10-K 1 e608177_10k-gulf.htm Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010
or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________________ to ________________

Commission file number 000-20936

Gulf Resources, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
13-3637458
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
Cheming Industrial Park, Shouguang City, Shandong, China
 
262714
(Address of principal executive offices)
 
(Zip Code)
 
+86 (536) 567-0008
Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
Name of each exchange on which registered
Common Stock, $0.0005 par value
NASDAQ Global Select Market
 
Securities registered pursuant to section 12(g) of the Act:
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been  subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference  in Part III of this Form 10-K or any amendment to this Form 10-K o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer," "accelerated filer,” and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
(Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o  No x
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. As of June 30, 2010, the aggregate market value of the common stock of the registrant held by non-affiliates (excluding shares held by directors, officers and others holding more than 5% of the outstanding shares of the class) was $118,077,814 based upon a closing sale price of $8.59.
 
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15 of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes o  No o

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.   As of March 14, 2011, the registrant had outstanding 34,735,912 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement relating to the Registrant’s 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
 
 
 

 
 
Table of Contents
 
PART I
       
Item 1.
  
  
  1
Item 1A.
  
  
  10
Item 1B
   
  17
Item 2.
  
  
  17
Item 3.
  
  
  24
Item 4.
  
  
  24
PART II
Item 5.
  
  
  25
Item 6.
  
  
  27
Item 7.
  
  
  28
Item 7A.
  
  
  37
Item 8.
  
  
  38
Item 9.
  
  
  39
Item 9A.
  
  
  39
Item 9B.
  
  
  41
PART III
Item 10.
  
  
  41
Item 11.
  
  
  41
Item 12.
  
  
  41
Item 13.
  
  
  41
Item 14.
  
  
  41
PART IV
Item 15.
  
  
  41
     
  
  44
 
 
Special Note Regarding Forward Looking Information
 
This report contains forward-looking statements that reflect management's current views and expectations with respect to our business, strategies, future results and events, and financial performance. All statements made in this report other than statements of historical fact, including statements that address operating performance, events or developments that management expects or anticipates will or may occur in the future, including statements related to future reserves, cash flows, revenues, profitability, adequacy of funds from operations, statements expressing general optimism about future operating results and non-historical information, are forward-looking statements. In particular, the words "believe", "expect", "intend", "anticipate", "estimate", "plan", "may", "will", variations of such words and similar expressions identify forward-looking statements, but are not the exclusive means of identifying such statements and their absence does not mean that the statement is not forward-looking. Readers should not place undue reliance on forward-looking statements which are based on management's current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include those discussed in this report, particularly under the caption "Risk Factors".  Except as required under the federal securities laws, we do not undertake any obligation to update the forward-looking statements in this report.
 
 
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 Company’s functional currency is the Renminbi, which had an average exchange rate of $0.14415, $0.14661 and $0.14787 during fiscal year 2008, 2009 and 2010, respectively.
 
Our Corporate History
 
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. 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, 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.
 
 
To satisfy certain ministerial requirements necessary to confirm certain government approvals required in connection with the acquisition of SCHC by Upper Class Group Limited, the shares of SCHC were transferred to a newly formed Hong Kong corporation named Hong Kong Jiaxing, all of the outstanding shares of which are now owned by Upper Class Group Limited.
 
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.
 
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.
 
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.cn. 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.
 
In January 2007, stockholders holding approximately 62% of the then outstanding shares of our common stock consented in writing to change our corporate name from Diversifax, Inc. to Gulf Resources, Inc. Accordingly, on February 20, 2007, we filed a Certificate of Amendment to our Certificate of Incorporation changing our corporate name to Gulf Resources, Inc.
 
On November 28, 2007, we amended our certificate of incorporation to increase our authorized shares of common stock from 70,000,000 to 400,000,000 and to effect a 2-for-1 forward stock split of our outstanding shares of common stock.
 
On August 31, 2008, Gulf Resources 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 January 24, 2009, the Company entered into an agreement to issue 5.25 million shares of the Company's common stock at a price equal to $4.05 per share to Top King Group Limited ("Top King"), Billion Gold Group Limited ("Billion Gold"), Topgood International Limited ("Topgood"), in lieu of paying off in cash approximately $21.3 million in existing loans payable to Shenzhen Hua Yin Guaranty and Investment Limited Liability Company, a shareholder of the Company.  On March 3, 2009 the Company issued the 5.25 million shares and the aforesaid loans were deemed paid in full and cancelled.
 
On October 12, 2009 we completed a 1-for-4 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”.
 
On December 21, 2009, Gulf Resources closed a private placement financing. In the transaction the Company issued  2,941,182 shares of the Company's common stock at a price of $8.50 per share for an approximate aggregate purchase price of $25.0 million. Brean Murray, Carret & Co., LLC acted as the exclusive placement agent for the financing. The Company plans to use the proceeds of the private placement to acquire additional bromine and crude salt production assets, as well as for general corporate purposes such as working capital
 
Acquisitions of Production Facilities
 
On January 8, 2008, we acquired substantially all of the assets owned by Xiaodong Yang in the Shouguang City Hanting Area (the “Yangxiaodong property” or “Factory No. 6”).  The Yangxiaodong property includes a 47 years and 6 months (as of acquisition date) mineral rights and land lease covering 2,641 acres of real property, with 294 wells, 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 $9,722,222.
 
 
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, SCHC 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 US$26,048.
 
Each of the asset 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. 6, the assets had not been operational for eighteen months; 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, the assets had not been operational for six months. The Company recorded the above transactions as purchase of assets.
 
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 Renminbi (“RMB”) 5 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. According to figures published by the China Crude Salt Association, we are one of the largest manufacturers of bromine in China, as measured by production output.
 
The extraction of bromine in the Shandong Province is limited by the Provincial Government.  We hold one of such licenses.   As part of our business strategy, we will 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; 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
 
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 21,000 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.
 
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 expected annual production capacity of 5,000 tons. Formal production of this chemical production line started on September 15, 2008.
 
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 is now under pilot testing. We expect the new production line will start operation in mid of 2011 with positive cash from operations.
 
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 PetroChina 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.  Because our assets for crude salt production as at December 31, 2010 and the amount of our reported profit from sales of crude salt during fiscal year 2010 exceeded the 10% threshold of all of our total assets and operating profit, respectively, we established crude salt as our third segment for fiscal year 2010.  Certain comparative segment information of crude salt during fiscal year 2009 is not presented here as the necessary information is not available and we consider that the cost to develop it would be excessive.
 
The amounts set forth below are based upon on an average Renminbi to US Dollar exchange rates of $0.14787 and $0.14661 during fiscal year 2010 and 2009, respectively.
 
   
Net Revenue by Segment
 
   
Year Ended
December 31, 2010
   
Year Ended
December 31, 2009
 
             
Segment:
 
% of total
 
% of total
Bromine
 
$
99,211,812
     
63
%
 
$
63,679,888
     
58
%
Crude Salt
 
$
14,971,774
     
9
%
 
$
10,650,698
     
9
%
Chemical Products
 
$
44,151,437
     
28
%
 
$
35,946,322
     
33
%
Total sales
 
$
158,335,023
     
100
%
 
$
110,276,908
     
100
%
 
 
    Percentage Increase in Net Revenue
from fiscal year 2009 to 2010
               Percentage Increase in Net Revenue
from fiscal year 2008 to 2009
 
Segment:
     
Bromine
56%
4%
 
Crude Salt
41%
365%
 
Chemical Products
23%
51%
 
 
SCHC
 Product sold in metric tons
Year ended
December 31, 2010
Year ended
December 31, 2009
 
Percentage Change
Bromine
34,672
34,930
 
(0.7%)
         
Crude Salt
370,437
356,839
 
3.8%
 
   
Income from Operations by Segment
 
   
Year ended
December 31, 2010
   
Year ended
December 31, 2009
 
             
Segment:
       
% of total
     
% of total
Bromine (and Crude Salt for 2009)
 
$
48,250,896
     
67
%
 
$
32,954,828
     
72
%
 
Crude Salt
 
$
11,360,476
     
16
%
   
*
     
*
   
Chemical Products
 
$
12,218,613
     
17
%
 
$
12,530,417
     
28
%
 
Income from operations before corporate costs
 
$
71,829,985
     
100
%
 
$
45,485,245
     
100
%
 
Corporate costs
 
$
(2,957,467
)
         
$
(3,244,411
)
         
Income from operations
 
$
68,872,518
           
$
42,240,834
           
* Separate segment information not available
 
Year Ended
             
Chemical
   
Segment
             
December 31, 2010
 
Bromine
   
Crude Salt
   
Products
   
Total
   
Corporate
   
Total
 
                                     
Net revenue
  $ 99,211,812     $ 14,971,774     $ 44,151,437     $ 158,335,023     $ -     $ 158,335,023  
Income (loss) from operations
    48,250,896       11,360,476       12,218,613       71,829,985       (2,957,467 )     68,872,518  
Income taxes
    12,943,451       2,040,287       3,071,111       18,054,849       -       18,054,849  
Total assets
    128,513,686       39,696,781       38,153,844       206,364,311       356,713       206,721,024  
Depreciation and amortization
    7,570,660       1,286,253       2,240,236       11,097,149       -       11,097,149  
Capital expenditures
    19,458,955       13,712,849       7,483,230       40,655,034       -       40,655,034  
 
 
   
Bromine
                         
Year Ended
 
and Crude
   
Chemical
   
Segment
             
December 31, 2009
 
Salt*
   
Products
   
Total
   
Corporate
   
Total
 
                               
Net revenue
  $ 74,330,586     $ 35,946,322     $ 110,276,908     $ -     $ 110,276,908  
Income (loss) from operations
    32,954,828       12,530,417       45,485,245       (3,244,411 )     42,240,834  
Income taxes
    8,051,868       3,132,530       11,184,398       -       11,184,398  
Total assets
    115,621,458       28,274,118       143,895,576       2,527,592       146,423,168  
Depreciation and amortization
    6,048,995       1,150,663       7,199,658       -       7,199,658  
Capital expenditures
    36,066,805       8,838,440       44,905,245       -       44,905,245  
* Separate segment information not available.
 
Sales and Marketing
 
We have in-house sales staff of 11 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 customers.  Our principal customers during 2010 were Shouguang City Rongyuan Chemical Company Limited, Shandong Morui Chemical Company Limited, Shandong Brother Technology Limited, Shouguang Weidong Chemical Company Limited, Kuerle Xingdong Trading Limited and Shandong Yijia Chemical Company Limited.
 
During the year ended December 31, 2010, sales to our three largest bromine and crude salt customers, based on net revenue from such customers, aggregated $33,198,400 and $10,170,014, respectively, or approximately 33.4% and 67.9% of total net revenue from the sale of bromine and crude salt, respectively; and sales to our largest customer represented approximately 13.2% and 25.2% of total net revenue from the sale of bromine and crude salt, respectively. At December 31, 2010, amounts due from these customers were $7,070,782.
 
During the year ended December 31, 2009, sales to our two largest bromine and crude salt customers, based on net revenue from such customers, aggregated $22,911,853, or approximately 30.8% of total net revenue from the sale of bromine and crude salt, and sales to our largest customer represented approximately 15.4% of total net revenue from the sale of bromine and crude salt. At December 31, 2009, amounts due from these customers were $2,693,116.
 
This concentration of customers makes us vulnerable to an adverse near-term impact, should one or more of these relationships be terminated.
 
The following table shows our major customers (10% or more) for our bromine and crude salt business for the year ended December 31, 2010.
 
   
Bromine
Crude Salt
Number
Customer
Revenue
(000’s)
Percentage of Segment’s Revenue (%)
Revenue
(000’s)
Percentage of Segment’s Revenue (%)
1
Shouguang City Rongyuan Chemical Company Limited
$     13,106
13.2%
3,634
24.3%
2
Shandong Morui Chemical Company Limited
$     11,752
11.8%
2,765
18.4%
3
Shandong Brother Technology Limited
$       8,340
  8.4%
3,771
25.2%
   
$     33,198
33.4%
$10,170
67.9%
 
The following table shows our major customers (10% or more) for our chemicals business for the year ended December 31, 2010:
 
Number
 
Customer
 
Revenue
(000’s)
   
Percentage of
Segment’s
Revenue (%)
1
 
Kuerle Xingdong Trading Limited
 
11,686
   
26.5%
2
 
Shouguang Longteng Trading Limited
 
5,975
   
13.5%
3
 
Sinopec Shengli-field Ltd's Qinghe Factory
 
5,546
   
12.6%
TOTAL
     
23,207
   
52.6%
 
 
Principal Suppliers
 
Our principal suppliers during 2010 and 2009 were Shandong Haihua Chlorine & Alkali Colophony Chemicals Company Limited, Shouguang Hongye Trading Company Limited, and Shouguang City Rongguang Trading Company Limited.
 
During the year ended December 31, 2010, we purchased 49.7% of our products from two suppliers. As of December 31, 2010, the accounts payable due to these suppliers was approximately $2,544,011.
 
During the year ended December 31, 2009, we purchased 25.5% of our raw material from two suppliers. As of December 31, 2009, the accounts payable due to these suppliers was approximately $2,146,192.
 
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
 
 
The Company has announced its intent to acquire bromine properties that are unlicensed and thus not legally permitted to produce bromine.  Prior to 2010, the Company acquired seven such properties, expanded our annual production capacity to 43,300 metric tons of bromine and 450,000 metric tons of crude salt.  These properties were purchased with a combination of cash and shares of our common stock, at purchase prices totaling $62.5 million. In 2010, the Company acquired another bromine property of this kind at purchase price of $13.9 million, in form of a combination of cash and shares of our common stock. This property further expanded our annual production capacity by 3,000 metric tons of bromine and 100,000 metric tons of crude salt. We also acquired a crude salt field in late December 2010 at cash consideration of $11 million, which expected to increase our annual production capacity by 78,000 metric tons of crude salt in 2011.  The Company expects that it will continue its acquisition program in 2011 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 June 2010, we completed the construction of a new production line for wastewater treatment chemical additives located in our Yuxin Chemical Plant, at a total cost of $8,838,000. The new production line is now under pilot testing. We expect the new production line will start operation in 2011 with positive cash from operations. 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 term 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, 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 Haihua Group Company Limited, Shandong Haiwang Chemical Company Limited and Shandong Longwei Group Company Limited.
 
Our principal competitors in the chemical business are Shandong Haihua Group Company Limited, Shouguang Weidong Salt Field Company Limited, Shouguang Fukang Pharmaceutical Company Limited, and Shouguang Caiyangzhi Salt Field Company 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, 2010, we employed approximately 481 full-time employees, of whom about 77% are with SCHC and 23% are with SYCI. Approximately 5% of our employees are management personnel, 6% 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 16% 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 25% of the average monthly salary. We have purchased social insurance for almost all of our employees. Expense related to social insurance was approximately $457,805 for fiscal year 2010.
 
Research and Development
 
On June 11, 2007, the Company entered into a five-year agreement with East China University of Science and Technology to establish 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. SYCI will make an annual payment of $500,000 to the center until the agreement expires on June 14, 2012.  All research findings and patents developed by this Center will belong to Gulf Resources.
 
Since the second quarter of 2010, we conducted research, through SYCI, for the new production line of wastewater treatment additives, the purpose of which is for the testing of the manufacturing routine and samples. The research and development expense incurred for the new production line from outside parties and the use of SCHC’s raw materials for the fiscal year 2010 were $847,919 and $848,990, respectively.
 
 
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.
 
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 companys 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:
 
 
l
the success of identifying and completing mergers and acquisitions;
 
l
the introduction of competitive products by different or new competitors;
 
l
reduced demand for any given product;
 
l
difficulty in keeping current with changing technologies;
 
l
increased or uneven expenses, whether related to sales and marketing, product development or administration;
 
l
deferral of recognition of our revenue in accordance with applicable accounting principles due to the time required to complete projects; and
 
l
costs 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.
 
Conflicts of interest.
 
Mr. Ming Yang, our chairman, was a substantial owner of SCHC and SCYI before their acquisition by us, and remains 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.
 
 
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.
 
 
-
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.
 
 
-
Economic Reform Issues
 
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:
 
 
l
We will be able to capitalize on economic reforms;
 
l
The Chinese government will continue its pursuit of economic reform policies;
 
l
The economic policies, even if pursued, will be successful;
 
l
Economic policies will not be significantly altered from time to time; and
 
l
Business 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.
 
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:
 
 
l
In 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.
 
 
l
The 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:
 
 
l
environmental hazards; and
 
l
industrial accidents, including personal injury.
 
Such risks could result in:
 
 
l
damage to or destruction of properties or production facilities;
 
l
personal injury or death;
 
l
environmental damage;
 
l
monetary losses; and
 
l
legal 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.
 
 
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.
 
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, do 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.
 
We may issue shares of our capital stock or debt securities to complete an acquisition, which would reduce the equity interest of our stockholders or subject our company to risks upon default
 
We may issue our securities to acquire companies or assets. Most likely, we will issue additional shares of our common stock or preferred stock, or both, to complete acquisitions. If we issue additional shares of our common stock or shares of our preferred stock, the equity interest of our existing stockholders may be reduced significantly, and the market price of our common stock may decrease. The shares of preferred stock we issue are likely to provide holders with dividend, liquidation and voting rights, and may include participation rights, senior to, and more favorable than, the rights and powers of holders of our common stock.
 
If we issue debt securities as part of an acquisition, and we are unable to generate sufficient operating revenues to pay the principal amount and accrued interest on that debt, we may be forced to sell all or a significant portion of our assets to satisfy our debt service obligations, unless we are able to refinance or negotiate an extension of our payment obligation. Even if we are able to meet our debt service obligations as they become due, the holders of that debt may accelerate payment if we fail to comply with, and/or are unable to obtain waivers of, covenants that require us to maintain certain financial ratios or reserves or satisfy certain other financial restrictions. In addition, financial and other covenants in the agreements we may enter into to secure debt financing may restrict our ability to obtain additional financing and our flexibility in operating our business.
 
We have significant indebtedness. We are significantly leveraged and our indebtedness is substantial in relation to our stockholders' equity. Our ability to make principal and interest payments will depend on future performance, which is subject to many factors, some of which are outside our control. In the case of a continuing default with respect to this indebtedness, the lender will have the right to foreclose on our assets, which would have a material adverse effect on our business. Payment of principal and interest on this indebtedness may limit our ability to pay cash dividends to stockholders and the documents governing this indebtedness prohibit the payment of cash dividends in certain situations. Our leverage may also adversely affect our ability to finance future operations and capital needs, may limit our ability to pursue business opportunities and may make our results of operations more susceptible to adverse economic conditions.
 
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.
 
 
Item 1B. Unresolved Staff Comments.
 
None.
 
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 RMB 4,000, or approximately US$591. 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 $591.
 
 
The Company operates its bromine and crude salt production facilities through its wholly-owned subsidiary SCHC.  SCHC has land use rights to one property and land lease contracts to eight properties totaling nearly 23,388 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 nine 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 Factory No. 1 to 4 are included under a single permit, which was originally issued in January 2005.  For Factory No. 5 to 9, 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.   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.
 
Each of the nine properties is in the 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.
 
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.
 
 
As of December 31, 2010, the Company had invested approximately $77.6 million in its nine production factories, facilities and paid approximately $6.3 million in prepaid land lease payments and mineral rights.  In addition, the company estimates that equipment maintenance will cost approximately $6.0 million each year and that it will invest approximately $1.5 million in new extraction wells.
 
Each of the nine 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 nine properties held by SCHC as of December 31, 2010.
 
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
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
43.25 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
2052
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
42 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
2052
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
41.3 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
2054
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
43.83 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
2054
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
44 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
2055
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
44.5 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
2059
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
48.17 Years
Prior Fees Paid for Land Use Rights
Not applicable
Annual Rent
RMB163,000
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
2059
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
48.66 Years
Prior Fees Paid for Land Use Rights
Not applicable
Annual Rent
RMB330,600
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
2060
The number of remaining years to expiration of the of the land lease as of December 31, 2010
 
49.5 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
 
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 RMB 5 million, approximately $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.
 
The chart below represents the annual production capacity and utilization ratios for the eight 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.
 
   
Acres
   
Annual Production
Capacity
(in tons)
 
2009 Utilization
Ratio
2010
Utilization
Ratio
Factory No. 1
 
6,442
     
12,000
   
97%
79%
Factory No. 2 (1)
 
1,846
     
5,000
   
81%
73%
Factory No. 3 (2)
 
2,318
     
4,800
   
88%
79%
Factory No. 4 (3)
 
2,310
     
4,600
   
94%
77%
Factory No. 5 (4) and
Factory No. 7 (6) *
 
3,776
     
8,000
   
81%
82%
Factory No. 6 (5)
 
2,641
     
4,800
   
79%
72%
Factory No. 8 (7)
 
2,723
     
4,100
   
10%
79%
Factory No. 9 (8)
 
   759
     
3,000
   
-
31%
 
*
Bromine production for Factory No. 5 and Factory No. 7 were combined in early 2010 as both factories are located adjacent to each other.
 
 
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, the assets had not been operational for six months. This figures represent estimated annual production capacity based upon existing facilities, historical production rates and capital expenditure the Company planned for these assets to fund improvements and make them operational.
 
(1)  This facility was acquired on April 7, 2007.
(2)  This facility was acquired on June 8, 2007.
(3)  This facility was acquired on October 26, 2007.
(4)  This facility was acquired on October 25, 2007.
(5)  This facility was acquired on January 8, 2008.
(6)  This facility was acquired on January 7, 2009
(7)  This facility was acquired on September 7, 2009
(8)  This facility was acquired on June 7, 2010
 
The following table shows the annual bromine production sold for each of our nine production facilities and the weighted average price received for all products sold for the last three years.
 
Facility
 
2008
 
2009
 
2010
 
 
Production
(in tons)
Price
(RMB/ton)
Production
(in tons)
Price
(RMB/ton)
Production
(in tons)
Price
(RMB/ton)
 
Factory No. 1
 
9,502.22
 
14,899
 
11,659.20
 
12,583
 
9,492.08
 
20,018
 
Factory No. 2 (1)
 
4,235.10
 
14,819
 
4,054.00
 
12,637
 
3,642.14
 
20,558
 
Factory No. 3 (2)
 
3,221.10
 
14,858
 
4,237.00
 
12,459
 
3,779.52
 
20,282
 
Factory No. 4 (3)
 
4,396.80
 
14,843
 
4,327.00
 
12,744
 
3,545.12
 
20,032
 
Factory No. 5 (4) and
Factory No. 7 (6) *
 
3,579.30
 
14,822
 
6,470.00
 
12,685
 
6,580.57
 
19,800
 
Factory No. 6 (5)
 
3,738.00
 
14,891
 
3,787.80
 
12,581
 
3,447.71
 
19,902
 
Factory No. 8 (7)
 
-
 
-
 
395.00
 
15,356
 
3,242.59
 
19,905
 
Factory No. 9 (8)
 
-
 
-
 
-
 
-
 
942.75
 
22,759
 
Total
 
28,672.52
     
34,930.00
     
34,672.48
     
 
*
Bromine production for Factory No. 5 and Factory No. 7 were combined in early 2010 as both factories are located adjacent to each other.
 
(1)  This property was acquired on April 7, 2007.
(2)  This property was acquired on June 8, 2007.
(3)  This property was acquired on October 26, 2007.
(4)  This property was acquired on October 25, 2007.
(5)  This property was acquired on January 8, 2008.
(6)  This facility was acquired on January 7, 2009
(7)  This facility was acquired on September 7, 2009
(8)  This facility was acquired on June 7, 2010
 
 
Item 3. Legal Proceedings.
 
We are not a party to any legal proceedings other than the following.
 
The Company recently retained Loeb & Loeb LLP to act as litigation counsel 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, Shouguang City Haoyuan Chemical Company Limited (the “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.
 
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.  That Motion remains pending and is set for hearing on March 15, 2011.
 
Item 4. [Removed and Reserved]
 
 
 
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 “GFRE”.  Before October 27, 2009 our common stock was traded in the Over-the-Counter Bulletin Board, or OTCBB under the symbol GRUS. 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.
 
The prices set forth below reflect the quarterly high and low bid price information for our common stock prior to October 27, 2009 as reported by the OTCBB, and the high and low sale prices for our common stock from October 27, 2009.
 
   
High
   
Low
 
2011
           
             
First Quarter (through March 14)
 
$
10.56
   
$
7.54
 
                 
2010
               
                 
First Quarter
 
$
14.74
   
$
9.37
 
Second Quarter
 
$
11.85
   
$
8.06
 
Third Quarter
 
$
9.40
   
$
6.33
 
Fourth Quarter
 
$
11.80
   
$
7.94
 
                 
2009
               
                 
First Quarter
 
$
2.16
   
$
1.20
 
Second Quarter
 
$
2.68
   
$
1.72
 
Third Quarter
 
$
7.92
   
$
1.96
 
Fourth Quarter (through October 26)
 
$
10.30
   
$
7.40
 
Fourth Quarter (from October 27 to December 31)
 
$
11.94
   
$
8.64
 
 
Holders
 
As of March 14, 2011, our common stock was held of record by approximately 44 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, 2010 about our equity compensation plans and arrangements.
 
Equity Compensation Plan Information - December 31, 2010
 
Plan category
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities remaining available for future issuance under equity compensation plans(excluding securities reflected in column (a))
  
(a)
(b)
(c)
Equity compensation plans approved by security holders
0
0
0
Equity compensation plans not approved by security holders
257,500
$8.83
2,042,500
Total
257,500
$8.83
2,042,500
 
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
 
   
PERIOD/YEAR ENDING
 
COMPANY/INDEX
 
12/12 2006(1)
 
12/31 2006
 
12/31 2007
 
12/31 2008
 
12/31 2009
 
12/31 2010
 
Gulf Resources, Inc.
 
  100.00
 
 122.73
 
509.09
 
54.55
 
530.00
 
485.91
 
NASDAQ Composite Index
  100.00
 
  99.32
 
109.08
 
64.86
 
93.32
 
109.10
 
S&P Chemicals Index
 
  100.00
 
  101.62
 
126.06
 
73.42
 
103.38
 
123.11
 
 
(1)  The Company ceased being a public “shell” company on December 12, 2006.
 
 
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
 
During the fourth quarter of our fiscal year ended December 31, 2010, 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 2010 in our Reports on Form 10-Q or Form 8-K, as applicable.
 
Item 6. Selected Financial Data.
 
The selected financial information for each of the five years ended December 31, 2010, 2009, 2008, 2007 and 2006 has been derived from, and should be read in conjunction with, our audited consolidated financial statements and other financial information presented elsewhere herein.  Capitalized terms are as defined and described in the consolidated financial statements or elsewhere herein.
 
   
Years Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(in thousands)
 
Statement of Operations Data:
                             
Net revenue
  $ 158,335     $ 110,277     $ 87,488     $ 54,248     $ 31,736  
Cost of net revenue
    (80,255 )     (61,403 )     (52,302 )     (32,108 )     (20,504 )
Gross profit
    78,080       48,874       35,186       22,140       11,232  
Operating expenses:
                                       
Sales, marketing and other operating expenses
    (136 )     (22 )     -       -       -  
Research and development cost
    (2,200 )     (500 )     (515 )     (268 )     -  
General and administrative expenses
    (6,871 )     (6,111 )     (4,094 )     (1,847 )     (5,789 )
Total operating expenses
    (9,207 )     (6,633 )     (4,609 )     (2,115 )     (5,789 )
Income from operations
    68,873       42,241       30,577       20,025       5,443  
Interest income (expense), net
    242       64       34       (107 )     6  
Other income (expense), net
    223       (529 )     (4 )     113       246  
Income before income taxes
    69,338       41,776       30,607       20,031       5,695  
Income tax
    (18,055 )     (11,184 )     (8,212 )     (7,798 )     (1,884 )
Net income
  $ 51,283     $ 30,592     $ 22,395     $ 12,233     $ 3,811  
Net income per share
                                       
Basic
  $ 1.48     $ 1.00     $ 0.90     $ 0.51     $ 0.18  
Diluted
  $ 1.48     $ 1.00     $ 0.90     $ 0.51     $ 0.18  
Weighted average number of shares outstanding:
 
 
   
 
   
 
                 
Basic
    34,614,667       30,698,824       24,917,211       24,172,126       21,602,720  
Diluted
    34,675,329       30,701,697       24,917,211       24,172,126       21,602,720  
       
   
Year Ended December 31,
 
    2010     2009     2008     2007     2006  
   
(in thousands)
 
Balance Sheet Data:
                                       
Cash, cash equivalents and short-term investments
  $ 68,494     $ 45,537     $ 30,878     $ 10,773     $ 5,692  
Working capital
    79,763       51,667       24,669       1,150       3,151  
Total assets
    206,721       146,423       89,359       46,329       14,955  
Total debt (including current maturities)
    14,036       12,040       36,890       19,861       6,722  
Stockholders' equity
    192,685       134,383       52,469       26,468       8,232  
 
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
 
Overview
 
We are a holding company which conducts operations through our wholly-owned China subsidiaries.  Our business is conducted and reported in three segments.
 
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, 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”.
 
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, 2010 as compared to year ended December 31, 2009
 
   
Years ended
       
   
December 31, 2010
   
December 31, 2009
   
% Change
 
                   
Net Revenue
 
$
158,335,023
   
$
110,276,908
     
44
%
                         
Cost of Net Revenue
 
$
(80,254,759
)
 
$
(61,402,820
)
   
31
%
                         
Gross Profit
 
$
78,080,264
   
$
48,874,088
     
60
%
                         
Sales, Marketing and Other Operating Expense
 
$
(136,364
)
 
$
(21,712
)
   
528
%
                         
Research and Development Costs
 
$
(2,200,291
)
 
$
(500,406
)
   
340
%
                         
General and Administrative Expenses
 
$
(6,871,091
)
 
$
(6,111,136
)
   
12
%
                         
Income from Operations
 
$
68,872,518
   
$
42,240,834
     
63
%
                         
Other Income (Expenses), Net
 
$
465,651
   
$
(465,021
)
   
200
%
                         
Income before Taxes
 
$
69,338,169
   
$
41,775,813
     
66
%
                         
Income Taxes
 
$
(18,054,849
)
 
$
(11,184,398
)
   
61
%
                         
Net Income
 
$
51,283,320
   
$
30,591,415
     
68
%
                         
Basic and Diluted Earnings Per Share
 
$
1.48
   
$
1.00
         
 
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%.
 
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 $1,823 per tonne for the fiscal year 2009 to $2,861 per tonne for fiscal year 2010, an increase of 57%. The sales volume of bromine slightly decreased by 0.7%, from 34,930 tonnes for fiscal year 2009 to 34,672 tonnes for fiscal year 2010. 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, and (ii) expansion of bromine applications in a variety of industries. 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 tonne to above $40.4 per tonne, an increase of approximately 35%.
 
The increase in net revenue from our chemical segment was mainly due to the strong demand for environmentally friendly oil and gas exploration chemicals and agricultural intermediaries.
 
 
   
Net Revenue by Segment
 
2010 vs. 2009
   
Year Ended
 
Year Ended
 
Percent Increase
   
December 31, 2010
 
December 31, 2009
 
of Net Revenue
Segment
       
Percent of total
       
Percent of total
     
Bromine
  $ 99,211,812       63 %   $ 63,679,888       58 %     56 %
Crude Salt
  $ 14,971,774       9 %   $ 10,650,698       9 %     41 %
Chemical Products
  $ 44,151,437       28 %   $ 35,946,322       33 %     23 %
Total sales
  $ 158,335,023       100 %   $ 110,276,908       100 %     44 %
 
   
Years Ended December 31
 
Percentage Change
Bromine and crude salt segments product sold in tonnes
 
2010
 
2009
 
Increase/(Decrease)
Bromine
 
34,672
 
34,930
 
(0.7%)
             
Crude Salt
 
370,437
 
356,839
 
3.8%
 
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.
 
Due to the diverse product mix and varying values, management does not believe that the tonne sold by the chemical product division is a meaningful metric.
 
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 $18.9 million (or approximately 31%) from the cost of net revenue in fiscal year 2009.  This increase resulted primarily from the increase in purchase price in raw materials and mineral resources compensation fees paid in the bromine and chemical products segments. The rate of increase for cost of net revenue was lower than that of net revenue because the rate of inflation relating to cost of net revenue was lower than the percentage increase in selling price of our products, as well as leverage due to the economies of scale.
 
Gross Profit
 
   
Years Ended December 31
     
2010
     
 % of Net revenue
   
 2009
     
 % of Net revenue
Cost of net revenue
 
$
80,254,759
     
50.7%
 
$
61,402,820
     
55.7%
Gross Profit
 
$
78,080,264
     
49.3%
 
$
48,874,088
     
44.3%
 
Our gross profit was $78,080,264, or 49.3% of net revenue, for fiscal year 2010 compared to $48,874,088, or 44.3% 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. For the fiscal year 2010 as compared to 2009, the average selling price of bromine increased from $1,823 per tonne to $2,861 per tonne with an increase of 57% and the average selling price of crude salt increased from approximately $29.9 per tonne to over $40.4 per tonne with an increase of approximately 35%, while the inflation rate for cost of net revenue in our bromine and crude salt segments were much lower than the increase rate of selling price because the demand exceeded the supply of bromine in the China domestic market. We expect the trend will continue in the year of 2011.
 
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 $759,955, or approximately 12%, from the general and administrative expenses of $6,111,136 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, which were previously treated as other income (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, the Company incurred a loss on disposal of property, plant and equipment of approximately $1.3 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 (i) 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; and (ii) the reclassification of PRC mineral resources compensation fees of approximately $1.3 million for fiscal year 2009, which were previously treated as general and administrative expenses, but were reclassified as cost of net revenue (approximately $2 million) for the fiscal year 2010.
 
Income from Operations
 
   
Income from Operations by Segment
   
Year Ended December 31, 2010
 
Year Ended December 31, 2009
         
Percent of total
     
Percent of total
Segment:
                 
Bromine (and Crude Salt for 2009)
 
$
48,250,896
     
67%
 
$
32,954,828
     
72%
Crude Salt
   
11,360,476
     
16%
   
*
     
*
Chemical Products
   
12,218,613
     
17%
   
12,530,417
     
28%
Income from operations before corporate costs
   
71,829,985
     
100%
   
45,485,245
     
100%
Corporate costs
   
(2,957,467
)
           
(3,244,411
)
       
Income from operations
 
$
68,872,518
           
$
42,240,834
         
 * Separate segment information not available
 
Income from operations was $68,872,518 in fiscal year 2010 (or 43.5% of net revenue), an increase of $26,631,684 (or approximately 63.0%) 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. In fiscal year 2010, aggregate income from operations in the bromine and crude salt segments was $59,611,372, an increase of 80.9% from $32,954,828 in fiscal year 2009. 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 increase in the income from operations of bromine and crude salt was mainly due to the increase in the selling price of bromine. 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 (Expense) Other income was $465,651 for fiscal year 2010, an increase of $930,673 from an expense of $465,021 for fiscal year 2009. Such increase in other income was primarily due to the increase in interest income of approximately $162,000 and the sale of wastewater to some of our customers in the amount of approximately $0.2 million 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. For fiscal year 2009, the major component of the other expense was the loss on disposal of property, plant and equipment of approximately $0.5 million.
 
Net Income Net income was $51,283,320 in fiscal year 2010, an increase of $20,691,905 (or approximately 67.6%) as compared to fiscal year 2009. This increase was primarily attributable to the increase in selling price of bromine and crude salt.
 
 
Year ended December 31, 2009 as compared to year ended December 31, 2008
 
   
Years ended
       
   
December 31, 2009
   
December 31, 2008
   
%Change
 
                   
Net Revenue
 
$
110,276,908
   
$
87,488,334
     
26
%
                         
Cost of Net Revenue
 
$
(61,402,820
)
 
$
(52,302,085
)
   
17
%
                         
Gross Profit
 
$
48,874,088
   
$
35,186,249
     
39
%
                         
Sales, Marketing and Other Operating Expense
 
$
(21,712
)
 
$
-
     
n/a
 
                         
Research and Development Costs
 
$
(500,406
)
 
$
(514,780
)
   
-3
%
                         
General and Administrative Expenses
 
$
(6,111,136
)
 
$
(4,094,312
)
   
49
%
                         
Income from Operations
 
$
42,240,834
   
$
30,577,157
     
38
%
                         
Other Income (Expenses), Net
 
$
(465,021
)
 
$
30,254
     
1637
%
                         
Income before Taxes
 
$
41,775,813
   
$
30,607,411
     
36
%
                         
Income Taxes
 
$
(11,184,398
)
 
$
(8,211,939
)
   
36
%
                         
Net Income
 
$
30,591,415
   
$
22,395,472
     
37
%
                         
Basic and Diluted Earnings Per Share
 
$
1.00
   
$
0.90
         
 
Net Revenue   Net revenue was $110,276,908 in fiscal year 2009, an increase of $22,788,574 (or approximately 26%) as compared to fiscal year 2008. This increase was primarily attributable to the growth (i) in our bromine and crude salt segment with revenue increasing from $63,664,156 for fiscal year 2008 to $74,330,586 for fiscal year 2009, an increase of approximately 17%; and (ii) in our sales of chemical products, which increased from $ 23,824,178 for fiscal year 2008 to $35,946,322 for fiscal year 2009, an increase of approximately 51%.
 
The increase in the net revenue of bromine and crude salt was primarily due to the net effect of (i) the increase in sales volume arising from the increase in production capacity after the asset acquisitions made in January of 2009 and in September of 2009, which are now in full operation; and (ii) the decrease in average selling price of both bromine and crude salt. As the demand for bromine always exceeded the supply available, the increase in production of the Company contributed to the increase in sales in the current year. Among the total increase of net revenue, $7,145,507 was due to the asset acquisitions.  The increase in the net revenue of our chemical products was due to the introduction of new environmental friendly additive products which was in operation since September 2008, solid lubricant and polyether lubricant, for use in oil and gas exploration in fourth quarter of 2009, and improvement of our pesticide intermediate products.
 
   
Net Revenue by Segment
 
2009 vs. 2008
   
Year Ended
 
Year Ended
 
Percent Increase
   
December 31, 2009
 
December 31, 2008
 
of Net Revenue
Segment
       
Percent of total
       
Percent of total
     
Bromine and Crude salt
  $ 74,330,586       67 %   $ 63,664,156       73 %     17 %
Chemical Products
  $ 35,946,322       33 %   $ 23,824,178       27 %     51 %
Total sales
  $ 110,276,908       100 %   $ 87,488,334       100 %     26 %
 
 
   
Years Ended December 31
 
Percentage Change
Bromine and crude salt segment product sold in tonnes
 
2009
 
2008
 
Increase/(Decrease)
Bromine
 
34,930
 
28,673
 
21.8%
             
Crude Salt
 
356,839
 
66,500
 
436.6%
 
The proportion of our total net revenue represented by bromine and crude salt in fiscal year 2009 decreased as compared to the same period in 2008 as a result of fast growth in chemical production segment.  Although net revenue in both segments grew, the growth of sales of bromine and crude salt was lower than that of our chemical products operations mainly due to the introduction of new environmental friendly additive products, solid lubricant and polyether lubricant, for use in oil and gas exploration in fourth quarter of 2009, and improvement of our pesticide intermediate.
 
Cost of Net Revenue Cost of net revenue reflects the raw materials consumed, direct salaries and benefits, electricity and other manufacturing costs. Our cost of net revenue was $61,402,820 in fiscal year 2009, an increase of $9,100,735 (or approximately 17%) from the cost of net revenue in fiscal year 2008.  The rate of increase for cost of net revenue was lower than the increase rate of sales due to the cost inflation rate was lower than the increase rate of selling price.
 
Gross Profit
 
   
Years Ended December 31
     
2009
     
 % of Net revenue
   
 2008
     
 % of Net revenue
Cost of net revenue
 
$
61,402,820
     
55.7%
 
$
52,302,085
     
59.8%
Gross Profit
 
$
48,874,088
     
44.3%
 
$
35,186,249
     
40.2%
 
Our gross profit rate increased from 40.2% in 2008 to 44.3% in 2009 due to an increase in our net revenue by 26% in 2009 compared to 2008, which enabled us to leverage our fixed costs.  The increase was also due to the fact that increases in our selling prices were higher than increases in the rate of inflation in the PRC in 2009, because the demand exceeded the supply of bromine in the China domestic market.
 
Research and Development Costs Research and development costs result from a five year agreement entered into by SYCI and East China University of Science and Technology 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. The research and development costs incurred for the year ended December 31, 2009 and 2008 was $500,406 and $514,780, respectively.
 
General and Administrative Expenses General and administrative expenses were $6,111,136 in fiscal year 2009, an increase of $2,016,824 (or approximately 49%) from the general and administrative expenses of $4,094,312 during fiscal year 2008. This increase in general and administrative expenses was primarily due to an expense in the amount of $1,367,156 related to a warrant issued to the placement agent in our December 2009 private placement and expenses in the amount of $ 227,478 relating to our listing on Nasdaq in October 2009.
 
Income from Operations
 
   
Income from Operations by Segment
   
Year Ended December 31, 2009
 
Year Ended December 31, 2008
         
Percent of total
     
Percent of total
Segments:
                 
Bromine and Crude salt
 
$
32,954,828
     
72%
 
$
24,663,244
     
75%
Chemical Products
   
12,530,417
     
28%
   
8,121,203
     
25%
Income from operations before corporate costs
   
45,485,245
     
100%
   
32,784,447
     
100%
Corporate costs
   
(3,244,411
)
           
(2,207,290
)
       
Income from operations
 
$
42,240,834
           
$
30,577,157
         
 
 
Income from operations was $42,240,834 in fiscal year 2009 (or 38.3% of net revenue), an increase of $11,663,677 (or approximately 38%) over income from operations in fiscal year 2008. This increase resulted primarily from the increase in revenues and relatively lower increase in cost of net revenue as shown above. This increase resulted from increases in income from operations in both the bromine and crude salt, and the chemical products segments of the Company. In fiscal year 2009, income from operations in the bromine and crude salt segment was $32,954,828, an increase of 34% from $24,663,244 in fiscal year 2008. In fiscal year 2009, income from operations in the chemical products division was $12,530,417, an increase of 54% from income from operations in this division of $8,121,203 in fiscal year 2008. The increase in the income from operations of bromine and crude salt was primarily as a result of the assets acquisitions as well production capacity expansion. The increase in the income from operations of our chemical products was due to the new product of friendly additive products, solid lubricant and polyether lubricant, for use in oil and gas exploration in fourth quarter of 2009, and improvement of our pesticide intermediate.
 
Other Income (Expense) Other expense was $465,021 for fiscal year 2009, an increase of $495,275 from the other income of $30,254 for fiscal year 2008. This increase was primarily due to the loss from disposal of property, plant and equipment. During the year ended December 31, 2009, a loss on disposal of property, plant and equipment of $528,749 was resulted because the property, plant and equipment being disposed of were specialized equipment used in the bromine producing industry in which there are a few suppliers and second-hand market is not active, resulting in low second-hand price.
 
Net Income Net income was $30,591,415 in fiscal year 2009, an increase of $8,195,943 (or approximately 37%) as compared to fiscal year 2008. This increase was primarily attributable to the $10,666,430 net revenue increase from Bromine and Crude Salt segment and the $12,122,144 net revenue increase from chemical products segment. Another reason for this result was the leverage of fixed cost due to expansion of sales.
 
LIQUIDITY AND CAPITAL RESOURCES
 
As of December 31, 2010, cash and cash equivalents were $68,494,480 as compared to $45,536,735 as of December 31, 2009.  The components of this increase of $22,957,745 are reflected below.
 
Statement of Cash Flows
 
   
Years Ended December 31
   
2010
   
2009
Net cash provided by operating activities
 
$
57,999,451
   
$
39,820,378
 
Net cash used in investing activities
 
$
(39,084,512
)
 
$
(38,244,301
)
Net cash provided by financing activities
 
$
2,210,919
   
$
13,073,463
 
Effects of exchange rate changes on cash and cash equivalents
 
$
1,831,887
   
$
9,151
 
Net cash inflow
 
$
22,957,745
   
$
14,658,691
 
 
For the fiscal year 2010 and 2009, the Company met its working capital and capital investment requirements mainly by using cash flows from operations. The Company intends to continue to explore opportunities relating to bromine asset purchases.
 
Net Cash Provided by Operating Activities
 
During the year ended December 31, 2010, we had positive cash flow from operating activities of $57,999,451, primarily attributable to net income of $51,283,320.  Net cash provided by operating activities in 2010 increased by $18,179,073 from that of 2009.  The primary source of this increment was due to the increase in net income. As a result of increasing demand for bromine and crude salt in the China market, the selling price per tonne of bromine and crude salt for fiscal year 2010 increased by approximately 57% and 35% respectively, over fiscal year 2009.
 
Net Cash Used In Investing Activities and Provided by Financing Activities
 
We used approximately $7 million cash for the construction of waste water chemical additives line during fiscal year 2010. We used another approximately $14 million cash for the acquisition of bromine assets in June of 2010. We also used approximately $7 million to build new channels and wells for bromine facilities during the fiscal year 2010. In late December 2010, we used approximately $11 million cash to acquire a crude salt field. These projects were financed by opening cash balances as of January 1, 2010, proceeds from one of the placees of approximately $2.2 million from a private placement and cash generated from operations during fiscal year 2010.
 
 
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 production line of wastewater treatment additives.  We expect to raise those funds through the issuance of additional shares of our equity securities in one or more public or private offerings, or through credit facilities obtained with lending institutions or a combination of both.  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 at December 31, 2010 was approximately $79.8 million at December 31, 2010 as compared to approximately $51.7 million at December 31, 2009. The increase was mainly attributable to the cash provided by operating activities during fiscal year 2010.
 
We had available cash of approximately $68.5 million at December 31, 2010, 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, and we do not anticipate paying cash dividends in the foreseeable future.
 
For the immediate future we intend to focus our efforts on the activities of SCHC and SYCI as these segments continue to expand within the Chinese market. Our long-term strategic goal is to extend our market to overseas countries.  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.
 
As of December 31, 2010, we have committed approximately $17,516,000 for (1) a 20-year capital lease of a real property adjacent to Factory No. 1, with the related production facility, the land and pipelines, other production equipment and the buildings located on the property, with an annual payment of approximately $755,000 up to December 31, 2030, aggregating $15,100,000; and (2) an extension construction of buildings and plant and machinery in Factory No. 1, of approximately $2,416,000. This capital lease commitment of $17,516,000 is included in the table shown below.
 
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 Commitments
 
The following table sets forth payments due by period for fixed contractual obligations as of December 31, 2010.
 
Contractual Obligations
       
Payments due by period
 
         
Less than
               
More than
 
   
Total
   
1 year
   
1-3 years
   
3-5 years
   
5 years
 
Operating Lease Obligations
    9,601,175       61,445       216,186       226,994       9,096,550  
Capital Lease Obligations
    15,100,000       755,000       1,510,000       1,510,000       11,325,000  
Purchase Obligations
    2,416,000       2,416,000       -       -       -  
Contract for R&D expenses     500,000       500,000       -        -        -  
Total
    27,617,175       3,732,445       1,726,186       1,736,994       20,421,550  
 
Critical Accounting Policies and Estimates
 
(a)           Use of Estimates
 
Our 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. We base its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ significantly from these estimates under different assumptions or conditions.
 
(b)           Accounts Receivable and Allowance of Doubtful Accounts
 
Accounts receivable is stated at cost, net of allowance for doubtful accounts. We established 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 we consider the historical level of credit losses and apply certain percentage to accounts receivable balance. We make 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, 2010 and 2009, allowance for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the years ended December 31, 2010, 2009 and 2008.
 
(c)           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 expenditures that extend the useful lives 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.
 
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.
 
Construction in progress primarily represents the renovation costs of plant, machinery and equipment. Costs incurred are capitalized and transferred to property and equipment upon completion, at which time depreciation commences. Cost of repairs and maintenance is expensed as incurred.
 
Our depreciation and amortization policies on property, plant and equipment other than mineral rights and construction in progress are as follows:
 
 
Useful life
(in years)
Buildings
20
Machinery
8
Motor vehicles
5
Equipment
8
 
(d)           Asset Retirement Obligation
 
We follow 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.
 
(e)           Recoverability of Long Lived Assets

Long-lived and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. We are not aware of any events or circumstances which indicate the existence of an impairment which would be material.
 
(f)           Mineral Rights
 
We follow FASB ASC 805 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.
 
(g)           Revenue Recognition
 
We recognize 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.
 
(h)           Income Taxes
 
We use the asset and liability method of accounting for income taxes.  Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and tax loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
 
 
(i)           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.
 
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 Renminbi (“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.
 
 
Inflation
 
Inflationary factors, such as increases in the cost of our products and overhead costs, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future 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 sales revenue 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. Financial Statements and Supplementary Data (in thousand).
 
 
March 31
 
June 30
 
September 30
 
December 31