Gulf Resources Inc (GURE) 2010 Q2 法說會逐字稿

Good day ladies and gentlemen. Welcome to the Gulf Resources second quarter 2010 conference call. My name is Kelly and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today's call, Mr. Crocker Coulson.

Thank you very much operator. Good morning ladies and gentlemen. Good evening to those of you who are joining us from China. I would like to welcome all of you to Gulf Resources second quarter 2010 earnings call. I am Crocker Coulson from CCG, the Company's investor relations firm. And I'm pleased to say that with us today are Mr. Xiaobin Liu, the Company's CEO, and also Mr. Min Li, the Company's Chief Financial Officer, and then Mr. David Wang, VP of Finance. Also joining us on the call is [Johnny Wong] of CCG, who will provide translation for your questions and answers at the end of this call.

I would like to remind our listeners that in this call management remarks contain forward-looking statements which are subject to risks and uncertainties. Management may make some additional forward-looking statements in response to your questions. Therefore the Company would like to claim the protection for Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today depending upon a number of risks factors including but not limited to the general economic and business conditions in China; future product development and production capabilities of Gulf Resources; shipments to end customers; market acceptance of the Company's new and existing products; additional competition from existing or new competitors for bromine and other oilfield, agricultural and flame retardant production chemicals; changes in technology; the ability to make future bromine asset purchases; and various other factors that are beyond the Company's control. Therefore, all forward-looking statements are expressly qualified in their entirety by this precautionary statement and the risk factors detailed in the Company's reports filed with the SEC.

Although the Company believes the expectations reflected in these statements are reasonable, we can provide no assurance that these expectations will prove to be correct. In addition, any references to the Company's future performance represent management's estimates as of today, August 17, 2010, and Gulf Resources assumes no obligation to update these projections in the future as market conditions change.

If any of you are not able to listen to the entire call at this time we're going to make a replay available for 14 days, and the call is also accessible through a webcast with a link that will be accessible on our website. Please refer to our press release issued earlier for details.

With those initial formalities out of the way, I would now like to turn the call over to Mr. Liu, the Company's CEO, who is going to provide some initial remarks that will be translated by Johnny Wong.

(Interpreted). First of all, I want to thank you for participating in Gulf Resources' second quarter 2010 earnings conference call.

The second quarter is traditionally peak season bromine production. This quarter we successfully increased marketshare to above 20% and increase gross profit margin and bottom-line profitability.

We successfully acquired bromine and crude salt production assets, our eighth acquisition thus far. This past quarter we also focused on increasing capacity utilization of our bromine factory while starting trial production at our newest production line for additives for water treatment chemicals.

I would now like to hand over this call to Crocker Coulson, who will present an overview of Gulf Resources' business development in the first quarter.

Thank you Mr. Liu and thank you Johnny. In the interest of time, as Mr. Liu shared I'm going to now continue with presenting the Company's results for the second quarter of 2010 on behalf of Mr. Liu.

So as Mr. Liu shared, the second quarter was extremely successful for Gulf Resources. Our bromine and crude salt segment contributed 74.8% of total revenues for the quarter. Within this segment, sale of bromine contributed to the majority or 88.8% of revenues while the sale of crude salt contributed 11.2% of revenues in the segment compared to 11.3% in the prior year period.

Following a very cold first quarter that impacted bromine production, we were able to successfully ramp up production in the second quarter. And some of the orders that were unfilled in the first quarter due to cold weather moved into the second quarter. As a result we operated at full capacity during the quarter, up from only 65% capacity in Q1. We have since normalized production at about 80% of capacity, which is a level we feel is sustainable over the long-term.

In line with our strategy to entry increase bromine production capacity, we successfully acquired additional bromine and crude salt production assets that will help us increase our annual bromine production by 3000 tons and will add an additional 100,000 tons of crude salt production. These assets, which are expected to start operation by the end of August, are anticipated to contribute approximately $8.5 million in annualized revenue at the current market prices, which corresponds to approximately $3 million in revenues and $1 million in net income for the remainder of the fiscal year 2010.

The demand for bromine remains robust mainly due to the continued demand in China for brominated flame retardants, fumigants, water purification compounds, dyes, medicines, disinfectants and other bromine-based products. Bromine prices continued increasing throughout the second quarter and the market price peaked at around RMB20,000 which is approximately $3000 per ton.

In light of the impressive pricing environment, we were able to successfully renegotiate contract prices with many of our major customers over the -- throughout the second quarter, resulting and current contract prices that are near to current market price levels. Since then, market prices have stabilized at about RMB19,000 per ton. Although the future price development is uncertain, we believe the demand outlook for bromine-based chemicals and compounds coupled with significant restrictions on increasing supply will continue to support attractive prices.

The improvement in gross margin reflects higher bromine prices, increased economies of scale and improved negotiating power with our suppliers. Although we have seen some increases in raw materials, and this would mainly be chlorine and phosphor, which may impact gross margins in the short term, we remain confident that we'll be able to transfer such prices to end users over time.

Another area contributing to the strong performance in the second quarter was continued demand for our new pesticide additives which have replaced our original pesticide products. Demand for environmentally friendly oil and gas exploration chemicals also remains strong. As a result, chemical products contributed 25.2% of total revenues for Q1.

The main focal point in the chemical segment is increasing integration with our bromine production by identifying products where bromine is a key component. In June, ahead of schedule, we started trial production of our new wastewater treatment chemical additives that utilize bromine in their formulations. We expect that this production line will contribute approximately $9 million to $10 million in revenues with an estimated gross profit margin of over 40% during the first year of operation.

This line is our first successful attempt in venturing down stream into production and commercialization of bromine-based chemicals and what we hope will become an area of increased importance for our Company's future development. Although we started commercial production only recently, we have already received good feedback from customers for these new products.

With that overview of the key developments during the second quarter, I would now like to turn this call over to Gulf Resources' VP of Finance, David Wang, who is going to discuss our financial performance in more detail and also provide some information on outlook for the second half of the year. David, over to you.

Thank you Crock. For the three months ended June 30, 2010, total revenue was [$26.8 million], up [15.8] year-over-year. The increase in net revenue was primarily attributable to growth in the Company's bromine segment as a result of the increased sales price of bromine which was driven by the strong demand of bromine flame retardants, fumigants, water purification (inaudible), dyes, medicines and (inaudible) in China.

Revenue from bromine and the crude salt product segment was [$35 million], up [17%] year-over-year. Revenue from the chemical product segment was $11.8 million for the second quarter, up 13% year over year. The increase in revenue was mainly due to the strong demand of (inaudible) environmentally friendly oil and gas exploration, chemicals and (inaudible) [upgrade] at the end of last year.

Gross profit for the second quarter was [$26.1 million] compared to $13.1 million one year ago. Gross profit margin for the second quarter was 49% compared to 44% last year due to the higher sales price of bromine and crude salt, which increased (inaudible) net revenue in the segment.

Selling, general and administrative [expenses] in the second quarter was [$7.8 million] compared to $1 million a year ago. This was mainly due to the reclassification of non-cash expense from options granted to employees. As a result, net income from operations from second quarter of 2010 was [$21.9 million], up [18.2] year-over-year. Operating margin was 47% compared to 41% for the second quarter of 2009. Operating income was [$0.06 million] compared with [other] expense of $0.02 million for the same period last year.

Income tax was $5.5 million, up 79% year over year. Our effective income rate was 25 compared to 26 in the year ago period. Net income was $16.4 million, up [18.3] year over year. Basic and diluted earnings per share in the second quarter of 2010 was $0.47 compared to $0.29 for the second quarter of 2009.

We continue to have [healthy] selling and a strong cash position. As of June 30, 2009 Gulf Resources had a cash [equivalent rate $75.2 million], (inaudible) liabilities of [$20.9 million] and shareholders' equity of $161.3 million. At the quarter end, we had working capital of [$61.1 million] and (inaudible) of [349].

For the six months ended June 30, 2009 we generated $27.9 million in cash flow from operations, primarily attributable to net income of $20.9 million investing activities mainly due to the construction with the water treatment chemical additives production line and the acquisition of bromine and crude salt production assets.

This year we plan to lay the foundation for commercialization of chemical products that utilize our bromine and salts as raw materials. Our (inaudible) introduction of additives for wastewater treatment chemicals is the first step in this direction. We are currently reviewing several other sectors in downstream bromine production.

We see a lot of potential in the pharmaceutical industry due to its favorable demographic, regulatory progress [and its effect]. So we've begun developing bromine based pharmaceuticals several years ago. Our strategy to expand into downstream production is still in the initial stage as we're assessing different options to develop the required capabilities, including acquisition of the (inaudible) chemical producers with access to [critical] technology, internal research and development, [cooperation with the research institute], [and the] in-house construction of production capacity. Once we [crystallize] our strategy we will share specific milestone information with investors.

In addition to expanding the chemical business segment, [increasing] bromine production capacity and the (inaudible) [market industry and positive elements] of our growth strategy. We continue to assess additional idle production [assets] and have identified our (inaudible) to (inaudible) targets that are suitable in terms of geographic location and access to bromine (inaudible).

While high bromine prices have delayed the negotiation process somewhat, we feel confident we are close to one additional acquisition this year. The magnitude and the timing of additional acquisitions depends on the pricing of the targets and the quality of the assets. As well, we carefully assess the return on the investment of any acquisition we make. After acquiring suitable targets, we plan to (inaudible) increasing the productivity of each property.

To support this growth strategy (inaudible) [shelf register] payment for the issues of up to [120 million] of securities to be [reasoned] over the next two, three years. We're pleased this provides us with the flexibility to execute our growth strategy quickly once we identify attractive investment opportunities.

We expect to maintain a conservative stance to raising additional capital and will carefully consider the timing, amount and optimal mix of any debt and the [equity security] offered. While we recognize that our results in the first half of 2010 (inaudible) of our annual revenue and net income guidance, we're currently assessing the pricing environment and the bromine production now (inaudible) return to normal levels. Therefore we reiterate guidance of revenue between [$146 million and $115 million] and net income between [$43 million and $46 million] for the fiscal year 2010.

Please note that this guidance [has closely impact] the acquisition number (inaudible) and any additional acquisition we make in the months ahead. We will continue to provide timely updates to our investors as our business evolves. With that, I would like to thank our shareholders and open this call to any questions that you may have. Operator, would you take the first question now?

(Operator Instructions) Katherine Lu, Oppenheimer & Co.

Thank you for taking my question. Congratulations on a very strong quarter. My first question is regarding to your guidance.

You had a very strong second quarter. I understand that there were some unfilled orders from first quarter, but you keep the full-year guidance unchanged. I understand you also talked about the bromine price peaked in second quarter at RMB20,000 and then stabilized at RMB19,000 recently. I'm just wondering how should I be looking at your guidance.

Should I take it that you're trying to be overly conservative? Or if there's any uncertainty that concerns you at this point, if you can talk about your expectations for the bromine price for the rest of the year, your capacity utilization rate of the assets excluding the newly acquired assets, that would be great. And if you can also give us some additional color in terms of how quickly you expect the new bromine asset to be up and running and what kind of utilization rate should we expect from these assets this year, that will be very helpful. Thank you.

Those are a lot of questions. Johnny and Liu, do you want to go through this and we can break it into pieces?

(Interpreted). The management has always has been and will be conservative about their current and future guidance. In terms of your first question or first element on the bromine pricing for the rest of the year, the management believes that the price currently will look to stabilize in the near future. For the rest of the year it is a likelihood that bromine prices will reach another stage or will even increase higher.

The capacity utilization for the rest of the year for the second half is estimated to be around 75%. The new acquired asset will likely to be in production at the end of August, and since we only have approximately 4 months of production it will reach a utilization rate of about 18%.

Okay, that's great. Thank you for the color.

I just want to follow-up a little bit on the bromine pricing. You mentioned the bromine pricing peaked at second quarter RMB20,000 and sequentially came down and stabilized at RMB19,000. I'm just wondering, what are some of the market dynamics that caused the stabilization at this level? Was that due to some retreat in terms of demand or was there an increased supply on the bromine side that led to the prize stabilizing at RMB20,000?

(Interpreted). So part of the reason is because there's a little bit more supply to the market, but the major reason it is just a pricing correction in the market. In the long run the prices will not go up -- will not stop. It won't reach a point where it will come retreat a little bit to correct itself and Mr. Liu believes that in the second quarter we've witnessed a little correction on bromine market price.

Thank you. You mentioned you expect -- potentially the bromine price can further increase in second half. I'm just wondering, what are some of the drivers that make you believe the bromine price will increase in the second half potentially?

(Interpreted). The major reason for the potential price increase on the bromine market price will be the increase in demand. The reason why the price retreated a little as mentioned before, there was a little bit more supply. And the second quarter is usually the peak season of the bromine production for the Company, so for the rest of the year we don't expect there to be a huge increase in bromine supply. But at the same time, we see an increase -- consistent increase in demand for the product. So the demand will be the major reason to drive the pricing for the rest of the year.

Katya Voronchuk, Rodman & Renshaw.

Congratulations on a great quarter. My first question is about government restrictions on new bromine mining [classes]. Do you think if the prices of bromine continue to rise, the government may actually issue additional licenses to ease the supply?

(Interpreted). Thank you for your question. There's always a possibility that a government will change its policies for any industry in China and the likelihood of government issuing new license or licenses is likely, but it will issue to new players in the market and not existing and licensed players. So the Company will continue with its strategy to seek out attractive targets once the new licenses are issued to strengthen its M&A strategies in the future.

I see. My second question is actually about the weather in China. Has the current production of bromine been affected at all by floods in China?

(Interpreted). The flooding in China right now is concentrated on the West part of the country and major production order companies have [quartered] their production sites are located on the east and northeast, so it is not affected.

And some of the bromine that you mine is being used internally in the production of bromine based chemicals. Can you tell us as a percentage of total bromine production or in tons how much is being used internally?

(Interpreted). It is about 8% of the bromine resources used internally.

I see. In your press release you mentioned that you're planning to strengthen your R&D efforts. So going forward, what kind of R&D expense should we expect either as a percentage of revenues or in absolute terms?

(Interpreted). Right now as a percentage of revenue, R&D expenses are very low. Going forward as the Company is putting more investment in R&D to target a goal to think about is about 1.5% to 2% of overall revenue.

(Interpreted). Although this is not a high percentage, this is the first step. The Company would like to take it step-by-step in terms of strengthening or making more investment in R&D.

I see. Just a follow-up question on your R&D efforts, in one of your previous calls you have mentioned the use of bromine for mercury emission reduction technologies. Is this something that the Company's actively pursuing? And if yes, can you maybe give us some color on the market for this product and when we can expect this product to come to the market?

(Interpreted). The management believes that there's a huge market for the above mentioned mercury, the technology (inaudible) mercury intermediate product including as well as the rest of the environmental friendly chemical compounds going forward. And the Company is actively -- or it will be a part of the R&D project, but nothing specific.

We just entered this area right now and we look forward to making more investments in the future.

Thank you for taking my questions. I will jump back in the queue.

Leeanne Su, Brean Murray.

Thank you for taking my call. My first question is your bromine utilization rate in the second quarter. You produce about 11,000 metric tons in the second quarter. I'm just wondering, is that at full capacity or close to full capacity? And can you further improve your production efficiency? Say, will we be able to see or expect margin improvement due to further enhanced production efficiency as opposed to coming from the rising bromine selling prices? Thank you.

(Interpreted). To answer your question, the Company has reached 80% -- almost 80% -- around 80% utilization rate and there is not going to be that much room in terms of efficiency improvement. The Company is more looking into cost control in terms of raising its margins.

Okay, good. Just in terms of the [contracts side] that you have been able to successfully renegotiate with your major customers, I'm just wondering at what price range that you had locked in the contract prices.

(Interpreted). So on average, it's about RMB19,000 per ton.

So that's about US$2800.

(Interpreted). That's right.

Is that secured for the remainder of the year, or what kind of timeframe are we looking at?

(Interpreted). So the newly negotiated contract price, usually this price will be valid for three months. But, however, if the price increases dramatically the Company will go back and renegotiate with customers to raise it further.

I understand. And just a follow-on question on the -- in terms of percentages your internally produced bromine that is being used internally for your chemical segment, you mentioned currently it's about 8%. I'm just wondering, do you plan to take the numbers up? And what kind of consideration that you would -- to consider to make such decision versus -- internally versus external sales?

(Interpreted). That (inaudible) a huge factor to increase the percentage of internal use bromine is the R&D and the development of the downstream products, of bromine-based products. And if the Company is developing significantly more amount of these products then we will consider to raise the percentage of internally used bromine.

Okay. Just given such favorable bromine pricing in the environment, I'm just wondering why would you want to use it internally versus sell it to the external customers. But that is okay, that's just a thought.

My last question given that you -- I know that you've been very close in finalizing a [variation or] negotiation regarding your second acquisition. Just wondering -- but given the fact that you have not been able to close it, and at the same time you have filed S-3 to raise up to $120 million, I'm just trying to understand here. Did you see a [light up] of acquisition targets in the pipeline that you are confident in closing them in the near future that sort of prompt your need for additional capital at this point?

(Interpreted). So in terms of the acquisition, Mr. Liu mentioned first that the Company has always been actively looking for attractive targets to acquire. The reason why it hasn't finished the second acquisition is partly due to the increase in bromine prices and also partly due to the decreasing number of targets that are available for the Company to acquire. And the Company's management is actively engaged in negotiations to hopefully finish the second acquisition soon.

In terms of the shelf filing, this is for the long-term growth and development of the Company. There are a couple of elements that management will think about before drawing down from the shelf, one being its future development goals or available targets [acquired] in the future. The second is market conditions and share price. The Company will incorporate all of these elements and definitely put the shareholders' interests at heart and first before making any decisions.

Okay. So it's not that you have something already in the pipeline that you foresee to close anytime soon? Or it's more for the long run?

(Interpreted). It's not that there is a target in the pipeline that needs this much capital, but this capital's purpose is for the Company's long-term growth.

Okay, great. Thank you very much for taking my call.

Jason Nevader, Surfside Capital.

Thanks for taking my call. Congratulations on a great quarter. (multiple speakers)

One quick -- a quick clarification question; you mentioned 75% utilization for the second half of 2010, but then you mentioned earlier you thought 80% was a good run rate. Was that 75% utilization in the second half of 2010 because that was taken into consideration, the latest acquisition closed in June which would -- since that's only at 18% utilization that would lower the overall utilization to 75%? Or was that 75% just for all of the plants excluding this latest one?

(Interpreted). So for the 75% utilization rate for the rest of 2010, that does not include the newly acquired asset, the [Ace] acquisition. The 75% utilization rate is believed to be a healthy balance for supply and demand.

And the reason why exceeded that number in the second quarter is because one, it is usually the strong or peak season of bromine production. And second, part of the orders from first quarter were delayed into the second quarter. That is why it pushed the utilization rate of up. But 75% is believed to be a good number or a comfortable number where the Company is producing.

So is 80% then the right number to use on an annual basis for the entire year?

(Interpreted). So 80% is probably still a little bit high to think about for the whole year. 80%, if the Company does reach that on average for the entire year it has a somewhat negative impact on its equipment and also not a healthy market demand for its product price.

Okay. And then on gross margin I saw that gross margin improved from 45.3% to -- I think it was 49.2% in the latest quarter from Q1 to Q2. Can you comment a little bit on gross margin in the second half of the year? Should we continue to look for continued improvement or would it stay at around the 49% rate?

(Interpreted). The gross margin, it probably is not going to stabilize for the rest of the second half.

Okay, thank you. My last question was on crude salt. I saw you had a nice increase from I think it was $25 to $40. Is crude salt also stabilized at $40 for the rest of the year, or do you see any change in pricing?

(Interpreted). As far as we can see as of now, we believe there will be a healthy growth for crude salt going forward as well, since there's an increase in commodity price overall for the next -- for the rest of the year. So steady increase for crude salt as well.

Steady increase in the price of crude salt?

(Interpreted). Yes, the market price for crude salt.

Lastly on G&A expenses, I see that those came down 20% year over year. Is that just due to cost controls or are those numbers we could use going forward?

(Interpreted).