Business context and reporting period
Gulf Resources, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. Its PRC subsidiaries produce bromine and crude salt, chemicals for industrial uses, and chemical products used in human and animal antibiotics. All operations and assets are in China.
Results include SCRC, acquired on February 4, 2015. The $79.7 million purchase consideration comprised $66.3 million cash and $13.4 million in 7.27 million Gulf shares; the shares are subject to a five-year lock-up. Comparisons with 2014 are therefore affected by SCRC’s partial-year consolidation.
Financial performance
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue | $42.6 million; +37% | $126.9 million; +43% |
| Gross profit / margin | $15.6 million / 36.6%, versus $9.2 million / 29.6% | $42.1 million / 33.2%, versus $25.2 million / 28.5% |
| Operating income / margin | $13.9 million / 32.6%; +108% | $35.6 million / 28.0%; +79% |
| Net income | $10.7 million; +112% | $26.8 million; +79% |
| Diluted EPS | $0.23, versus $0.13 | $0.58, versus $0.38 |
| Operating cash flow | Not presented quarterly in the supplied filing text | $34.9 million, versus $32.5 million |
For the nine-month period, cash used in investing was $55.7 million, principally reflecting the SCRC acquisition; financing used $0.3 million. Cash declined $25.7 million to $120.9 million, including a $4.6 million adverse exchange-rate effect. Foreign-currency translation losses were $14.6 million in Q3 and $14.2 million year to date, leaving Q3 comprehensive income at a loss of $3.9 million despite positive net income.
At September 30, cash was $120.9 million, current assets $202.9 million, current liabilities $26.3 million, and working capital approximately $176.6 million. Total liabilities were $28.9 million; capital lease obligations were $2.76 million, with no other conventional borrowings reported in the supplied text. Total assets were $367.2 million and stockholders’ equity $338.3 million.
Material changes versus the prior comparable period
- SCRC contributed $11.8 million of Q3 revenue and $3.0 million of Q3 net income; for the nine months since acquisition it contributed $40.4 million of revenue and $10.2 million of net income. Pro forma nine-month revenue and net income, assuming SCRC had been included from the beginning of both periods, were $132.6 million and $28.2 million in 2015, versus $127.3 million and $24.6 million in 2014.
- Chemical-products revenue increased 97% in Q3 and 113% year to date, largely due to SCRC. Bromine revenue declined 6.5% in Q3 and 7% year to date; crude-salt revenue rose 14.2% in Q3 but declined 1% year to date.
- Management attributed bromine volume declines partly to PRC macroeconomic tightening and the transfer of sales to acquired SCRC, which are eliminated in consolidation. Bromine selling prices rose 11% in Q3 and 8% year to date.
- Accounts receivable rose 77% from year-end to $74.3 million, mainly due to SCRC; inventory increased 37% to $7.4 million. Accounts payable and accrued expenses rose to $19.8 million from $4.0 million, including $7.7 million in construction payables.
Outlook, risks, contingencies and unusual items
- Management expected bromine and crude-salt prices to remain near current levels through year-end 2015, subject to continued PRC macroeconomic tightening. It stated available funds and operating cash flows should cover anticipated needs for the next 12 months. No formal earnings or revenue guidance was provided.
- The company incurred $0.82 million of Q3 property and equipment write-offs for replaced transmission-channel protective shells and bromine-facility equipment. Nine-month exploration expense was $0.33 million; cumulative natural-gas exploration spending was $7.85 million. Management said it was discussing trial production with the government after a test report supported the economics of a Sichuan-area gas resource.
- Key exposures include customer and supplier concentration: the top five customers represented 31.6% of nine-month sales, and the top five suppliers provided 57.2% of nine-month raw materials. Management warned that losing these relationships could have a severe near-term impact. Approximately 69% of receivables aged over 90 days at quarter-end was collected in October; no doubtful-account allowance was recorded.
- All operations are in the PRC; substantially all cash is held in PRC banks and is uninsured or otherwise unprotected. The filing also reports land-use parcels without certificates and buildings or salt pans without ownership certificates. The company reported $30.2 million of acquisition goodwill, not expected to be tax deductible, and no impairment at the reporting date.
- Subsequent to quarter-end, shareholders approved a 6.0 million-share increase to the equity-plan reserve and reincorporation from Delaware to Nevada, which management said was intended to reduce franchise-tax costs. The company reported no legal proceedings and no changes to previously disclosed risk factors.
Important facts for investors to verify
- How much of revenue and earnings growth reflects acquired SCRC versus performance in the existing businesses, and whether SCRC’s contribution and margins are sustainable.
- Subsequent collection and aging of the $74.3 million receivable balance, including the reported October collections, and the absence of a bad-debt allowance.
- Whether bromine and crude-salt volumes, prices, and production utilization can hold up amid PRC economic conditions; Q3 bromine utilization was 49%, down from 54%.
- Progress and required approvals for natural-gas trial production, along with future exploration spending and potential returns.
- Exposure arising from PRC cash custody, foreign-exchange movements, concentrated counterparties, and unresolved land-use or property certificates.
- Potential dilution from the acquisition shares, outstanding options, and the approved increase in shares available under the equity incentive plan.