GULF RESOURCES, INC. quarterly report, Q2 FY2015

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Gulf Resources, Inc. — Q2 2015 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2015. Unaudited results are in U.S. dollars. The company operates in China across bromine, crude salt and chemical products.

Financial performance

  • Q2 revenue: $49.35 million, up 55% year over year; gross profit was $17.07 million and gross margin 35%, versus 29% a year earlier. Operating income was $14.56 million (about 30% of revenue); net income was $10.78 million, up 90%. Basic and diluted EPS were $0.23.
  • First-half revenue: $84.26 million, up 47%; gross profit was $26.50 million and gross margin 31%, versus 28%. Operating income was $21.67 million (about 26% of revenue); net income was $16.09 million, up 62%. Basic and diluted EPS were $0.36.
  • Segment mix: First-half revenue was $26.13 million from bromine, $4.87 million from crude salt and $53.26 million from chemical products. SCRC, acquired in February, contributed $28.59 million of first-half revenue and $7.20 million of net income from acquisition onward.
  • Cash flow: First-half operating cash flow was $24.53 million, compared with $23.10 million in 2014. Investing cash use was $52.86 million, principally the $66.31 million cash payment for SCRC, partly offset by $14.07 million of acquired cash. Cash declined $28.56 million to $118.03 million.
  • Liquidity and debt: Working capital was approximately $176.7 million, down from $186.0 million at year-end. Total liabilities were $26.82 million, including $2.83 million of capital lease obligations; the filing reports no bank borrowings. Management said available funds and operating cash flow should cover anticipated needs for the next 12 months.
  • Balance sheet changes: Accounts receivable rose 80% from December 31 to $75.43 million, with $31.20 million attributable to acquired SCRC. Goodwill was $31.40 million on the balance sheet. Shares outstanding increased to 46.01 million from 38.67 million, primarily reflecting 7.27 million shares issued for the acquisition.

Changes versus the prior comparable periods

  • Growth in reported revenue and earnings was driven largely by SCRC’s consolidation; the acquisition contributed $18.08 million of Q2 revenue and $4.61 million of Q2 net income. Pro forma first-half revenue and net income, assuming SCRC had been acquired at the start of each period, were $89.98 million and $17.56 million in 2015, versus $87.74 million and $17.28 million in 2014.
  • Legacy bromine revenue fell 7% in both Q2 and the first half; first-half sales volume fell 12%, while average selling price rose 6%. Crude salt first-half revenue fell 9%, mainly as its average selling price declined 9%.
  • Chemical-products revenue increased sharply with SCRC included. Excluding SCRC, the company reported modest first-half revenue growth in its established oil-and-gas, paper and pesticide additives.
  • First-half gross margin improved to 31% from 28%, largely reflecting higher bromine margins; crude salt margin declined to 11% from 17%. Q2 margin rose to 35% from 29%.

Outlook, risks and notable items

  • Management expected bromine and crude salt selling prices to remain near then-current levels through year-end 2015, conditional on continuation of PRC government macroeconomic tightening policies.
  • The company planned to resume channel and duct enhancement work at Factories No. 10 and No. 11 in the third and fourth quarters, weather permitting; work had been delayed by extreme heat. Bromine utilization was 41% for the first half, versus 43% a year earlier.
  • The company reported $325,840 of first-half exploration expense and cumulative natural-gas exploration costs of $7.85 million. Management said a May 2015 testing report confirmed the economics of natural gas found beneath a bromine well in Sichuan; the filing does not provide a production timetable or quantified expected returns.
  • Receivables and customer concentration merit attention: approximately 69% of receivables aged over 90 days at June 30 were reportedly collected in July, and the top five customers accounted for 30.0% of first-half sales. The top five suppliers provided 56.6% of first-half raw materials.
  • Substantially all cash was held at PRC financial institutions and was uninsured or otherwise unprotected. The filing also describes land-use and property-title limitations: the company lacked land-use certificates for certain collectively owned land and ownership certificates for certain buildings and salt pans.
  • Other notable items include $343,800 of first-half stock-based compensation and a $79.68 million SCRC acquisition consideration, paid with cash and stock. Management reported no long-lived-asset impairment, no legal proceedings, and effective disclosure controls; it reported no material change in internal control over financial reporting.

Important facts for investors to verify

  • Whether the acquired SCRC business sustains its reported contribution to earnings and cash generation, and how acquisition accounting and integration affect future margins.
  • Collections and aging of the enlarged receivables balance, including follow-up on the July settlements of older balances.
  • Performance of legacy bromine and crude salt operations amid weaker volumes or prices, and progress and costs of planned infrastructure enhancements.
  • Evidence supporting natural-gas economics, permitting, development plans and any expected capital requirements.
  • Exposure from PRC-held cash, customer and supplier concentration, land-use/title documentation and the potential withholding tax on future distributions of PRC earnings.
  • The filing’s acquisition note lists goodwill as $31,399,066, while the balance sheet and segment disclosure show $31,396,066; verify the correct amount in the underlying filed statements.