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:
Our production feeds include (i) natural brine; (ii) vitriol; (iii) chlorine; (iv) sulfur; and (v) coal.
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:
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.