businesses could increase materially. We may effect an acquisition with a target business which may be financially unstable, under-managed, or in its early stages of development or growth. In addition, if competition for acquisition candidates or operations were to increase, the cost of acquiring businesses could increase materially. Our inability to implement and manage our expansion strategy successfully may have a material adverse effect on our business and future prospects.
Contractual Obligations and Commitments
As described in the notes to the Consolidated Financial Statements and as referenced in the tables below, we have contractual obligations and commercial commitments that may affect our financial condition. Based on our assessment of the underlying provisions and circumstances of our contractual obligations and commercial commitments, including material sources of off-balance sheet and structured finance arrangements, other than the risks that we and other similarly situated companies face with respect to the condition of the capital markets (as described in Item 1A of Part I of this report), there is no known trend, demand, commitment, event, or uncertainty that is reasonably likely to occur that would have a material adverse effect on our consolidated results of operations, financial condition, or liquidity. In addition, our commercial obligations, financings, and commitments are customary transactions that are similar to those of other comparable corporations. The following table sets forth payments due by period for fixed contractual obligations as of December 31, 2011.
Material Off-Balance Sheet Arrangements
We do not currently have any off-balance sheet arrangements falling within the definition of Item 303(a) of Regulation S-K.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), which requires us to make judgments, estimates and assumptions. See “Note 1 - Nature of Business and Summary of Significant Accounting Policies,” in Notes to the Consolidated Financial Statements, which is included in “Item 8. Financial Statements and Supplementary Data,” which describes our significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The methods, estimates and judgments that we use in applying our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain.
Our most critical estimates include:
•allowance for doubtful accounts, which impacts revenue;
•the valuation of inventory, which impacts gross margins;
•impairment of long-lived assets;
•the valuation and recognition of share-based compensation, which impacts gross margin and operating expenses; and
•the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions), which impact our provision for taxes.
Allowance for Doubtful Accounts
We makes estimates of the uncollectibility of accounts receivable, especially analyzing accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts. Credit evaluations are undertaken for all major sale transactions before shipment is authorized. On a quarterly basis, we evaluate aged items in the accounts receivable aging report and provide an allowance in an amount we deem adequate for doubtful accounts. If management were to make different judgments or utilize different estimates, material differences in the amount of our reported operating expenses could result.
Inventory Valuation
Inventory is stated at the lower of cost or market, with cost determined on a first-in first-out basis. The carrying value of inventory is reduced for estimated obsolescence by the difference between its cost and the estimated market value based upon assumptions about future demand. We evaluate the inventory carrying value for potential excess and obsolete inventory exposures by analyzing historical and anticipated demand. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required in the future, which could have a material adverse effect on our results of operations.
Depreciation of Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation and any impairment losses. Expenditures for new facilities or equipment, and major expenditures for betterment of existing facilities or equipment are capitalized and depreciated using the straight-line method at rates sufficient to depreciate such costs over the estimated productive lives. All other ordinary repair and maintenance costs are expensed as incurred. Mineral rights are recorded at cost less accumulated depreciation and any impairment losses. Mineral rights are amortized ratably over the term of the lease, or the equivalent term under the units of production method, whichever is shorter. In some situations, the life of the asset may be extended or shortened if circumstances arise that would lead us to believe that the estimated life of the asset has changed. The life of leasehold improvements may change based on the extension of lease contracts with our landlords. Changes in the estimated lives of assets will result in an increase or decrease in the amount of depreciation recognized in future periods.
Impairment of Long Lived Assets
We periodically evaluate whether events or circumstances have occurred that indicate long-lived assets may not be recoverable or that the remaining useful life may warrant revision. When such events or circumstances are present, we assess the recoverability of long-lived assets by determining whether the carrying value will be recovered through the expected undiscounted future cash flows resulting from the use of the asset. In the event the sum of the expected undiscounted future cash flows is less than the carrying value of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded.
Valuation Allowance on Deferred Tax Assets
We evaluate our deferred income tax assets to determine if valuation allowances are required or should be adjusted. A valuation allowance is established against our deferred tax assets based on consideration of all available evidence, both positive and negative, using a “more likely than not” standard. This assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the duration of statutory carry forward periods, our experience with tax attributes expiring unused and tax planning alternatives. In making such judgments, significant weight is given to evidence that can be objectively verified.
Stock-based compensation
We account for stock-based compensation in accordance with the fair value recognition provisions of U.S. GAAP. We use the Black-Scholes model which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them, the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements. The assumptions for expected volatility and expected term are the two assumptions that significantly affect the grant date fair value. Changes in expected risk-free rate of return do not significantly impact the calculation of fair value, and determining this input is not highly subjective.
We use annualized historical stock price volatility which is deemed to be appropriate to serve as the expected volatility of our stock price and is assumed to be constant and prevailing. The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected term is based on the observed and expected time to post-vesting exercise of options by employees. We use historical exercise patterns of previously granted options in relation to stock price movements to derive an employee behavioral pattern used to forecast expected exercise patterns.
U.S. GAAP requires us to develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. Adjustments in the estimated forfeiture rates can have a significant effect on our reported share-based compensation, as we recognize the cumulative effect of the rate adjustments for all expense amortization in the period the estimated forfeiture rates were adjusted. We estimate and adjust forfeiture rates based on a periodic review of recent forfeiture activity and expected future employee turnover. If a revised forfeiture rate is higher than previously estimated forfeiture rate, we may make an adjustment that will result in a decrease to the expense recognized in the financial statements during the period when the rate was changed. Adjustments in the estimated forfeiture rates could also cause changes in the amount of expense that we recognize in future periods.
Recent Accounting Pronouncements
See “Note 1 - Nature of Business and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on Consolidated Balance Sheets and Consolidated Statements of Income.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Credit Risk
The Company is exposed to credit risk from its cash at bank and fixed deposits and accounts receivable. The credit risk on cash at bank and fixed deposits is limited because the counterparties are recognized financial institutions. Accounts receivable are subjected to credit evaluations. An allowance has been made for estimated irrecoverable amounts which have been determined by reference to past default experience and the current economic environment.
Foreign Exchange Risk
The value of the RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. Since July 2005, the RMB has no longer been pegged to the U.S. Dollar at a constant exchange rate. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate within a flexible peg range against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Because substantially all of our earnings and cash assets are denominated in RMB, but our reporting currency is the U.S. dollar, fluctuations in the exchange rate between the U.S. dollar and the RMB will affect our balance sheet and our earnings per share in U.S. dollars. In addition, appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue in the future that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Most of the transactions of the Company are settled in RMB and U.S. dollars. In the opinion of the directors, the Company is not exposed to significant foreign currency risk.
Impact of Inflation
Inflationary factors, such as increases in the cost of our product and overhead costs, may adversely affect our operating results. Based on the Consumer Price Index in the PRC, the average annual rate of inflation over the three-year period from 2008 to 2010 was 2.8%. Inflationary pressures increased in 2011, reflecting the rise in our cost of raw materials and electricity expenses. As of January 31, 2012, the rate of inflation was 4.6%. The Company believes that in the long run the selling prices of its products could be increased at a similar level to compensate the adverse effect. In the foreseeable future, a high rate of inflation may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.
Company’s Operations are Substantially in Foreign Countries
Substantially all of our operations are conducted in China and are subject to various political, economic, and other risks and uncertainties inherent in conducting business in China. Among other risks, the Company and its subsidiaries’ operations are subject to the risks of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations. Additional information regarding such risks can be found under the heading “Risk Factors” in this Form 10-K.
Item 8.
Item 8. Financial Statements and Supplementary Data (in thousands).
(1)For the fourth quarter of fiscal years 2011, our operating income margin recognized was 6.2%, a decrease of 17.0% as compared with the third quarter of 2011. This decrease resulted primarily from (i) the decrease in sales volume of bromine and crude salt by 23.4% or 1,612 tonnes (from 6,900 tonnes in third quarter of 2011) and 2.1% or 1,386 tonnes (from 66,014 tonnes in third quarter of 2011), respectively, due to the traditional low season during the winter; (ii) the drop in gross profit margins of bromine to 35% (from 40% in third quarter of 2011) and crude salt to 48% (from 55% in third quarter of 2011) due to the continual macro-economic tightening policy imposed by the PRC government since the second quarter of 2011; (iii) consultancy fee of $3.15 million paid to an unrelated PRC agent in the fourth quarter of 2011 for searching suitable crude salt fields and bromine factories for acquisition; and (iv) the increase in repair and maintenance expenses for our bromine factories by $1 million from the quarter of 2011. Following our acquisition of several bromine factories in recent years, the core manufacturing machineries were in need of repair and maintenance. Management decided it would be best to carry out such work during our traditionally slower period in winter, which is resulted in a significant amount of the work and expense was carried out in the fourth quarter of 2011. The repair and maintenance costs of $0.1 million incurred during the nine-months ended September 30, 2011 represented only miscellaneous routine maintenance work for day-to-day operations and not the full repair and maintenance.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 and 2009
CONTENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Gulf Resources, Inc. and Subsidiaries
We have audited the internal control over financial reporting of Gulf Resources, Inc. and Subsidiaries (the "Company") as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management’s assessment:
1.Improper accounting for translation loss on intercompany payable, denominated in a foreign currency, due to a subsidiary.
2.Failure to maintain effective control over the identification of a related party and the disclosure of related party transactions in the Company’s consolidated financial statements.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2011 consolidated financial statements and financial statement schedule, and this report does not affect our report dated March 15, 2012 on these consolidated financial statements and financial statement schedule.
In our opinion, because of the effect of the aforementioned material weaknesses on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Management’s Report on Internal Control Over Financial Reporting contains disclosures about corrective actions taken by the entity after the date of management’s assessment relating to material weaknesses that existed as of December 31, 2011. The scope of our work was not sufficient to enable us to express, and we do not express, an opinion about such corrective actions.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2011 of the Company and our report dated March 15, 2012 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.
/s/ Morison Cogen LLP
Bala Cynwyd, Pennsylvania
March 15, 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Gulf Resources, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Gulf Resources, Inc. and Subsidiaries (the "Company") as of December 31, 2011, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for the year ended December 31, 2011. Our audit also included the financial statement schedule as of and for the year ended December 31, 2011 listed in the Index at Item 15(a)2. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2011, and the consolidated results of their operations and their cash flows for the year ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule as of and for the year ended December 31, 2011, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2012 expressed an adverse opinion on the Company’s internal control over financial reporting because of material weaknesses.
/s/ Morison Cogen LLP
Bala Cynwyd, Pennsylvania
March 15, 2012
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Gulf Resources, Inc.
We have audited the accompanying consolidated balance sheet of Gulf Resources, Inc. (the “Company”) as of December 31, 2010, and the related consolidated statements of income and comprehensive income, stockholders' equity and cash flows for the years ended December 31, 2010 and 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2010, and the results of its operations and its cash flows for the years ended December 31, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO Limited
BDO Limited
Hong Kong, March 16, 2011
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. dollars)
The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Expressed in U.S. dollars)
The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2011, 2010 AND
(Expressed in U.S. dollars)
The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. dollars)
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Expressed in U.S. dollars)
The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
(Expressed in U.S. dollars)
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The accompanying audited consolidated financial statements have been prepared by Gulf Resources, Inc. a Delaware corporation and its subsidiaries (collectively, the “Company”).
Upper Class Group Limited was incorporated with limited liability in the British Virgin Islands on July 28, 2006 and was inactive until October 9, 2006 when Upper Class Group Limited acquired all the issued and outstanding stock of Shouguang City Haoyuan Chemical Company Limited (“SCHC”). SCHC is an operating company incorporated in Shouguang City, Shangdong Province, the People’s Republic of China (the “PRC”) on May 18, 2005. SCHC is engaged in manufacturing and trading bromine and crude salt in China. Since the ownership of Upper Class Group Limited and SCHC were the same, the merger was accounted for as a transaction between entities under common control, whereby Upper Class Group Limited recognized the assets and liabilities transferred at their carrying amounts.
On December 12, 2006, Gulf Resources, Inc. (formerly Diversifax, Inc.), a public “shell” company, acquired Upper Class Group Limited and its wholly-owned subsidiary, SCHC (together “Upper Class”). Under the terms of the agreement, all stockholders of Upper Class received a total amount of 13,250,000 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of voting common stock of Gulf Resources, Inc. in exchange for all shares of Upper Class’ common stock held by all stockholders. Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction in substance, rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class for the net monetary assets of Gulf Resources, Inc., accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange will be identical to that resulting from a reverse acquisition, except no goodwill will be recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class, which is considered to be the accounting acquirer. Share and per share amounts stated have been retroactively adjusted to reflect the merger.
On February 5, 2007, SCHC acquired Shouguang Yuxin Chemical Industry Co., Limited (“SYCI”), a company incorporated in PRC on October 30, 2000. SYCI manufactures chemical products utilized in oil and gas field explorations and as papermaking chemical agents. Under the terms of the merger agreement, all stockholders of SYCI received a total amount of 8,094,059 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of voting common stock of Gulf Resources, Inc. in exchange for all shares of SYCI’s common stock held by all stockholders. Also, upon the completion of the merger, Gulf Resources, Inc. paid a $2,550,000 dividend to the original stockholders of SYCI. Since the ownership of Gulf Resources, Inc. and SYCI are substantially the same, the merger was accounted for as a transaction between entities under common control, whereby Gulf Resources, Inc. recognized the assets and liabilities of the Company transferred at their carrying amounts. Share and per share amounts stated have been retroactively adjusted to reflect the merger.
On November 11, 2007, Upper Class formed Hong Kong Jiaxing Industrial Limited (formerly known as Jiaxing Technology Limited) (“HKJI”), a wholly-owned subsidiary of Upper Class, in Hong Kong. Upper Class transferred its equity interest in SCHC to HKJI.
The adoption of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC” or “Codification”) did not result in significant effect in the accounting policies adopted by the Company.
All relevant share data have been adjusted retrospectively to reflect a 1-for-4 stock split effective on October 12, 2009.
(b) Nature of the Business
The Company manufactures and trades bromine and crude salt through SCHC, and manufactures chemical products for use in the oil industry and paper manufacturing industry through SYCI.
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
(c) Basis of Consolidation
The consolidated financial statements include the accounts of Gulf Resources, Inc. and its wholly-owned subsidiaries, Upper Class, a company incorporated in the British Virgin Islands, which owns 100% of HKJI, a company incorporated in Hong Kong, which owns 100% of SCHC and SYCI, which is 100% owned by SCHC. All material intercompany transactions have been eliminated on consolidation.
The consolidated financial statements have been restated for all periods prior to the mergers to include the financial position, results of operations and cash flows of the commonly controlled companies.
(d) Use of Estimates
The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and this requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The most significant accounting estimates with regard to these consolidated financial statements that require the most significant and subjective judgments include, but are not limited to, useful lives of property, plant and equipment, recoverability of long-lived assets, determination of impairment losses, assessment of market value of inventories and provision for inventory obsolescence, allowance for doubtful accounts, recognition and measurement of current and deferred income taxes, valuation allowance for deferred tax assets, and assumptions used for the valuation of share based payments. Accordingly, actual results may differ significantly from these estimates under different assumptions or conditions.
(e) Cash and Cash Equivalents
Cash and cash equivalents consist of all cash balances and highly liquid investments with original maturities of three months or less. Because of short maturity of these investments, the carrying amounts approximate their fair values.
(f) Accounts Receivable and Allowance of Doubtful Accounts
Accounts receivable is stated at cost, net of allowance for doubtful accounts. The Company establishes an allowance for doubtful accounts based on management’s assessment of the collectability of trade and other receivables. A considerable amount of judgment is required in assessing the amount of allowance and the Company considers the historical level of credit losses and applies certain percentage to accounts receivable balance. The Company makes judgments about the credit worthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the customer begins to deteriorate, resulting in their inability to make payments, a larger allowance may be required.
As of December 31, 2011 and 2010, allowance for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the years ended December 31, 2011, 2010 and 2009.
(g) Concentration of Credit Risk
The Company is exposed to credit risk in the normal course of business, primarily related to accounts receivable and cash and cash equivalents. Substantially all of the Company’s cash and cash equivalents are maintained with financial institutions in the PRC, namely, Industrial and Commercial Bank of China Limited and China Merchants Bank Company Limited, which are not insured or otherwise protected. The Company placed $78,526,060 and $68,444,480 with these institutions as of December 31, 2011 and 2010, respectively. The Company has not experienced any losses in such accounts in the PRC.
Concentrations of credit risk with respect to accounts receivable exists as the Company sells a substantial portion of its products to a limited number of customers. However, such concentrations of credit risks are limited since the Company performs ongoing credit evaluations of its customers’ financial condition and due to the generally short payment terms. The balances of accounts receivable as of December 31, 2011 and 2010 are all amounts outstanding for less than three months.
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
(h) Inventories
Inventories are stated at the lower of cost, determined on a first-in first-out cost basis, or market. Costs of work-in-progress and finished goods comprise direct materials, direct labor and an attributable portion of manufacturing overhead. Net realizable value is based on estimated selling price less costs to complete and selling expenses.
(i) Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation and any impairment losses. Expenditures for new facilities or equipment, and major expenditures for betterment of existing facilities or equipment are capitalized and depreciated using the straight-line method at rates sufficient to depreciate such costs over the estimated productive lives. All other ordinary repair and maintenance costs are expensed as incurred.
Mineral rights are recorded at cost less accumulated depreciation and any impairment losses. Mineral rights are amortized ratably over the term of the lease, or the equivalent term under the units (in tonnes) of production method, whichever is shorter.
Construction in progress primarily represents direct costs of construction of property, plant and equipment. Costs incurred are capitalized and transferred to property, plant and equipment upon completion, at which time depreciation commences.
The Company’s depreciation and amortization policies on property, plant and equipment other than mineral rights and construction in progress are as follows:
In April 2011, the Company changed the estimated useful life of certain protective shells and transmission channels and ducts that included in plant and machinery from 8 years to 5 years. Initially, the Company expected the protective shells’ useful lives would be 8 years with reference to the past wear and tear experienced in 2005. In view of the increased rate of erosion experienced in last 2 years, which reduced the volume of brine water flowing into the bromine production process and adversely affected the annual bromine and crude salt production capacities and efficiencies; and the recent directional information from the Crude Salt Institutional Association in Shandong Province, PRC, which indicated that the latest erosion rate would be 20% per annum, the Company reduced the useful lives of such protective shells to 5 years to reflect the most productive cycle. Changes in estimates are accounted for on a prospective basis, by depreciating those plant and machinery current carrying values over their revised remaining useful lives. The effect of this change in estimate, compared to the original depreciation, for fiscal year 2011 was a pre-tax increment in depreciation expense of $975,517. The pre-tax increase (decrease) to depreciation expense in future periods is expected to be $1,115,252, $836,863, $219,197, ($380,464), ($1,225,851), ($927,600), ($566,456) and ($46,457) in the eight years ending December 31, 2019.
Property, plant and equipment under capital leases are depreciated over their expected useful lives on the same basis as owned assets, or where shorter, the term of the lease, which is 20 years.
(j) Asset Retirement Obligation
The Company follows FASB ASC 410, which established a uniform methodology for accounting for estimated reclamation and abandonment costs. FASB ASC 410 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which the legal obligation associated with the retirement of the long-lived asset is incurred. When the liability is initially recorded, the offset is capitalized by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. To settle the liability, the obligation is paid, and to the extent there is a difference between the liability and the amount of cash paid, a gain or loss upon settlement is recorded.
Currently, there are no reclamation or abandonment obligations associated with the land being utilized for exploitation.
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
(k) Recoverability of Long Lived Assets
In accordance with ASC 360-10-35 “Impairment or Disposal of Long-lived Assets”, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable or that the useful lives of those assets are no longer appropriate. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment.
The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the carrying amount of the assets. An impairment loss, if one exists, is then measured as the amount by which the carrying amount of the asset exceeds the discounted estimated future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value of such assets less costs to sell. Asset impairment charges are recorded to reduce the carrying amount of the long-lived asset that will be sold or disposed of to their estimated fair values. Charges for the asset impairment reduce the carrying amount of the long-lived assets to their estimated salvage value in connection with the decision to dispose of such assets.
In accordance with the provisions of the FASB ASC 360-10 “Impairment or Disposal of Long-lived Assets” subsections, (i) owned long-lived assets held and used with a carrying amount of $9,421,857 were written down to their fair value of $7,616,259, resulting in an impairment charge of $1,805,598, which was included in earnings for the year ended December 31, 2011; and (ii) long-lived assets held and used under capital lease with a carrying amount of $3,051,054 were written down to their fair value of $2,368,008, resulting in an impairment charge of $683,046, which was included in earnings for the year ended December 31, 2011. The following table sets forth the fair value and related impairment charges for the year ended December 31, 2011:
The above owned long-lived assets, which is classified as Level 3 in the fair value hierarchy, was valued using a discounted cash flow model incorporating assumptions that, in management’s judgment, reflect the assumptions marketplace participants would use at December 31, 2011. Such assumptions included an estimate of future cash flows and a discount rate based on the 5-year PRC Treasury bill rate.
The long-lived assets held under capital lease, which is classified as Level 2 in the fair value hierarchy, was valued by an independent appraiser using the market approach, which included mainly quoted prices for similar assets.
The Company determined that no impairment was required after going through the impairment testing to the operating long-lived assets as of December 31, 2010.
(l) Retirement Benefits
Pursuant to the relevant laws and regulations in the PRC, the Company participates in a defined contribution retirement plan for its employees arranged by a governmental organization. The Company makes contributions to the retirement scheme at the applicable rate based on the employees’ salaries. The required contributions under the retirement plans are charged to the consolidated income statement on an accrual basis when they are due. The Company’s contributions totaled $431,428, $457,805 and $270,324 for the years ended December 31, 2011, 2010 and 2009, respectively.
(m) Mineral Rights
The Company follows FASB ASC 805 “Business Combinations” that certain mineral rights are considered tangible assets and that mineral rights should be accounted for based on their substance. Mineral rights are included in property, plant and equipment.
(n) Leasing arrangements
Rentals payable under operating leases are charged to the statements of income on a straight line basis over the term of the relevant lease. For capital leases, the present value of future minimum lease payments at the inception of the lease is reflected as an asset and a liability in the statement of financial position. Amounts due within one year are classified as short-term liabilities and the remaining balance as long-term liabilities.
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
(o) Reporting Currency and Translation
The financial statements of the Company’s foreign subsidiaries are measured using the local currency, Renminbi (“RMB”), as the functional currency; whereas the functional currency and reporting currency of the Company is the United States dollar (“USD” or “$”).
As such, the Company uses the “current rate method” to translate its PRC operations from RMB into USD, as required under ASC 830 “Foreign Currency Matters”. The assets and liabilities of its PRC operations are translated into USD using the rate of exchange prevailing at the balance sheet date. The capital accounts are translated at the historical rate. Adjustments resulting from the translation of the balance sheets of the Company’s PRC subsidiaries are recorded in stockholders’ equity as part of accumulated comprehensive income. The statement of income and comprehensive income is translated at average rates during the reporting period. Gains or losses resulting from transactions in currencies other than the functional currencies are recognized in net income for the reporting periods as part of general and administrative expense. The statement of cash flows is translated at average rates during the reporting period, with the exception of issuance of shares and payment of dividends which are translated at historical rates.
(p) Foreign Operations
All of the Company’s operations and assets are located in PRC. The Company may be adversely affected by possible political or economic events in this country. The effect of these factors cannot be accurately predicted.
(q) Revenue Recognition
The Company recognizes revenue, net of value-added tax, when persuasive evidence of an arrangement exists, delivery of the goods has occurred, customer acceptance has been obtained, which means the significant risks and ownership have been transferred to the customer, the price is fixed or determinable and collectability is reasonably assured.
(r) Income Taxes
The Company accounts for income taxes in accordance with the Income Taxes Topic of the FASB ASC, which requires the use of the liability method of accounting for deferred income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences on future years of temporary differences between the tax basis of assets and liabilities and their reported amounts at each period end. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. The guidance also provides criteria for the recognition, measurement, presentation and disclosures of uncertain tax positions. A tax benefit from an uncertain tax position may be recognized if it is “more likely than not” that the position is sustainable based solely on its technical merits.
(s) Exploration Costs
Exploration costs, which included the cost of researching appropriate places to drill wells and the cost of actual drilling of potential natural brine resources, were charged to the income statement as incurred. For the year ended December 31, 2011, the Company incurred exploration costs in the amount of $7,034,153, in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. The Company completed the drilling of exploratory wells in December 2011 and received a testing report in mid-January 2012 which confirmed the underground brine water resources.
(t) Shipping and Handling Fees and Costs
The Company does not charge its customers for shipping and handling as all customers arrange their own transportation of finished goods. The Company classifies shipping and handling costs for purchase of raw materials as part of the cost of net revenue, which amounted to $506,331, $567,686 and $492,582 for the years ended December 31, 2011, 2010 and 2009, respectively.
(u) Contingencies
The Company accrues for costs relating to litigation, including litigation defense costs, claims and other contingent matters, including liquidated damage liabilities, when such liabilities become probable and reasonably estimable. Such estimates may be based on advice from third parties or on management’s judgment, as appropriate. Revisions to accruals are reflected in earnings (loss) in the period in which different facts or information become known or circumstances change that affect the Company’s previous assumptions with respect to the likelihood or amount of loss. Amounts paid upon the ultimate resolution of such liabilities may be materially different from previous estimates.
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
(v) Stock-based Compensation
Common stock, stock options and stock warrants issued to employees or directors are recorded at their fair values estimated at grant date using the Black-Scholes model and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period.
Common stock, stock options and stock warrants issued to other than employees or directors are recorded on the basis of their fair value using the Black-Scholes model on the basis of the market price of the underlying common stock on the “valuation date,” which for options and warrants related to contracts that have substantial disincentives to non-performance is the date of the contract, and for all other contracts the measurement date is the date that the service is complete. Expense related to the options and warrants is recognized on a straight-line basis over the shorter of the period over which services are to be received or the vesting period. Where expense must be recognized prior to a valuation date, the expense is computed under the Black-Scholes model on the basis of the market price of the underlying common stock at the end of the period, and any subsequent changes in the market price of the underlying common stock up through the valuation date is reflected in the expense recorded in the subsequent period in which that change occurs.
(w) Basic and Diluted Net Income per Share of Common Stock
Basic earnings per common share are based on the weighted average number of shares outstanding during the periods presented. Diluted earnings per share are computed using weighted average number of common shares plus dilutive common share equivalents outstanding during the period. Anti-dilutive common stock equivalents which were excluded from the calculation of number of dilutive common stock equivalents amounted to 535,449, 14,250 and 305,449 shares for the years ended December 31, 2011, 2010 and 2009, respectively.
The following table sets forth the computation of basic and diluted earnings per share:
(x) Reclassification
The Company reclassified mineral resources compensation fees, previously included in “General and administrative expenses”, for year ended December 31, 2009 into “Cost of net revenue” and sales of wastewater and gain or loss on disposal of property, plant and equipment, previously included in “Other Income (Expense)” after “Income from Operations”, for the years ended December 31, 2010 and 2009 into “Other operating income” for sales of wastewater and gain on disposal of property, plant and equipment and “General and administrative expenses” for loss on disposal of property, plant and equipment to conform to the current year presentation. The above reclassifications had no impact on previously reported net income for the years ended December 31, 2010 and 2009.
(y) Recently adopted accounting pronouncements
In October 2009, the FASB issued Accounting Standard Update (“ASU”) No. 2009-13, “Multiple-Delivery Revenue Arrangements” (“ASU 2009-13”), which establishes the accounting and reporting guidance for arrangements including multiple deliverable revenue-generating activities, and provides amendments to the criteria for separating deliverables, and measuring and allocating arrangement consideration to one or more units of accounting.
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
(y) Recently adopted accounting pronouncements - Continued
The amendments of ASU 2009-13 also establish a hierarchy for determining the selling price of a deliverable, and require significantly enhanced disclosures to provide information about a vendor’s multiple-deliverable revenue arrangements, including information about their nature and terms, significant deliverables, and the general timing of delivery. The amendments also require disclosure of information about the significant judgments made and changes to those judgments, and about how the application of the relative selling price method affects the timing or amount of revenue recognition. The amendments of ASU 2009-13 are effective prospectively for revenue arrangements entered into or materially modified in annual reporting periods beginning on or after June 15, 2010. On January 1, 2011, the Company adopted ASU 2009-13 on a prospective basis. The adoption did not have a material impact on the Company’s financial position or results of operations, but could have an impact on how the Company accounts for any future collaboration agreements, should the Company enter into any such agreements in the future.
In January 2010, FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements” (“ASU2010-06”). This update provides amendments to ASC Topic 820 that provide disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted the disclosure requirements effective January 1, 2011. The adoption of this update did not have a material impact to the Company’s financial position.
(z) Recently issued accounting pronouncements not yet adopted
In May 2011, FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 82) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). The amendments in this update will ensure that fair value has the same meaning in U.S. GAAP and in IFRS and that their respective fair value measurement and disclosure requirements are the same. This update is effective prospectively for interim and annual periods beginning after December 15, 2011. Early adoption by public entities is not permitted, and the Company is therefore required to adopt this ASU on January 1, 2012. The Company is evaluating the guidance and does not expect its adoption to have a material impact on the Company’s results of operations, financial position or cash flows.
In June 2011, FASB issued ASU No. 2011-05, Comprehensive Income (“ASU 2011-05”), which will require companies to present the components of net income and other comprehensive income (“OCI”) either as one continuous statement or as two consecutive statements. ASU 2011-05 eliminates the option to present components of OCI as part of the statement of changes in stockholders’ equity. The update does not change the items which must be reported in OCI, how such items are measured or when they must be reclassified to net income. In December 2011, FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05” (“ASU 2011-12”), which defers the requirement in ASU 2011-05 that companies present reclassification adjustments for each component of accumulated OCI and OCI. ASU 2011-05 was set to be effective for interim and annual periods beginning after December 15, 2011, but is deferred by ASU 2011-12. The Company does not expect ASU 2011-05 or ASU 2011-12 to have a material impact on its financial statements or results of operations.
In December 2011, FASB issued ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”), which will require disclosures for entities with financial instruments and derivatives that are either offset on the balance sheet in accordance with ASC 210-20-45 or ASC 815-10-45, or subject to a master netting arrangement. ASU 2011-11 is effective for interim and annual periods beginning on or after January 1, 2013. The Company has not completed its review of ASU 2011-11, but it does not expect its adoption to have a material impact on the Company’s results of operations, financial position or cash flows.
The Company does not believe that any other accounting standards and guidance with an effective date during year ended December 31, 2011 or issued during 2011 had or are expected to have a significant impact on the Company’s consolidated financial statements and the disclosures presented in the consolidated financial statements.
NOTE 2 - ASSETS ACQUISITIONS
On January 7, 2009, the Company acquired substantially all of the assets owned by Qiufen Yuan, Han Wang and Yufen Zhang in the Shouguang City Renjiazhuangzi Village North Area (the “Qiufen Yuan, Han Wang & Yufen Zhang property” or “Factory No. 7”). The Qiufen Yuan, Han Wang and Yufen Zhang property includes a 50-year land lease covering 1,611 acres of real property, with the related production facility, the pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was $10,615,000, consisting of $10,000,000 in cash and 375,000 shares of the Company’s Common Stock valued at $615,000 (fair value).
NOTE 2 - ASSETS ACQUISITIONS - Continued
On September 7, 2009, the Company acquired substantially all of the assets owned by Yuliang Gao, Han Wang and Qing Yang in the Shouguang City Yingli Township Beishan Village (the “Yuliang Gao, Han Wang & Qing Yang property” or “Factory No. 8”). Fengxia Yuan acted as Attorney-in-Fact for one of the owners of Factory 8, Yuliang Gao, and entered into the acquisition agreement relating to Factory 8 on behalf of Yuliang Gao. The Yuliang Gao, Han Wang and Qing Yang property includes a 50-year land lease covering 2,723 acres of real property, with the related production facility, the pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was $16,930,548, consisting of $11,516,960 in cash and 1,057,342 shares of the Company’s Common Stock valued at $5,413,588 (fair value).
On June 7, 2010, the Company acquired substantially all of the assets owned by Jinjin Li and Qiuzhen Wang in the Shouguang City Yangkou Township Yangzhuang Village (the “Jinjin Li and Qiuzhen Wang property” or “Factory No. 9”). Jinjin Li was acting individually and as Attorney-in-Fact for four other owners of Factory 9, Yueliang Wang, Kunming Tian, Gaoming Tian and Zhiqiang Wei. The Jinjin Li and Qiuzhen Wang property includes a 50-year land lease covering 759 acres of real property, with the related production facility, the pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was $13,905,719, consisting of $13,297,492 in cash and 70,560 shares of the Company’s Common Stock valued at $608,227 (fair value).
On December 30, 2010, SCHC acquired substantially all of the assets owned by the State-Operated Shouguang Qingshuibo Farm (the “Crude Salt Field”). The Crude Salt Field includes a 30-year land lease covering 568 acres of crude salt field, as well as the related fixtures and facilities located on the crude salt field. The total purchase price for the Crude Salt Field was $11,023,000 in cash consideration.
Pursuant to the lease contract signed by SCHC on November 5, 2010 with State-Operated Shouguang Qingshuibo Farm (the “Lessor”), the Company recognized in January 2011 (1) a 20-year capital lease of a real property adjacent to Factory No. 1, with the related production facility, channels and ducts, other production equipment and the buildings located on the property, with an annual payment of RMB1,877,000 (approximately $295,365) up to December 31, 2030 to the Lessor, aggregating $3,127,913 (the present value of the minimum lease payments); and (2) a 20-year land lease and rights to new extraction wells on which the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings are situated, with an annual payment of RMB3,123,000 (approximately $495,651) up to December 31, 2030 to the Lessor. The lease was accounted for under FASB ASC 840-10-25 “Leases - Recognition” and the cost of $3,127,913 was included in property, plant equipment under capital lease in the first quarter of 2011.
The Company also enhanced the new plant and machinery leased in the first quarter of 2011 by making capital improvement in reconstruction and renovation work at a cost of approximately $3,050,400, which was recorded as buildings and plant and machinery, for the operation of the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings located on the property.
In the second quarter of 2011, the Company carried out enhancement projects to its existing bromine extraction and crude salt production facilities. In particular, the Company incurred reconstruction and renovation works at a cost of approximately $12,379,153 for its crude salt fields in Factory No. 1, 5 to 9, and at a cost of approximately $20,087,600 for its extraction wells and transmission channels and ducts in Factory No. 1 to 9. The above enhancement projects have estimated useful lives of 5 to 8 years and are capitalized as buildings and plant and machinery.
On December 22, 2011, the Company acquired substantially all of the assets owned by Liangcai Zhang in the Shouguang City Yangkou Township Area (the “Liangcai Zhang property” or “Factory No. 10”). The Liangcai Zhang property includes a 10-year land lease covering 1,700 acres of real property, with the related production facility, the wells, pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was RMB63 million (approximately $9,998,730) in cash. The Company expected to resume production with the newly acquired assets by the end of first quarter 2012 after repair and adjustments. A rental agreement was subsequently signed in February 2012 with the State-Operated Shandong Caiyangzi Saltworks for the lease of the parcel of land on which the aforesaid real property, production facilities, the wells, pipelines, other production equipment, and the buildings are situated, with an annual payment of RMB688,000 (approximately $109,192) up to December 31, 2021.
Each of the bromine factories and Crude Salt Field acquisitions described above was not in operation when the Company acquired the assets. The owners of each of the bromine factories did not hold the proper license for the exploration and production of bromine, and production at each of the assets acquired had previously been halted by the government. With respect to Factory No. 7, the assets had not been operational for twelve months; with respect to Factory No. 8, the assets had not been operational for thirteen months; with respect to Factory No. 9, the assets had not been operational for six months; and with respect to Factory No. 10, the assets had not been operational for more than six months. The Crude Salt Field had not been in operation for six months. The Company recorded the above transactions as purchase of assets.
NOTE 3 - INVENTORIES
Inventories consist of:
NOTE 4 - PREPAID LAND LEASE
The Company prepaid for land leases with lease terms for periods ranging from one to fifty years to use the land on which the office premises, production facilities and warehouses of the Company are situated. The prepaid land lease is amortized on a straight line basis.
During the year ended December 31, 2011, amortization of prepaid land lease totaled $424,467, which was recorded as cost of net revenue. During the year ended December 31, 2010, amortization of prepaid land lease totaled $104,940, of which $104,349 and $591 were recorded as cost of net revenue and administrative expenses, respectively. During the year ended December 31, 2009, amortization of prepaid land lease totaled $57,985, of which $57,398 and $587 were recorded as cost of net revenue and administrative expenses, respectively.
The Company has the rights to use certain parcels of land located in Shouguang, the PRC, through lease agreements signed with local townships. Such parcels of land are collectively owned by local townships and accordingly, the Company could not obtain land use rights certificates on these parcels of land. The parcels of land of which the Company could not obtain land use rights certificates covers a total of approximately 101.52 square kilometers of aggregate carrying value of $766,748 and approximately 92.32 square kilometers square meters of aggregate carrying value of $743,275 as at December 31, 2011 and 2010, respectively.
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net consist of the following:
The Company has certain buildings and salt pans erected on parcels of land located in Shouguang, PRC, and such parcels of land are collectively owned by local townships. The Company has not been able to obtain property ownership certificates over these buildings and salt pans as the Company could not obtain land use rights certificates on the underlying parcels of land. The Company could not obtain property ownership certificates covering certain properties of aggregate carrying value of $33,108,012 and $33,868,298 as at December 31, 2011 and 2010, respectively.
In the fiscal year 2011, the Company reclassified certain protective shells for crude salt pans with cost of $2,204,600 (RMB14.6 million), previously included in building, into plant and equipment for consistent classification with other similar assets. Comparative figures for the fiscal year 2010 were reclassified to conform to the current year presentation. There is no impact on the statements of income as estimated useful lives of the assets being reclassified was not changed.
During the year ended December 31, 2011, depreciation and amortization expense totaled $17,432,382, of which $16,348,509 and $1,083,873 were recorded as cost of net revenue and administrative expenses, respectively.
During the year ended December 31, 2010, depreciation and amortization expense totaled $11,097,149 of which $10,236,230 and $860,919 were recorded as cost of net revenue and administrative expenses, respectively.
During the year ended December 31, 2009, depreciation and amortization expense totaled $7,199,658, of which $7,019,608 and $180,050 were recorded as cost of net revenue and administrative expenses, respectively.
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT, NET - Continued
In June 2010, the Company completed the construction of a production line for wastewater treatment chemical additives line at a total cost of RMB60 million (equivalent to $8,838,000). A retention amount of $453,000 as of December 31, 2010, representing 5% of the total cost will be paid to Shouguang City Shengkun Construction Co., Ltd. upon one year after the completion date.
In mid-May 2011, the local PRC government requested to take the leased land of original Factory No. 4 for redevelopment and agreed to lease another parcel of land to the Company nearby to the existing Factory No. 4. The total construction cost of the new Factory No. 4 was approximately $6,207,901, which was completed and restarted operations in December 2011. A rental agreement was subsequently signed in February 2012 with the local Township government for the lease of the parcel of land with an annual payment of RMB100,000 (approximately $15,871) up to December 31, 2031.
The operations of the original Factory No. 4 were stopped in early July 2011 to cooperate with the demolition of the factory and the relocation of useful plant and machinery to the new factory. For those fixed assets that could not be relocated to the new factory, the Company recognized write-offs of $1,384,443 in the second quarter of 2011 and included the impairment loss in write-off / impairment on property, plant and equipment. A sum of $1,340,026 was received from the local PRC government in the third quarter of 2011 as compensation for the demolition of original Factory No. 4 and included in the income statement as other operating income.
Besides the assets acquisition as mentioned in Note 2, the Company carried out the following major enhancement projects to the existing facilities in 2011:
(a)In the first quarter of 2011, the Company carried out enhancements to the new property, plant and machinery acquired under finance lease in January 2011 (see Note 6) by making capital improvement in reconstruction and renovation work at a cost of approximately $3,050,400, which was recorded as buildings ($297,349) and plant and machinery ($2,753,051), for the operation of the real property, production facilities, channels and ducts, other production equipment and the buildings located on the property (“Branch 1 of Factory No. 1”). The capital improvement works to the buildings and plant and equipment have estimated useful lives of 15-20 years and 5-8 years, respectively.
(b)In late June 2011, the Company completed enhancement projects to its crude salt fields, extraction wells and transmission channels and ducts at a total cost of RMB210,113,600 (equivalent to $32,466,753), which were recorded as plant and machinery. In particular, the Company incurred reconstruction and renovation works at a cost of approximately $12,379,153 for its existing crude salt fields in Factory No. 1, 5 to 9, at costs of approximately $12,361,600 for its extraction wells in Factory No. 1 to 9, and $7,726,000 for its transmission channels and ducts, respectively, in Factory No. 1 to 9. The enhancement work to existing extraction wells, drilling deeper underground for better quality brine water, has estimated useful lives of 8 years. None of the existing extraction wells were impaired as a result of the drilling enhancement. The enhancement works to crude salt fields, transmission channels and ducts, replacing eroded protective shells for crude salt fields and transmission channels and ducts, have estimated useful lives of 5 years. Certain eroded protective shells for crude salt fields and transmission channels and ducts, with net book values of $1,632,004 and $1,315,476, respectively, were replaced during the enhancement projects, write-offs of the same amounts, were made in the second quarter of 2011 and included in write-off / impairment on property, plant and equipment. The Company also recognized write-offs of certain eroded protective shells for transmission channels and ducts, without enhancement works, with net book values of $749,999, during the regular inspection of fixed assets, and included in write-off / impairment on property, plant and equipment.
(c)In mid-June 2011, the Company switched its production line for wastewater treatment chemical additives, with net book value of $8,320,410, to the production of pharmaceutical and agricultural chemical intermediates at a cost of $153,426 as the Company experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. An impairment of $1,805,598 was made in the second quarter of 2011 and included in write-off / impairment on property, plant and equipment.
Enhancements of protective shells to the crude salt fields, extraction wells and transmission channels and ducts are carried out every 5 to 8 years, depending on the need to do so, that is, when regular repair and maintenance work identifies the replacement needs. The erosion rate of protection shells is affected by different weather conditions and the change in acid components of brine water over time.
There were no impairment provisions made at December 31, 2010 and 2009.
For the years ended December 31, 2011, 2010 and 2009, ordinary repair and maintenance expenses were $1,078,134, $199,257 and $27,317, respectively.
NOTE 6 - PROPERTY, PLANT AND EQUIPMENT UNDER CAPITAL LEASES, NET
Property, plant and equipment under capital leases, net consist of the following:
The above buildings erected on parcels of land located in Shouguang, PRC, are collectively owned by local townships. The Company has not been able to obtain property ownership certificates over these buildings as the Company could not obtain land use rights certificates on the underlying parcels of land.
During the year ended December 31, 2011, depreciation and amortization expense totaled $265,057, of which $172,103 and $92,954 were recorded as cost of sales and administrative expenses respectively.
An impairment of $683,046 was made in the second quarter of 2011 for those idle assets without enhancements and adjustments been performed in early 2011, and included in write-off / impairment on property, plant and equipment.
NOTE 7 - ACCOUNTS PAYABLE AND ACCRUED EXPENSE
Accounts payable and accrued expenses consist of the following:
NOTE 8 - DUE TO A RELATED PARTY AND RELATED PARTY TRANSACTIONS
Related party transactions consist of the following:
Note (a) - Mr. Zhi Yang, a shareholder and son of the Chairman of the Company, had a 10% equity interest in Shouguang Hongye Trading Company Limited (“Hongye”) for the period from August 4, 2010 to December 2, 2010. Since December 2, 2010, Mr. Zhi Yang has not had any ownership interest in Hongye. Hongye is one of the major suppliers to the Company of sulfur, raw coal and various chemicals for the production of bromine and chemical products. The outstanding payables to Hongye, which were included in accounts payable as at December 31, 2010, amounted to $1,146,810. The products were sold to the Company by Hongye at market prices.
During the fiscal year 2011, the Company borrowed a sum of $7,823,475, and fully repaid later during the same year, from Jiaxing Lighting Appliance Company Limited (“Jiaxing Lighting”), in which Mr. Ming Yang, a shareholder and the Chairman of the Company, had a 100% equity interest in Jiaxing Lighting. The amounts due to Jiaxing Lighting were unsecured, interest free and repayable on demand.
NOTE 9 - TAXES PAYABLE
Taxes payable consists of the following:
NOTE 10 - CAPITAL LEASE OBLIGATIONS
The components of capital lease obligations are as follows:
Interest expense from capital lease obligations amounted to $210,347, was charged to the income statements for the year ended December 31, 2011.
NOTE 11 - RETAINED EARNINGS - APPROPRIATED
In accordance with the relevant PRC regulations and the PRC subsidiaries’ Articles of Association, the Company’s PRC subsidiaries are required to allocate its profit after tax to the following reserve:
Statutory Common Reserve Funds
SCHC and SYCI are required each year to transfer 10% of the profit after tax as reported under the PRC statutory financial statements to the Statutory Common Reserve Funds until the balance reaches 50% of the registered share capital. This reserve can be used to make up any loss incurred or to increase share capital. Except for the reduction of losses incurred, any other application should not result in this reserve balance falling below 25% of the registered capital. The Statutory Common Reserve Fund as of December 31, 2011 for SCHC and SYCI is 30% and 50% of its registered capital respectively.
NOTE 12 - COMMON STOCK
The Company changed the trading ticker symbol of its common stock on the NASDAQ Global Select Market to “GURE” effective at the open of the market on June 30, 2011.
Effective October 12, 2009, the Company effected a one for four reverse stock split. All shares and per share amount for all periods presented have been adjusted to reflect the reverse stock split.
In March 2009, the Company issued 5,250,000 shares of its common stock as payment for $21,287,493 of Notes and Loan Payable-Related Party.
In March 2009, the Company issued 375,000 shares of its common stock, valued at $615,000, to acquire assets owned by Qiufen Yuan, Han Wang and Yufen Zhang.
In September 2009, the Company issued 1,057,341 shares of its common stock, valued at $5,413,588, to acquire assets owned by Han Wang, Qing Yang and Yuliang Gao.
NOTE 12 - COMMON STOCK - Continued
In December 2009, the Company issued 2,941,182 shares of its common stock at a price of $8.50 per share in a private placement. A portion of the proceeds were received by the Company in January 2010.
In August 2008, the Company granted to one investor relations firm a warrant to purchase a total of 25,000 shares of the Company’s common stock at an exercise price of $4.80 per share and the options vested immediately. In January 2010, the investor relations firm made a cashless exercise for the warrant. The Company issued 15,881 shares based on the fair market price of $13.16.
In the fourth quarter of 2008, the Company granted to one Board member options to purchase a total of 12,500 shares of the Company’s common stock at an exercise price of $1.44 per share and the options vested immediately. In February 2010, the Company issued 12,500 shares of its common stock upon the exercise of such stock options by the Board member.
In June 2010, the Company issued 70,560 shares of its common stock, valued at $608,227, to acquire assets owned by Mr Jinjin Li, Ms Qiuzhen Wang, Yueliang Wang, Kunming Tian, Gaoming Tian and Zhiqiang Wei.
In the fourth quarter of 2010, the Company issued 95,905 shares of its common stock based on the fair market prices of $8.3 - $11.8 upon the cashless exercise of 187,500 stock options granted to the Board members and employees.
In the second quarter of 2011, the Company issued 9,430 shares of its common stock based on the fair market price of $3.42 upon the cashless exercise of 12,500 stock options granted to a Board member.
NOTE 13 - TREASURY STOCK
In June 2011, the Company repurchased 100,500 shares of common stock of the Company at an average price of $3.46 per share for a total cost of $348,147 under the approval of the Board of Directors. In September 2011, the Company repurchased 84,099 common stock of the Company at an average price of $1.81 per share for a total cost of $151,853 under the approval of the Board of Directors. The Company recorded the entire purchase price of the treasury stock as a reduction of equity.
NOTE 14 - STOCK-BASED COMPENSATION
Pursuant to the Company’s Amended and Restated 2007 Equity Incentive Plan, the aggregate number shares of the Company’s common stock available for grant of stock options and issuance is 4,341,989 shares.
The fair value of each option award below is estimated on the date of grant using the Black-Scholes option-pricing model. The risk free rate is based on the yield-to-maturity in continuous compounding of the US Government Bonds with the time-to-maturity similar to the expected tenor of the option granted, volatility is based on the annualized historical stock price volatility of the Company, and the expected life is based on the expected tenor, which has been taken into account of early exercise behavior of the option holder.
The Company issued 25,000 warrants on August 1, 2008 at a price of $4.80 per share as part of a consulting agreement with its investor relations firm. These options fully vested on August 1, 2009. The warrants were valued at $65,000, fair value, with assumed 162% volatility, a four-year expiration term, a risk free rate of 3% and no dividend yield. The value of the warrants will be expensed over one year, which is the term of the consulting agreement. For the year ended December 31, 2009, $48,616 was recognized as consulting expense.
In March 2009, the Company granted to 9 management staff (including 4 directors of the Company) options to purchase a total of 150,000 shares (25,000 for each of the executive directors, and 12,500 each for one non-executive independent director and 5 other management staff) of the Company’s common stock at an exercise price of $4.80 per share and the options vested immediately. The options were valued at $143,820 fair value, with assumed 174% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $143,820 was recognized as general and administrative expenses.
In May 2009, the Company granted to a director options to purchase 12,500 shares of the Company’s common stock at an exercise price of $4.80 per share and the options vested immediately. The options were valued at $20,486 fair value, with assumed 170% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $20,486 was recognized as general and administrative expenses.
NOTE 14 - STOCK-BASED COMPENSATION - Continued
In June 2009, the Company granted to a director options to purchase 25,000 shares of the Company’s common stock at an exercise price of $4.80 per share and the options vested immediately. The options were valued at $39,534 fair value, with assumed 167% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $39,534 was recognized as general and administrative expenses.
In October 2009, the Company granted to 2 management staff options to purchase 37,500 shares of the Company’s common stock at an exercise price of $6.44 per share and the options vested immediately. The options were valued at $219,656 fair value, with assumed 161% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $219,656 was recognized as general and administrative expenses.
In October 2009, the Company granted to an independent director options to purchase 12,500 shares of the Company’s common stock at an exercise price of $9.65 per share and the options vested immediately. The options were valued at $90,648 fair value, with assumed 160% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $90,648 was recognized as general and administrative expenses.
In November 2009, the Company granted to an independent director options to purchase 12,500 shares of the Company’s common stock at an exercise price of $10.14 per share and the options vested immediately. The options were valued at $92,315 fair value, with assumed 152% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $92,315 was recognized as general and administrative expenses.
In December 2009, the Company granted to an investment bank warrants to purchase 176,471 shares of the Company’s common stock at an exercise price of $10.2 per share and the warrants vested immediately. The warrants were valued at $1,367,156 fair value, with assumed 156% volatility, a three-year expiration term, a risk free rate of 1.43% and no dividend yield. For the year ended December 31, 2009, $1,367,156 was recognized as general and administrative expenses.
In February 2010, the Company granted to 8 management staff options to purchase 132,500 shares of the Company’s common stock at an exercise price of $8.25 per share and the options vested immediately. The options were valued at $995,539 fair value, with assumed 154% volatility, a three-year expiration term with expected tenor of 1.5 years, a risk free rate of 1.60% and no dividend yield. For the year ended December 31, 2010, $995,539 was recognized as general and administrative expenses.
In February 2010, the Company granted to the investor relations firm warrants to purchase 25,000 shares of the Company’s common stock at an exercise price of $12 per share and the warrants vested immediately. The warrants were valued at $193,428 fair value, with assumed 155% volatility, a four-year expiration term, a risk free rate of 1.60% and no dividend yield. For the year ended December 31, 2010, $193,428 was recognized as general and administrative expenses.
In November 2010, the Company granted to 2 independent directors options to purchase 25,000 shares of the Company’s common stock at an exercise price of $10.43 per share and the options vested immediately. The options were valued at $93,462 fair value, with assumed 76% volatility, a three-year expiration term with expected tenor of 1.5 years, a risk free rate of 0.30% and no dividend yield. For the year ended December 31, 2010, $93,462 was recognized as general and administrative expenses.
In February 2011, the Company granted to the investor relations firm a warrant to purchase 50,000 shares of the Company’s common stock at an exercise price of $12.6 per share and the warrants vested immediately. The warrant was valued at $452,000 fair value, with assumed 193.42% volatility, a five-year expiration term, a risk free rate of 2.30% and no dividend yield. For the year ended December 31, 2011, $452,000 was recognized as general and administrative expenses.
In early March 2011, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $9.16 per share and the options vested immediately. The options were valued at $35,000 fair value, with assumed 64.5% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.46% and no dividend yield. For the year ended December 31, 2011, $35,000 was recognized as general and administrative expenses.
In late March 2011, the Company granted to 3 executive officers options to purchase 1,200,000 shares of the Company’s common stock at an exercise price of $4.97 per share and the options are exercisable in equal installments over periods of two years. The options were valued at $4,317,000 fair value, with assumed 77.22% to 94.36% volatility, a four-year expiration term with expected tenors of 2 to 2.49 years, risk free rates of 0.81% to 1.05% and no dividend yield. For the year ended December 31, 2011, $1,945,000 was recognized as general and administrative expenses.
NOTE 14 - STOCK-BASED COMPENSATION - Continued
In late March 2011, the Company also granted to 18 management staff options to purchase 654,000 shares of the Company’s common stock at an exercise price of $4.97 per share and the options are exercisable in equal installments over periods of three years. The options were valued at $2,632,000 fair value, with assumed 77.22% to 118.84% volatility, a four-year expiration term with expected tenors of 2 to 3 years, risk free rates of 0.81% to 1.29% and no dividend yield. For the year ended December 31, 2011, $706,000 was recognized as general and administrative expenses.
In early May 2011, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.93 per share and the option vested immediately. The option was valued at $15,800 fair value, with assumed 79.91% volatility, a four-year expiration term with expected tenor of 2 years, a risk free rate of 0.57% and no dividend yield. For the year ended December 31, 2011, $15,800 was recognized as general and administrative expenses.
In late June 2011, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $3.10 per share and the option vested immediately. The option was valued at $15,200 fair value, with assumed 86.36% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.32% and no dividend yield. For the year ended December 31, 2011, $15,200 was recognized as general and administrative expenses.
In late September 2011, the Company and certain management staff and directors mutually agreed to cancel certain unexercised and all non-vested stock options previously granted for an aggregate of 1,181,000 shares of the Company’s common stock, having exercise prices between $4.97 to $8.25 per share, without consideration. In accordance with ASC 718-20-35-9, “Awards Classified as Equity - Cancellation and Replacement”, the Company accelerated the remaining expense on these cancelled awards that resulted in $4,298,000 recorded in general and administrative expense for the year ended December 31, 2011.
In November 2011, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.41 per share and the option vested immediately. The option was valued at $14,400 fair value, with assumed 94.7% volatility, a three-year expiration term with expected tenor of 1.5 years, a risk free rate of 0.16% and no dividend yield. For the year ended December 31, 2011, $14,400 was recognized as general and administrative expenses.
The following table summarizes all Company stock option transactions between January 1, 2009 and December 31, 2011.
NOTE 14 - STOCK-BASED COMPENSATION - Continued
The weighted average grant-date fair values as at December 31, 2011, 2010 and 2009 were $7.29, $8.83 and $6.84, respectively.
At December 31, 2011 and 2010, the aggregate intrinsic value of the stock options and warrants were $1,382,612 and $75,647, respectively.
NOTE 15 - INCOME TAXES
The Company utilizes the asset and liability method of accounting for income taxes in accordance with FASB ASC 740-10.
(a) United States
Gulf Resources, Inc. is subject to the United States of America Tax law at tax rate of 34%. No provision for the US federal income taxes has been made as the Company had no US taxable income for the years ended December 31, 2011, 2010 and 2009, and management believes that its earnings are permanently invested in the PRC.
(b) BVI
Upper Class Group Limited was incorporated in the BVI and, under the current laws of the BVI, it is not subject to tax on income or capital gain in the BVI. Upper Class Group Limited did not generate assessable profit for the years ended 31 December 31, 2011, 2010 and 2009.
(c) Hong Kong
Hong Kong Jiaxing Industrial Limited was incorporated in Hong Kong and is subject to Hong Kong profits tax. The Company is subject to Hong Kong taxation on its activities conducted in Hong Kong and income arising in or derived from Hong Kong. No provision for profits tax has been made as the Company has no assessable income for the years. The applicable statutory tax rates for the years ended December 31, 2011, 2010 and 2009 are 16.5%.
(d) PRC
Enterprise income tax (“EIT”) for SCHC and SYCI in the PRC is charged at 25% of the assessable profits.
The operating subsidiaries SCHC and SYCI are wholly foreign-owned enterprises (“FIE”) incorporated in the PRC and are subject to PRC Foreign Enterprise Income Tax Law.
On February 22, 2008, the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) jointly issued Cai Shui [2008] Circular 1 (“Circular 1”). According to Article 4 of Circular 1, distributions of accumulated profits earned by a FIE prior to January 1, 2008 to foreign investor(s) in 2008 will be exempted from withholding tax (“WHT”) while distribution of the profit earned by an FIE after January 1, 2008 to its foreign investor(s) shall be subject to WHT at 5% effective tax rate.
As of December 31, 2011 and 2010, the accumulated distributable earnings under the Generally Accepted Accounting Principles (“GAAP”) of PRC are $180,939,187 and $129,201,268, respectively. Since the Company intends to reinvest its earnings to further expand its businesses in mainland China, its foreign invested enterprises do not intend to declare dividends to their immediate foreign holding companies in the foreseeable future. Accordingly, as of December 31, 2011 and 2010, the Company has not recorded any WHT on the cumulative amount of distributable retained earnings of its foreign invested enterprises in China. As of December 31, 2011 and 2010, the unrecognized WHT are $7,965,999 and $5,431,616, respectively.
NOTE 15 - INCOME TAXES - Continued
The components of the provision for income taxes from continuing operations are:
The effective income tax expenses differ from the PRC statutory income tax rate of 25% from continuing operations in the PRC as follows:-
As of December 31, 2011 and 2010, the Company had US federal net operating loss (“NOL”) of approximately $30 million and $25 million available to offset against future federal income tax liabilities, respectively. NOL can be carried forward up to 15 years from the year the loss is incurred. NOL of approximately $12 million will expire at the beginning of 2014. The Company believes the realization of benefits from these losses remains uncertain due to the Company’s limited operating history and continuing losses. Accordingly, a 100% deferred tax asset valuation allowance has been provided.
Differences between the application of accounting principles and tax laws cause differences between the bases of certain assets and liabilities for financial reporting purposes and tax purposes. The tax effects of these differences, to the extent they are temporary, are recorded as deferred tax assets and liabilities. Significant components of the Company’s deferred tax assets and liabilities at December 31, 2011 and 2010 are as follows:
The increase in valuation allowance for each of the years ended December 31, 2011, 2010 and 2009 is $2,413,596, $1,005,799 and $1,101,800, respectively.
There was no unrecognized tax benefits and accrual for uncertain tax positions as of December 31, 2011 and 2010.
Tax returns filed regarding tax years from 2005 through 2011 are subject to review by the respective tax authorities.
NOTE 16 - BUSINESS SEGMENTS
The Company has three reportable segments: bromine, crude salt and chemical products. The reportable segments are consistent with how management views the markets served by the Company and the financial information that is reviewed by its chief operating decision maker. The Company manages its sensors and controls businesses as components of an enterprise for which separate information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance.
An operating segment’s performance is primarily evaluated based on segment operating income, which excludes share-based compensation expense, certain corporate costs and other income not associated with the operations of the segment. These corporate costs (income) are separately stated below and also include costs that are related to functional areas such as accounting, treasury, information technology, legal, human resources, and internal audit. The Company believes that segment operating income, as defined above, is an appropriate measure for evaluating the operating performance of its segments.
NOTE 16 - BUSINESS SEGMENTS - Continued
* Certain common production overheads, operating and administrative expenses and asset items (mainly cash and certain office equipment) of bromine and crude salt segments in SCHC were split by reference to the average selling price and production volume of respective segment.
The following table shows the major customer(s) (10% or more) for the year ended December 31, 2011.
The following table shows the major customer(s) (10% or more) for the year ended December 31, 2010.
The following table shows the major customer(s) (10% or more) for the year ended December 31, 2009.
NOTE 17 - MAJOR SUPPLIERS
During the year ended December 31, 2011, the Company purchased 80.7% of its raw materials from its top five suppliers. At December 31, 2011, amounts due to those suppliers included in accounts payable were $2,883,384. During the year ended December 31, 2010, the Company purchased 89.1% of its raw materials from its top five suppliers. At December 31, 2010, amounts due to those suppliers included in accounts payable were $5,126,619. During the year ended December 31, 2009, the Company purchased 49.5% of its raw materials from its top five suppliers. At December 31, 2009, amounts due to those suppliers included in accounts payable were $4,016,890. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.
NOTE 18 - CUSTOMER CONCENTRATION
The Company sells a substantial portion of its products to a limited number of customers. During the year ended December 31, 2011, the Company sold 42.2% of its products to its top five customers. At December 31, 2011, amount due from these customers was $9,933,995. During the year ended December 31, 2010, the Company sold 41.7% of its products to its top five customers. At December 31, 2010, amount due from these customers were $10,226,812. During the year ended December 31, 2009, the Company sold 40.1% of its products to its top five customers. At December 31, 2009, amount due from these customers were $5,449,638. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of financial instruments, which consist of cash, accounts receivable and accounts payable and other payables, approximate their fair values due to the short-term nature of these instruments. There were no material unrecognized financial assets and liabilities as of December 31, 2011 and 2010.
NOTE 20 -RESEARCH AND DEVELOPMENT EXPENSES
On September 6, 2007, SYCI and East China University of Science and Technology formally opened a Co-Op Research and Development Center. The research center is equipped with state of the art chemical engineering instruments for the purpose of pursuing targeted research and development of refined bromide compounds and end products. According to the Co-Op Research Agreement, any research achievement or patents will become assets of the Company. Originally, the Company will provide $500,000 annually until June 2012 to East China University of Science and Technology for research. On June 7, 2011, the Company and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for the Company.
Since the second quarter of 2010, SYCI conducted research for the new production line of wastewater treatment additives, the purpose of which is for the testing of the manufacturing routine and samples. The new production line was started operation and normal production in April 2011. However, the Company switched the aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as the Company experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. The research and development expense incurred for the new production line of wastewater treatment additives from outside parties and the consumption of bromine produced by the Company during the year ended December 31, 2011 were $56,286 and $105,739, respectively. The research and development expense incurred for the new production line of wastewater treatment additives from outside parties and the consumption of bromine produced by the Company during the year ended December 31, 2010 were $847,919 and $848,990, respectively.
The total research and development expense recognized in the income statements during the years ended December 31, 2011, 2010 and 2009 were $398,842, $2,200,291 and $500,406, respectively.
NOTE 21 - REVERSE STOCK SPLIT
A reverse stock split of the issued and outstanding shares of the Company's common stock was effected on the basis of one share for every four shares of common stock and was approved by the Board of Directors and shareholders owning a majority of the outstanding shares of the Company’s common stock and became effective on October 12, 2009. All shares and per share data (except par value) have been adjusted to reflect the effect of the stock split for all periods presented.
NOTE 22 - CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS
As of December 31, 2011, the Company has leased a real property adjacent to Factory No. 1, with the related production facility, channels and ducts, other production equipment and the buildings located on the property, under capital lease. The future minimum lease payments required under capital lease, together with the present value of such payments, are included in the table show below.
The Company has leased five pieces of land under non-cancelable operating leases, which are fixed in rentals and expired through December 2030, December 2040, February 2059, August 2059 and June 2060, respectively. The Company accounts for the leases as operating leases.
The Company has no purchase commitment as of December 31, 2011.
NOTE 22 - CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS - Continued
The following table sets forth the Company’s contractual obligations as of December 31, 2011:
Rental expenses related to operating leases of the Company amounted to $583,123, $104,940 and $42,102 were charged to the income statements for the years ended December 31, 2011, 2010 and 2009, respectively.
NOTE 23 - LEGAL PROCEEDINGS
Lock-up Agreement
The Company settled litigation in connection with 5,250,000 shares of the Company’s Common Stock (the “Shares”) pledged as collateral for certain loans from War Chest Capital Multi-Strategy Fund LLC, War Chest Capital Partners, LLC and/or a War Chest related entity (collectively, “War Chest”) to Top King Group Limited (“Top King”), Billion Gold Group Limited (“Billion Gold”), and Topgood International Limited (“Topgood”) (collectively, the “Holders”).
In connection with the Amendment Agreement dated January 24, 2009 by and among the Company, SCHC, China Finance, Inc., Shenzhen Hua Yin Guaranty and Investment Limited Liability Corporation (the “Shenzhen Hua Yin”) and the Holders, the Company entered into a Lock-up Agreement dated as of May 10, 2009 (the “Lock-up Agreement”) with the Holders and the following shareholders of the Company: Ming Yang, the Company’s Chairman, Wenxiang Yu, the wife of Mr. Yang, Zhi Yang, the son of Mr. Yang and Ms. Yu and Shandong Haoyuan Industry Group Ltd., of which Mr. Yang is the controlling shareholder, chief executive officer and a director (each a “Shareholder” and collectively, the “Shareholders”).
Under the Lock-up Agreement, the Holders and Shareholders agreed that they have not and will not sell in a public transaction on the Over the Counter Bulletin Board or on a national stock exchange, as the case may be, any shares of the Company’s common stock that the Holders and Shareholders presently own or may acquire on or after May 10, 2009 (the “Lock-Up Shares”) during the period commencing on May 10, 2009 and expiring on March 9, 2011 (the “Lock-up Period”). However, each Holder and Shareholder has a right, solely in a private transaction, to assign, trade, transfer, hypothecate, or pledge the Lock-Up Shares, provided that in the case of a proposed private transaction by a Holder: (i) the Holder complies with the provision of a right of first refusal; and (ii) the transferee in such private transaction, agrees to enter into the Lock-up Agreement prior to the Lock-Up Shares being transferred to them.
In addition, subject to compliance with Rule 144 under the Securities Act of 1933 (“Rule 144”), each Holder further agreed in each month of the next twelve months following the Lock-up Period not to transfer shares of the Company’s common stock in an amount greater than two percent (2%) of the total shares of the Company’s common stock issued and outstanding in a public transaction, and each Shareholder further agreed in each month of the next twelve months following the Lock-up Period not to transfer shares of the Company’s common stock in an amount greater than one percent (1%) of the total shares of Common Stock issued and outstanding of the Company.
In March of 2010, the Company’s legal counsel was contacted by the Holders’ legal counsel with a request that the Holders be allowed to pledge the Shares to War Chest as part of a loan transaction (the “Loan”). On March 11, 2010, War Chest’s legal counsel provided a letter confirming that War Chest agreed to abide by the terms of the Lock-up Agreement with respect to the Shares. The Company believes that on or about March 17, 2010 the Shares were transferred from the name of the Holders to War Chest as collateral for the Loans.
NOTE 23 - LEGAL PROCEEDINGS - Continued
Based on a Form 3 filed by HAP Trading, LLC (“HAP”) with the Securities and Exchange Commission (“SEC”) on November 10, 2010, the Company understood that, at least as of that date, HAP held a European Call FLEX Option on the Shares (“Option”). The Option permitted HAP to purchase a total of 5,730,000 shares of Gulf Resources stock (representing approximately 15% of the total outstanding shares of such stock) for $0.125 each. Based on discussions with War Chest’s legal counsel, the Company was informed that War Chest had used the Shares to create the Option.
After seeking-and not receiving-written assurances from War Chest that it did not intend to violate the Lockup Agreement, the Company commenced a litigation against War Chest and HAP by filing a Summons and Complaint in the Supreme Court of the State of New York, New York County, on January 20, 2011. The Summons and Complaint alleges that the Shares are subject to the Lockup Agreement and that War Chest and HAP are bound by the terms of the Lockup Agreement. The lawsuit seeks a court order prohibiting the sale or transfer of the Shares in violation of the Lockup Agreement, attorney’s fees, and other relief.
On January 26, 2011, HAP filed a Form 4 with the SEC disclosing that it had exercised the Option on February 21, 2011 and had taken possession of the Shares. On February 15, 2011, HAP filed an additional Form 4/A disclosing that it had sold 280,000 shares of Gulf Resources common stock on February 15, 2011 at $9.28 per share, and an additional 372,809 shares at $9.358 in “open market stock sales during the period 01/26/2011 to 02/15/2011”. The form indicates that as of February 15, 2011, HAP was beneficial owner of only 4,917,046 shares of Gulf Resources common stock, and it also indicates that HAP has purchased an additional Call Option to purchase 699,900 shares of Gulf Resources Common stock at $10 per share, exercisable from February 15, 2011 through April 15, 2011. On February 14, 2011 HAP filed a Motion to Dismiss the Company’s complaint as to HAP only.
As of May 6, 2011, all parties to the litigation entered into a settlement agreement resolving the litigation in its entirety. The terms of the settlement are confidential. The parties have fulfilled all necessary obligations under the settlement agreement, and the litigation (including HAP’s formerly pending motion) has been dismissed by stipulation of all parties, with prejudice.
Class Action
The Company and certain of its officers and directors (Ming Yang, Xiaobin Liu, and Min Li, collectively, the “Individual Defendants”) have been named as defendants in a putative securities class action lawsuit alleging violations of the federal securities laws. That action, which is now captioned Lewy, et al. v. Gulf Resources, Inc., et al., No. 11-cv-3722 ODW (MRWx), was filed on April 29, 2011 in the United States District Court for the Central District of California. The lead plaintiffs, who seek to represent a class of all purchasers and acquirers of the Company’s common stock between March 16, 2009 and April 26, 2011 inclusive, filed an amended complaint on September 12, 2011. Lead plaintiffs assert claims for violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. The amended complaint alleges the defendants made false or misleading statements in the Company’s Annual Reports on Form 10-K for the years ended December 31, 2008, 2009, and 2010, and in interim quarterly reports by, among other things, overstating revenue and net income and failing to disclose material related party transactions and certain facts about the CEO’s prior employment at another company. The amended complaint also asserts claims against the Individual Defendants for violations of Section 20(a) of the Securities Exchange Act of 1934. The amended complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. On December 30, 2011, lead plaintiffs filed an opposition to the Company’s motion to dismiss the amended complaint. The Company filed a reply in further support of its motion to dismiss on February 6, 2012. In response to the Company’s reply in further support of its motion to dismiss, lead plaintiffs filed an objection on February 17, 2012, to certain documents filed by the Company in support of its motion to dismiss. The Company opposed the objection on February 22, 2012, to which lead plaintiffs replied in further support of their objection on February 23, 2012. The Court has not yet ruled on the motion to dismiss nor the objections raised by lead plaintiffs. The Company intends to defend vigorously against the lawsuit. The Company currently cannot estimate the amount or range of possible losses from this litigation.
The legal costs incurred for the year ended December 31, 2011 in connection with the above legal cases amounted to $592,576, which was included in the income statements as general and administrative expenses.
NOTE 24 - SUBSEQUENT EVENTS
Management has evaluated subsequent events from December 31, 2011 to the date which our financial statements have been issued and were available to be issued, and has concluded that no material subsequent events have occurred since December 31, 2011 that required recognition or disclosure in our current year financial statements. Subsequent events that may occur after the date of issue of financial statements have not been evaluated.
SCHEDULE I - PARENT ONLY FINANCIAL INFORMATION
The following presents condensed parent company only financial information of Gulf Resources, Inc.
Condensed Balance Sheets
Condensed Statements of Income
S-1
Condensed Statements of Cash Flows
Notes:
(i)Basis of presentation
In the condensed parent-company-only financial statements, the Company’s investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition. The Company’s share of net income of its subsidiaries is included in condensed statements of income using the equity method. These condensed parent-company-only financial statements should be read in connection with the consolidated financial statements and notes thereto.
As of December 31, 2011, the Company itself has no purchase commitment, capital commitment and operating lease commitment for the condensed parent-company-only financial statements.
(ii)Restricted Net Assets
Schedule I of Article 5-04 of Regulation S-X requires the condensed financial information of registrant shall be filed when the restricted net assets of consolidated subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year. For purposes of the above test, restricted net assets of consolidated subsidiaries shall mean that amount of the registrant’s proportionate share of net assets of consolidated subsidiaries (after intercompany eliminations) which as of the end of the most recent fiscal year may not be transferred to the parent company by subsidiaries in the form of loans, advances or cash dividends without the consent of a third party (i.e., lender, regulatory agency, foreign government, etc.).
The condensed parent company financial statements have been prepared in accordance with Rule 12-04, Schedule I of Regulation S-X as the restricted net assets of the subsidiaries of Gulf Resources, Inc. exceed 25% of the consolidated net assets of Gulf Resources, Inc. The ability of the Company’s Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balances of the Chinese operating subsidiaries. Because a significant portion of the Company’s operations and revenues are conducted and generated in China, a significant portion of the revenues being earned and currency received are denominated in RMB. RMB is subject to the exchange control regulation in China, and, as a result, the Company may be unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict the Company’s ability to convert RMB into US Dollars.
S-2
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
Previous Independent Accountants
On December 8, 2011, we dismissed BDO Limited (“BDO”) as our principal independent accountant. BDO was engaged by us on February 10, 2010. The decision to dismiss BDO as our independent accountant was approved by our Audit Committee on December 8, 2011.
We have had no disagreements with BDO on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, within the period from BDO’s engagement and through the fiscal year ended December 31, 2010 and subsequently up to the date of dismissal which disagreements that, if not resolved to BDO’s satisfaction, would have caused BDO to make reference to the subject matter of the disagreement in connection with its report issued in connection with the audit of our financial statements.
None of the reportable events described under Item 304(a)(1)(v)(A)-(D) of Regulation S-K occurred within the period from BDO’s engagement and through the fiscal year of the Company ended December 31, 2010 and subsequently up to the date of dismissal except for the following: as described in BDO’s annual report dated March 16, 2011 on our internal control over financial reporting included in the Company’s Form 10-K for the year ended December 31, 2010, in BDO’s opinion the Company had not maintained effective internal control over financial reporting as of December 31, 2010 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We agreed with BDO’s report on the point that there was a weakness in our internal control and concluded that we did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2010.
BDO’s audit reports on financial statements for the fiscal years ended December 31, 2009 and December 31, 2010 of the Company contained no adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.
We provided BDO with a copy of this disclosure before its filing with the SEC, providing BDO with the opportunity to furnish us with a letter addressed to the SEC containing any new information, clarification of our expression of its views, or the respect in which BDO does not agree with the above statements. A copy of such letter from BDO dated December 8, 2011 has been filed as an Exhibit to our current report on Form 8-K filed with the SEC on December 14, 2011.
New Independent Accountants
On December 8, 2011, we engaged Morison Cogen LLP ("MC") to serve as our independent registered accounting firm. The decision to engage MC as our principal independent accountant was approved by our Audit Committee on December 8, 2011. MC was previously engaged as our independent principal accountant as of and during the fiscal years ended December 31, 2007, 2008 and 2009 and for the subsequent interim period ended February 9, 2010. Due to the engagement of BDO on February 10, 2010, MC did not perform an audit of our financial statements for the fiscal year ended December 31, 2009.
During the period of MC’s prior engagement (i) there were no disagreements with MC on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to MC’s satisfaction, would have caused MC to make reference in connection with its opinion to the subject matter of the disagreement, and (ii) there were no “reportable events,” as that term is described in Item 304(a)(1)(v) of Regulation S-K except for the following: as described in MC’s annual report dated March 12, 2009 on our internal control over financial reporting included in the Company’s Form 10-K for the year ended December 31, 2008, that in MC’s opinion we had not maintained effective internal control over financial reporting as of December 31, 2008 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Although we agreed with MC’s report on the point that there was a weakness in our internal control, management did not believe the weakness was material and concluded that our internal control over financial reporting was effective as of December 31, 2008.
Our Audit Committee discussed with MC its opinion that we had not maintained effective internal controls over financial reporting as of December 31, 2008. In addition, we have authorized MC to respond fully to the inquiries of MC’s successor accountant concerning such opinion. An amendment to a current report on Form 8-K was filed on March 23, 2010 to disclose the matters in connection with MC’s dismissal on February 9, 2011 and is hereby incorporated by reference.
During the period commencing February 10, 2010, when BDO was engaged by us as its independent principal accountant, until December 8, 2011 when MC was re-engaged in such capacity, we did not consult with MC regarding (i) the application of accounting principles to a specific completed or proposed transaction, or the type of audit opinion that might be rendered on our consolidated financial statements and no written or oral advice was provided by MC that was an important factor considered by us in reaching a decision as to the accounting, auditing or financial reporting issue or (ii) any matter that was either the subject of a disagreement or event as set forth in Item 304(a)(1)(iv) or Item 304(a)(1)(v) of Regulation S-K.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedure We maintain “disclosure controls and procedures”, as such term is defined under Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We have carried out an evaluation as required by Rule 13a-15(d) under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2011. Based upon their evaluation and the identification of two material weaknesses in our internal control over financial reporting, as further discussed below under “Management’s Report on Internal Control over Financial Reporting”, the Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2011, the Company did not maintain, in all material respect, effective disclosure controls and procedures in timely alerting it to material information to be disclosed in its periodic reports under the Exchange Act.
Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:
(1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
(2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of our assets that could have a material effect on the financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the company.
Management has used the framework set forth in the report entitled Internal Control-Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission, known as COSO, to evaluate the effectiveness of our internal control over financial reporting.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management has concluded that the Company had the following material weaknesses:
1.Improper accounting treatment for translation loss on intercompany payable, denominated in a foreign currency, due to a subsidiary; and
2.Failure to maintain effective controls over the identification of related parties and the disclosure of related party transactions in the Company’s consolidated financial statements.
During the preparation of our financial statements contained in this Annual Report, the auditor identified that short-term borrowings in USD from and settlements to Jiaxing Lighting Appliance Company Limited (“Jiaxing Lighting”) during the fiscal year 2011 are related party transactions as Mr. Ming Yang, a shareholder and the Chairman of the Company, had a 100% interest in Jiaxing Lighting. The Chairman explained that the short-term borrowings in USD were used to fulfill daily operating expenses denominated in USD as the procedures to convert RMB take times where most of our cash balances are denominated in RMB, and that the short-term borrowings were fully settled in short period of time in either RMB or USD. Management concluded that the subject transactions had no impact on the Company as a whole.
During the preparation of our financial statements contained in this Annual Report, the auditor also identified that a certain translation loss on an intercompany payable due to a subsidiary for a short-term borrowing was included improperly in our Statements of Comprehensive Income, which should have been charged to the Statements of Income instead. After this incident was identified, management further investigated all intercompany translations during the fiscal year 2011 and concluded that no similar incidents occurred.
Accordingly, management concluded that the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2011 because of two material weaknesses as stated above. As a result of this conclusion, management started to formulate and implement a program to remedy the material weaknesses described above. We also expect to increase the areas to be reviewed and discussed with the Board of Directors. As of the date of this report, we have taken the following steps to continue to improve our internal control over financial reporting:
˜ We will continue to educate our management personnel to comply with the related party disclosure requirements of the Exchange Act and Regulation S-K; and
˜ We will increase management oversight to timely report any related party transactions and the translation gain or loss on intercompany balances in the future.
Attestation Report of the Registered Public Accounting Firm See Page of this Form 10-K for the Report of Independent Registered Public Accounting Firm, Morison Cogen LLP, on our effectiveness of internal control over financial reporting as of December 31, 2011.
Changes in Internal Control Over Financial Reporting We have implemented the following steps during our most recently completed fiscal quarter to improve our internal control over financial reporting to address the material weaknesses as mentioned for the three-month period ended September 30, 2011:
˜ Provided several ongoing training courses in U.S. GAAP to our existing accounting department personnel, including our CFO.
There have not been other changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) under the Exchange Act) during our most recently completed fiscal quarter which is the subject of this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
Not applicable.
PART III
We are incorporating by reference the information required by Part III of this report on Form 10-K from our proxy statement relating to our 2012 annual meeting of stockholders (the “2012 Proxy Statement”), which will be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year ended December 31, 2011.
Item 10.
Item 10. Directors and Executive Officers and Corporate Governance.
The information required by this item is included under the captions “Election of Directors - Nominees,” “Information Concerning Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2012 Proxy Statement and incorporated herein by reference.
Item 11.
Item 11. Executive Compensation.
The information required by this item is included under the captions “Election of Directors - Compensation of Non-Employee Directors,” “Election of Directors - Compensation Committee Interlocks and Insider Participation,” “Compensation Discussion and Analysis,” and “Compensation Committee Report” in the 2012 Proxy Statement and incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item is included under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in the 2012 Proxy Statement and incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is included under the captions “Certain Relationships and Related Person Transactions, and Director Independence” and “Election of Directors - Board Meetings and Committees” in the 2012 Proxy Statement and incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this item is included under the caption “Audit Committee Report” in the 2012 Proxy Statement and incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a)Financial Statements and Schedules
(1)Financial Statements - The financial statements filed as part of this filing are listed on the index to the Financial Statements and Supplementary Data, Item 8 of Part II, on page.
(2)Financial Statement Schedules - “Schedule I - Parent Only Financial Information” filed as part of this filing is listed on the Financial Statements and Supplementary Data, Item 8 of Part II, on pages S-1 and S-2. All other financial statement schedules have been omitted because they are not applicable, or the information required is set forth in the Consolidated Financial Statements or related notes thereto.
(b)Exhibit Index
2.1
Agreement and Plan of Merger dated December 10, 2006, among the Registrant, DFAX Acquisition vehicle, Inc., Upper Class Group Limited and the shareholders of UCG, incorporated herein by reference to Exhibit 10 to the Registrant's Current Report on Form 8-K filed on December 12, 2007.
2.2
Share Exchange Agreement among the Registrant, Upper Class Limited, Shouguang Yuxin Chemical Industry Company Limited and shareholders of Shouguang Yuxin Chemical Industry Company Limited, incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed on February 9, 2007.
3.1
Restated Certificate of Incorporation, incorporated herein by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1 (No. 33-46580) declared effective on November 18, 1992.
3.2
Amendment to Restated Certificate of Incorporation., increasing the authorized capital stock, incorporated herein by reference to Exhibit A to the Registrant's definitive Schedule 14A filed on October_, 1995.
3.3
Amendment to Restated Certificate of Incorporation., increasing the authorized capital stock, incorporated herein by reference to Exhibit B to the Registrant's definitive Schedule 14A filed on August 12, 1997.
3.4
Amendment to Restated Certificate of Incorporation., increasing the authorized capital stock, incorporated herein by reference to Exhibit A to the Registrant's definitive Schedule 14A filed on October 16, 1998.
3.5
Amendment to Restated Certificate of Incorporation, filed with the Secretary of the State of Delaware on October 16, 2006, effecting a reverse stock split.
3.6
Amendment to Restated Certificate of Incorporation, changing the name of the Registrant to Gulf Resources, Inc., incorporated herein by reference to Exhibit 3.1 of the Registrant's Current Report on Form 8-K filed on February 20, 2007.
3.7
Amendment to Restated Certificate of Incorporation, increasing the authorized capital stock of the Registrant and effecting a 2-for-1 forward stock split, incorporated herein by reference to Exhibit 3.1 of the Registrant's Current Report on Form 8-K filed on December 4, 2007.
3.8
Amendment to Restated Certificate of Incorporation, filed with the Secretary of the State of Delaware on October 6, 2009, effecting a reverse stock split, incorporated herein by reference to Appendix C to the Registrant’s Schedule 14A filed on July 30, 2009.
3.9
By-laws, incorporated herein by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-1 (No. 33-46580) declared effective on November 18, 1992.
10.1
Lock-up Agreement by and among the Registrant, Top King Group Limited, Billion Gold Group Limited, Topgood International Limited, Ming Yang, Wenxiang Yu, Zhi Yang and Shandong Haoyuan Industry Group Ltd., dated May 10, 2009, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 14, 2009.
10.2
Asset Purchase Agreement by and among the Registrant, Shouguang City Haoyuan Chemical Company Limited, Fengxia Yuan, Han Wang and Qing Yang, dated September 7, 2009, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 10, 2009.
10.3
Securities Purchase Agreement by and among the Registrant and institutional investors dated December 11, 2009, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 11, 2009.
10.4
Registration Rights Agreement by and among the Registrant and institutional investors dated December 11, 2009, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 11, 2009.
10.5
Asset Purchase Agreement by and between Shouguang Haoyuan Chemical Co., Ltd., Jinjin Li, and Qiuzhen Wang dated June 7, 2010, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Amendment No. 3 on the Current Report on Form 8-K filed on February 22, 2011
10.6
Crude Salt Field Acquisition Agreement by and between Shouguang City Haoyuan Chemical Co., Ltd. and State-Operated Shouguang Qingshuibo Farm dated December 30, 2010, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on January 4, 2011.
10.7
Attachment to the Crude Salt Field Acquisition Agreement by and between Shouguang City Haoyuan Chemical Co., Ltd. and State-Operated Shouguang Qingshuibo Farm dated December 30, 2010, incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on January 4, 2011
10.8
Lease Contract dated November 5, 2010 by and between Shouguang City Haoyuan Chemical Co., Ltd. and State-Operated Shouguang Qingshuibo Farm, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on March 4, 2011.
10.9
Supplementary Agreement dated March 1, 2011 by and between Shouguang City Haoyuan Chemical Co., Ltd. and State-Operated Shouguang Qingshuibo Farm, incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on March 4, 2011.
10.10
Bromine Factory Relocation Compensation Agreement dated August 22, 2011 by and between Yangkou Township People’s Government of Shouguang Municipality and Shouguang City Haoyuan Chemical Co., Ltd., incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on August 25, 2011
10.11
Asset Purchase Agreement dated December 22, 2011 by and between Shouguang City Haoyuan Chemical Co., Ltd, Gulf Resources, Inc., and Liangcai Zhang, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 22, 2011.
Code of Ethics, incorporated herein by reference to Exhibit 14 to the Registrant’ annual report on Form 10-K filed on March 16, 2009.
16.1
Letter of Morison Cogen LLP dated February 10, 2010, incorporated herein by reference to Exhibit 16.1 to the Registrant’s Current Report on Form 8-K filed on March 23, 2010.
16.2
Letter from BDO Limited dated December 8, 2011, incorporated herein by reference to Exhibit 16.1 to the Registrant’s Current Report on Form 8-K filed on December 14, 2011
21.1
List of Subsidiaries, incorporated herein by reference to Exhibit 21.1 to the Registrant’s Annual Report on Form 10-K filed on March 12, 2008.
23.1
Consent of Morison Cogen LLP, an independent registered public accounting firm.*
23.2
Consent of BDO Limited, an independent registered public accounting firm*
31.1
Certification pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2
Certification pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
32.1
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
* Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act, the Company has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
By: /s/ Min Li
By: Min Li
Title: Chief Financial Officer
(principal financial and accounting officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following person on behalf of the Company and in the capacities and on the dates indicated.
SIGNATURE
TITLE
DATE
/s/ Xiaobin Liu
March 15, 2012
Xiaobin Liu
Chief Executive Officer and Director
/s/ Min Li
March 15, 2012
Min Li
Chief Financial Officer
/s/ Ming Yang
March 15, 2012
Ming Yang
Director
/s/ Naihui Miao
March 15, 2012
Naihui Miao
Director
/s/ Tengfei Zhang
March 15, 2012
Tengfei Zhang
Director
/s/ Yang Zou
March 15, 2012
Yang Zou
Director
/s/ Nan Li
March 15, 2012
Nan Li
Director
/s/ Shi Tong Jiang
March 15, 2012
Shi Tong Jiang
Director