Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
Overview
We are a Nevada holding company which conducts
operations through our wholly-owned China-based subsidiaries. Our business is conducted and reported in four segments, namely,
bromine, crude salt, chemical products and natural gas.
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 Tetramethylbenzidine. Bromine is commonly used in brominated flame retardants,
fumigants, water purification compounds, dyes, medicines and disinfectants. Crude salt is the principal material in alkali
production as well as chlorine alkali production and is widely used in the chemical, food and 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, papermaking
chemical agents, inorganic chemicals and materials that are used for human and animal antibiotics.
Our wholly-owned subsidiary, DCHC, was established
to explore and develop natural gas and brine resources (including bromine and crude salt) in Sichuan Province, China.
Bromine and Crude Salt
As disclosed in the Company’s Current Report
on Form 8-K filed on September 8, 2017, the Company received, on September 1, 2017, letters from the Yangkou County, Shouguang City government
addressed to each of its subsidiaries, SCHC and SYCI, which stated that in an effort to improve the safety and environmental protection
management level of chemical enterprises, the plants are requested to immediately stop production and perform rectification and improvements
in accordance with the country’s new safety and environmental protection requirements. In the Company’s press release of August
11, 2017 and on its conference call of August 14, 2017, the Company addressed concerns that increased government enforcement of stringent
environmental rules that were adopted in early 2017 to insure corporations bring their facilities up to necessary standards so that pollution
and other negative environmental issues are limited and remediated, could have an impact on our business in both the short and long-term.
The Company also expressed that although it believed its facilities were fully compliant at the time, the Company did not know how its
facilities would fare under the new rules. Teams of inspectors from the government were sent to many provinces to inspect all mining and
manufacturing facilities. The local government requested that facilities be closed, so that the facilities could undergo the inspection
and analysis in the most efficient manner by inspectors’ team. As a result, our facilities were closed on September 1, 2017.
The Company believes that this is another step
by the government to improve the environment. It further believes the goal of the government is not to close all plants, but rather to
codify the regulations related to project approval, land use, planning approval and environmental protection assessment approval so that
illegal plants are not able to open in the future and so that plants close to population centers do not cause serious environmental damage.
In addition, the Company believes that the Shandong provincial government wants to assure that each of its regional and county governments
has applied the Notice in a consistent manner.
The Shouguang City Bromine Association, on behalf
of all the bromine producers in Shouguang, initiated negotiations with the local government agencies. The local governmental agencies
acknowledged the facts that their initial requirements for the bromine industry did not include the project, the planning and the land
use rights approvals, which were later introduced by the provincial government as new requirements. The Company understood from the local
government that local government were coordinating with various government agencies to solve these three outstanding approval issues in
a timely manner and that all impacted bromine plants will not be allowed to commence production prior to obtaining those approvals. In
February 2019, the Company received a notification from the local government of Yangkou County that its Factories No. 1, No. 4, No. 7
and No. 9 passed inspection and were allowed to resume operations. In April 2019, Factory No. 1 and No. 7 resumed operations.
Subsequently, the Company received an approval
dated on February 27, 2020 issued by the local governmental authority which allows us to resume production after the winter temporary
closure. Further, the Company received another approval from the Shouguang Yangkou People’s Government dated on March 5, 2020 to
resume production at its bromine factories No.1, No. 4, No.7 and No. 9 in order to meet the needs of bromide products for epidemic prevention
and control (the “March 2020 Approval”). The Company’s factories No.7 and No.1 started trial production in middle-March,
2020, and commenced commercial production on April 3, 2020.
The Company received oral notification from the
government regarding Factory No. 8, allowing it to resume production in August 2022. Factory No.8 began contributing revenue in the fourth
quarter 2022.
30
The Company is awaiting governmental approval
for Factories No. 2 and No. 10. To our knowledge, the government is finalizing plans for all mining areas, including flood prevention
measures . As a result, we may be required to make certain modifications to our existing wells and aqueducts prior to commencement of
operations of these factories in order to satisfy the local government's requirements. The Company completed its flood prevention project
in December 2023. This project was implemented for safeguarding its bromine facilities.
Pursuant to the notification from the government
of Shouguang City, all bromine facilities in Shouguang City were temporarily closed from December 25, 2023 until February 20, 2024. In
compliance with the notification, the Company ceased production at its bromine facilities during this period and resumed operations at
the bromine and crude salt factories as scheduled in February 2024.
Chemical Products
On November 24, 2017, the Company received a letter
from the People’s Government of Yangkou County, Shouguang City notifying the Company that due to the new standards and regulations
relating to safety production and environmental pollution, from certain local governmental departments, such as the municipal environmental
protection department, the security supervision department and the fire department, its chemical enterprises would have to be relocated
to a new industrial park called Bohai Marine Fine Chemical Industry Park. Although our chemical companies were in compliance
with regulations, they were also close to a residential area. As a result, the government determined we should relocate to the Bohai park.
Chemical companies that are not being asked to move into the park are being permanently closed. Since our factories closed, the
Company has secured from the government the land use rights for its chemical plant. On January 6, 2020, the Company received the environmental
protection approval by the government of Shouguang City, Shandong Province for the proposed Yuxin Chemical factory. Construction of the
new chemical facilities at Bohai Marine Fine Chemical Industrial Park commenced in June 2020. Initially, the construction was projected
to last around one year, with an additional six months for equipment installation and testing. However, due to the COVID epidemic and
electrical restrictions, the opening of the chemical factory has been postponed. The Company has received the refrigeration and air
compressor units. Additionally, the procurement of the final equipment for our chemical factory has been postponed until we have
a better understanding of the potential for derivative bromine products. We anticipate proceeding with the completion of its chemical
factory in due course. However, in the event that the Chinese economy persists in its weakness and if we perceives this trend to be ongoing,
there is a possibility that the chemical factory could be repurposed for the production of Sodium-Ion batteries.
In January 2017, the Company completed the construction
of the first brine water and natural gas well field in Daying County, Sichuan Province, and commenced trial production in January 2019.
On May 29, 2019, the Company received verbal notice from the government of Tianbao Town, Daying County, Sichuan Province, mandating the
need for project approval for its Daying well, encompassing the entire natural gas and brine water project. This also includes approvals
for safety production inspection, environmental protection assessment, and to solve the related land issue. Until these approvals are
obtained, the Company must temporarily suspend trial production at its natural gas well in Daying. Additionally, in compliance with the
Chinese government new policies, the Company is required to obtain an exploration license for bromine and a mining license for natural
gas. Pursuant to the Opinions of the Ministry of Natural Resources on Several Issues in Promoting the Reform of Mineral Resources Management
(Trial) promulgated by the Ministry of Natural Resources of PRC on January 9, 2020, which came into effect on May 1, 2020, privately owned
enterprises are allowed to participate in the natural gas production. The Company is engaged in ongoing discussions with the government
of Daying County regarding the establishment of a joint venture for the exploration and production of natural gas and brine products in
Sichuan.
As a result of our acquisitions of SCHC and SYCI,
our historical consolidated financial statements and the information presented below reflects the accounts of SCHC、SYCI and
DCHC, the consolidated financial statements and the information presented below as of and for the year ended December 31, 2023. The
following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in
this report.
Flood Prevention Project
In August 2023, the Company
initiated its preventive measures for safeguarding its bromine facilities. Our strategy involves the renovation of the channels of four
major rivers within our mining area, encompassing the tributary of the Mihe River. The aim is to prevent flooding that could harm the
wells, aqueducts and crude salt pans at our plant. In December 2023, the Company completed this flood prevention project. As of December
31, 2023, we incurred $ 46,510,856 in other expenses for the project.
The cost incurred for four
major rivers are: (1) Liansigou Section for $8,057,722;(2) Mi River Section for $20,168,321;(3) Ta River Section $10,070,033 ; (4)
Weitan River Section for $8,214,780 .
31
RESULTS OF OPERATIONS.
Year ended December 31, 2023 as compared to
year ended December 31, 2022
Years ended
December 31,
2023
December 31,
2022
Percent Change Increase/
(Decrease)
Net Revenue
$ 30,043,790
$ 66,094,486
(55 %)
Cost of Net Revenue
$ (28,089,953 )
$ (28,669,152 )
(2 %)
Gross Profit
$ 1,953,837
$ 37,425,334
(95 %)
Sales, Marketing and Other Operating Expense
$ (59,055 )
$ (62,871 )
(6 %)
Direct labor and factory overheads incurred during plant shutdown
$ (9,544,675 )
$ (12,002,629 )
(20 %)
General and Administrative Expenses
$ (4,240,832 )
$ (6,028,079 )
(30 %)
Other Operating Expense
$
$ (2,850,059 )
(100 %)
(Loss)/Profit from Operations
$ (11,890,725 )
$ 16,481,696
(172 %)
Other Income, Net
$ 144,919
$ 164,739
(12 %)
Expenditure on water pollution treatment
$ (46,510,856 )
$
N/A
(Loss) /Income before Taxes
$ (58,256,662 )
$ 16,646,435
(450 %)
Income Tax Expense (Benefit)
$ (3,538,617 )
$ (6,586,985 )
(46 %)
Net (Loss) /Income
$ (61,795,279 )
$ 10,059,450
(714 %)
Net Loss of $61,795,279 was
mainly attributable to decreased sales, reduced margins. Additionally, the compensation expenses amounted to $451,350
for shares issued to company employees, officers and consultant for the year 2023 . The Company also incurred losses of $46,510,856
on a flood prevention project.
Net Revenue The table below
shows the changes in net revenue in the respective segment of the Company for the fiscal year 2023 compared to the same period in 2022:
Net Revenue by Segment
Year Ended
Year Ended
Percent
Increase (Decrease)
December 31, 2023
December 31, 2022
of Net Revenue
Segment
% of total
% of total
Bromine
$ 26,921,462
89.6 %
$ 58,964,941
89.2 %
(54.3 %)
Crude Salt
2,971,467
9.9 %
6,996,552
10.6 %
(57.5 %)
Chemical Products
—
—
—
—
—
Natural Gas
—
—
—
—
—
Total
$ 29,892,929
99.5 %
$ 65,961,493
99.8 %
(54.7 %)
Equipment Lease
150,861
0.5 %
132,993
0.2 %
13.4 %
Total sales
$ 30,043,790
100.0 %
$ 66,094,486
100.0 %
(54.5 %)
Years Ended December 31
Percent Change
Bromine and crude salt segments product sold in tonnes
2023
2022
Increase
Bromine (excluded volume sold to SYCI)
7,951
7,817
2
%
Crude Salt
97,101
184,520
(47
%)
32
Bromine segment
Net revenue from our bromine segment decreased by
54.3% to $26,921,462 for the year ended December 31, 2023, compared to $58,964,941 for the year ended December 31, 2022. This
decrease was due to a 55% decrease in average selling price.
Crude salt se g ment
Net revenue from our crude salt segment decreased by 57.5%
to $2,971,467 for the year ended December 31, 2023, compared to $6,996,552 for the last year. This decrease was due to a decrease in crude
salt unit price of 19% and a decrease in volume of 47%.
Chemical products segment
For the years ended December 31, 2023 and
December 31, 2022, the net revenue for the chemical products segment was $0 due to the closure of our chemical factories since September
1, 2017.
33
Natural gas segment
For the years ended December 31, 2023, and December
31, 2022, the net revenue for the natural gas production was $0.
Equipment Lease
For the year ended December 31, 2023, and December
31, 2022, the net revenue for the equipment lease was $150,861 and $132,993.
Cost of Net Revenue
Cost of Net Revenue by Segment
% Change
Year Ended
Year Ended
of Cost of
December 31, 2023
December 31, 2022
Net Revenue
Segment
% of total
% of total
Bromine
$
26,521,281
94
%
$
25,087,171
88
%
5.7
%
Crude Salt
1,567,993
6
%
3,581,567
12
%
(56.2
%)
Chemical Products
—
—
—
—
—
Natural Gas
679
—
414
—
64.0
%
Total
$
28,089,953
100
%
$
28,669,152
100
%
(2.0
%)
Cost
of net revenue primarily includes costs of the raw materials consumed, the direct salaries and benefits for production staff, electricity
costs, depreciation and amortization of manufacturing plant and machinery, and other manufacturing-related costs. Our cost of net revenue
was $28,089,953 for the year ended December 31, 2023, representing a $579,199 (or 2%) decrease compared to the preceding year.
In May 2022, we separated the bromine and the
crude salt business to comply with government regulations. This separation required a reevaluation of cost allocations, resulting in increased
allocations to bromine and decreased allocations to crude salt.
Bromine production capacity and utilization
of our factories
The table below represents the annual capacity
and utilization ratios for all of our bromine producing properties:
Annual Production Capacity (in tonnes)
Utilization
Ratio (i)
Fiscal year 2023
31,506
25
%
Fiscal year 2022
31,506
25
%
Variance of the fiscal year 2023 and 2022
0
0
%
(i)
Utilization ratio is calculated based on the annualized actual production volume in tonnes for the periods divided by the annual production capacity in tonnes.
Bromine segment
For the year ended December 31, 2023, the cost
of net revenue for the bromine segment was $26,521,281.
For the year ended December 31, 2022, the cost
of net revenue for the bromine segment was $25,087,171.
Crude salt segment
For the year ended December 31, 2023, the cost
of net revenue for the crude salt segment was $1,567,993.The cost of net revenue for our crude salt segment for the year ended December
31, 2022 was $3,581,567.
Chemical products segment
Cost of net revenue for our chemical products
segment for the fiscal year 2023 and 2022 was $0.
Natural gas segment
Cost of net revenue for our natural gas segment
for the year ended December 31, 2023 and 2022 was $679 and $414.
34
Gross Profit. Gross profit
was $1,953,837, or 7%, of net revenue for the year ended December 31, 2023, compared to $37,425,334, or 57%, of net revenue for the same
period in 2022.
Gross Profit (Loss) by Segment
% Point Change
Year Ended
Year Ended
of Gross
December 31, 2023
December 31, 2022
Profit Margin
Segment
Gross Profit (loss) Margin
Gross Profit (loss) Margin
Bromine
$
400,181
2
%
$
33,877,770
58
%
(56
%)
Crude Salt
1,403,474
47
%
3,414,985
49
%
(2
%)
Chemical Products
—
—
—
—
—
Natural Gas
—
—
—
—
—
Equipment Lease
150.182
100
%
132,579
100
%
0
%
Total Gross Profit
$
1,953,837
7
%
$
37,425,334
57
%
(50
%)
Bromine
segment
For the year ended December 31, 2023, gross
profit margin for our brom ine segment was 2% compared to 58% in the previous year.
This decrease was primarily attributable to the lower average selling price of bromine of $3,386 per ton in the year ended December 31,
2023, compared to $7,543 per ton in the year ended December 31, 2022.
For the year ended December 31, 2022, the gross
profit margin for our bromine segment was 58%.
Crude salt segment
For the year ended December
31, 2023, the gross profit margin for our crude salt segment was 47%, compared to 49% in the preceding year, representing a 2% decrease.
This decrease was primarily attributable to the lower average selling price of crude salt of $31 per ton in the year ended December 31,
2023 compared to $38 per ton in the year ended December 31, 2022 。
Direct
labor and factory overheads incurred during plant shutdown. On September 1, 2017, the Company received notification from the
government of Yangkou County, Shouguang City of PRC stating that production at all its bromine and crude salt and chemical factories
should be halted with immediate effect in order for the Company to perform rectification and improvement in accordance with the county’s
new safety and environmental protection requirements. On November 24, 2017, the Company received a letter from the Government of Yangkou
County, Shouguang City notifying the Company to relocate its two chemical production plants located in the second living area of the
Qinghe Oil Extraction Plant to Bohai Park. As such, direct labor and factory overhead costs (including depreciation of plant and machinery)
amounted $9,544,675 and $12,002,629 for fiscal years 2023 and 2022, which were presented as operating expenses instead of in cost of
revenue. The increase in direct labor and factory overhead costs was primarily attributable to the factories operation status during
the fiscal year 2023 and year 2022, respectively. These five factories (including No.1,No.4,No.7,No.8 and No.9)were in production during
the year 2023.
General
and Administrative Expenses. General and administrative expenses were $4,240,832 for the year ended December 31, 2023, representing
a decrease of $1,787,247 (or 30%) as compared to$6,028,079 for the same period in 2022.
35
(Loss)/Profit from Operations. Operating loss
was $11,890,725 for the fiscal year 2023, compared to a profit of $16,481,696 in the same period in 2022.
Income (loss) from Operations by Segment
Year ended December 31, 2023
Year ended December 31, 2022
Segment:
% of total
% of total
Bromine
$
(10,005,755
)
90.1
%
$
17,905,181
99.0
%
Crude Salt
$
640,309
(5.8
%)
$
2,301,885
12.7
%
Chemical Products
$
(1,653,349
)
14.9
%
$
(1,953,230
)
(10.8
%)
Natural Gas
$
(86,284
)
0.7
%
$
(148,099
)
(0.9
%)
Profit (Loss) from operations before corporate costs
$
(11,105,079
)
100
%
$
18,105,737
100
%
Corporate costs
$
(785,646
)
$
(1,060,405
)
Unrealized gain (loss) on translation of intercompany balance
$
—
$
(563,636
)
(Loss)/ Profit from operations before taxes
$
(11,890,725
)
$
16,481,696
Bromine
segment
Loss from operations from our
bromine segment was $10,005,755 for the fiscal year 2023, compared to an income of $17,905,181 in the same period in 2022. The decrease
in income was primarily due to a 55% decrease in average selling price.
Crude salt se g ment
Income from operations from our crude salt segment
was $640,309 for fiscal year 2023, compared to an income of $2,301,885 in the same period in 2022. The main reason for the decline in
crude salt in 2023 compared with 2022 is that the unit price of sales is down by 19%, and the sales volume is also down by 47%.
Chemical products
segment
Loss from operations from our chemical products segment
was $1,653,349 for the fiscal year 2023, compared to a loss of $1,953,230 in the same period in 2022.
Natural
g as segment
Loss from operations from our natural gas segment was $86,284
for the fiscal year 2023, compared to a loss of $148,099 in the same period in 2022.
Other (Expense)/Income, Net . Other income,
net, which represent bank interest income, net of finance lease interest expense was $144,919 for the fiscal year 2023, representing a
decrease of $19,820 (or approximately 12%) as compared to the preceding year.
Expenditure on water pollution treatment. Expenditure
on water pollution treatment was $46,510,856 in the fiscal year 2023.
Net (Loss)/Income. Net loss was $61,795,279
for the fiscal year 2023, compared to net income of $10,059,450 in the preceding year.
Net (Loss)/Income Per Share
For the fiscal year 2023, net loss per share was
$5.92 compared to net income of $1.00 in the preceding year. There were 10,726,924 shares outstanding compared to 10,431,924 shares.
Foreign Currency Translation Adjustment
For the fiscal year 2023,
the Company had a negative foreign currency translation adjustment of $5,025,980 versus a negative adjustment of $24,886,118 in the previous
year. This adjustment impacts all balance sheet translations into U.S. dollars.
36
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2023, cash and cash equivalents
were $72,223,894 as compared to $108,226,214 as of December 31, 2022. The components of this decrease of $36,002,320 are reflected
below.
Statement of Cash Flows
Years Ended December 31
2023
2022
Net cash (used in) provided by operating activities
$
(32,751,851
)
$
51,149,065
Net cash used in investing activities
$
$
(37,560,932
)
Net cash used in financing activities
$
(267,810
)
$
(264,863
)
Effects of exchange rate changes on cash and cash equivalents
$
(2,982,659
)
$
(864,319
)
Net decrease in cash and cash equipment
$
(36,002,320
)
$
12,458,951
For the fiscal years 2023 and 2022, we met our
working capital and capital investment requirements by using cash flows from operations and cash on hand.
Net Cash (Used in)/Provided
by Operating Activities
During the year ended December 31,
2023, cash flow used in operating activities of approximately $32.75 million was mainly due to a net loss of $61.8 million, offset by
a non-cash adjustment related to depreciation and amortization of property, plant and equipment of $27.13 million and an increase in accounts
and other payable and accrued expenses of $1.11 million.
During the
year ended December 31, 2022, cash flow provided by operating activities of approximately $51.1 million was mainly due to a net income
of $10.06 million, a decrease in accounts receivable of $8.2 million, a decrease in accounts payable of $0.8 million, a decrease in deferred
taxes of $6.59 million, and a non-cash adjustment related to depreciation and amortization of property, plant and equipment of $26.78
million, offset by an increases in operating leases and prepayments.
Accounts receivable
Cash collections on our accounts receivable had
a major impact on our overall liquidity. The following table presents the aging analysis of our accounts receivable as of December 31,
2023 and 2022.
December 31, 2023
December 31, 2022
% of total
% of total
Aged 1-30 days
$ 2,040,377
42 %
$ 2,792,156
52 %
Aged 31-60 days
2,460,233
51 %
2,571,010
48 %
Aged 61-90 days
365,086
7 %
—
—
Aged 91-120 days
—
—
—
—
Aged 121-150 days
—
—
—
—
Aged 151-180 days
—
—
—
—
Aged 181-210 days
—
—
—
—
Aged 211-240 days
—
—
—
—
Total
$ 4,865,696
100 %
$ 5,363,166
100 %
The overall accounts receivable balance as of
December 31, 2023 decreased by $497,470, compared to those of December 31, 2022. We have policies in place to ensure that sales are
made to customers with an appropriate credit history. We perform ongoing credit evaluation on the financial condition of our customers.
37
Inventory
Our inventory consists of the following:
December 31, 2023
December 31, 2022
% of total
% of total
Raw materials
$ 32,840
5 %
$ 26,192
2 %
Finished goods
544,389
95 %
1,572,380
98 %
Total
$ 577,229
100 %
$ 1,598,572
100 %
The net inventory
level as of December 31, 2023 decreased by $1,021,343, as compared to the net inventory level as of December 31, 2022, one of the main
reasons for the reduction in inventories was the decline in sales.
Raw materials increased by $6,648 as of December 31,
2023, as compared to December 31, 2022.
Finished goods decreased by $1,027,991 as of December 31, 2023, as compared to December 31, 2022.
Net Cash Used In Investing Activities
For the fiscal year 2023, we used $0 for investing activities.
For the fiscal year 2022, we used approximately
$37.6 million for investing activities.
Net Cash Used In Financing Activities
For the fiscal year 2023 and 2022, we used $0.3
million to repay finance lease obligations.
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 months.
As of December 31, 2023, we had approximately
$72 million in available cash, all of which is in highly liquid current deposits yielding minimal or no interest. We do not anticipate
paying cash dividends in the foreseeable future.
We intend to continue to focus our efforts on
the activities of SCHC, SYCI, SHSI and DCHC as these segments continue to expand within the Chinese market.
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’s 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.
Our inability to implement and manage our expansion strategy successfully may have a material adverse effect on our business and future
prospects.
Going Concern Consideration
There is no significant uncertainty
about the continuing operations of the Company.
Contractual Obligations and Commitments
We have no significant contractual obligations
not fully recorded on our consolidated balance sheets or fully disclosed in the notes to our consolidated financial statements. Additional
information regarding our contractual obligations and commitments at December 31, 2023 is provided in the notes to our consolidated financial
statements. See “Notes to Consolidated Financial Statements, Note 19 - Capital Commitment and Other Service Contractual Obligations.”
38
Material Off-Balance Sheet Arrangements
We do not currently have any off-balance sheet
arrangements falling within the definition of Item 303(a) of Regulation S-K.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements are prepared
in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), which requires us to make judgments,
estimates and assumptions. See “Note 1 – Nature of Business and Summary of Significant Accounting Policies,” in Notes
to the Consolidated Financial Statements, which is included in “Item 8. Financial Statements and Supplementary Data,” which
describes our significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The methods,
estimates and judgments that we use in applying our accounting policies require us to make difficult and subjective judgments, often as
a result of the need to make estimates regarding matters that are inherently uncertain.
Our most critical estimates include:
·
allowance for doubtful accounts, which impacts revenue;
·
the valuation of inventory, which impacts gross margins;
·
impairment of long-lived assets;
·
the valuation and recognition of share-based compensation, which impacts operating expenses; and
·
the recognition and measurement of deferred income taxes, which impact our provision for taxes.
Allowance for Doubtful Accounts
We make estimates of the uncollectibility of accounts
receivable, especially analyzing accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current
economic trends and changes in customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts. Credit evaluations
are undertaken for all major sale transactions before shipment is authorized. On a quarterly basis, we evaluate aged items in the accounts
receivable aging report and provide an allowance in an amount we deem adequate for doubtful accounts. If management were to make different
judgments or utilize different estimates, material differences in the amount of our reported operating expenses could result.
Inventory Valuation
Inventory is stated at the lower of cost or market,
with cost determined on a first-in first-out basis. The carrying value of inventory is reduced for estimated obsolescence by the difference
between its cost and the estimated market value based upon assumptions about future demand. We evaluate the inventory carrying value for
potential excess and obsolete inventory exposures by analyzing historical and anticipated demand. If actual future demand or market conditions
are less favorable than those projected by management, additional inventory write-downs may be required in the future, which could have
a material adverse effect on our results of operations.
Depreciation of 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 major expenditures for betterment
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. All other ordinary repair and maintenance costs are expensed as incurred. 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. In some situations, the life of the asset may be extended
or shortened if circumstances arise that would lead us to believe that the estimated life of the asset has changed. The life of leasehold
improvements may change based on the extension of lease contracts with our landlords. Changes in the estimated lives of assets will result
in an increase or decrease in the amount of depreciation recognized in future periods.
39
Impairment of Long Lived Assets
We periodically evaluate whether events or circumstances
have occurred that indicate long-lived assets may not be recoverable or that the remaining useful life may warrant revision. When such
events or circumstances are present, we assess the recoverability of long-lived assets by determining whether the carrying value will
be recovered through the expected undiscounted future cash flows resulting from the use of the asset. In the event the sum of the expected
undiscounted future cash flows is less than the carrying value of the asset, an impairment loss equal to the excess of the asset’s
carrying value over its fair value is recorded.
Valuation Allowance on Deferred Tax Assets
We evaluate our deferred income tax assets to
determine if valuation allowances are required or should be adjusted. A valuation allowance is established against our deferred tax assets
based on consideration of all available evidence, both positive and negative, using a “more likely than not” standard. This
assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the
duration of statutory carry forward periods, our experience with expiring unused tax attributes and tax planning alternatives. In making
such judgments, significant weight is given to evidence that can be objectively verified.
Stock-based compensation
We account for stock-based compensation in accordance
with the fair value recognition provisions of U.S. GAAP. We use the Black-Scholes model which requires the input of highly subjective
assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising
them, the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete
their vesting requirements. The assumptions for expected volatility and expected term are the two assumptions that significantly affect
the grant date fair value. Changes in expected risk-free rate of return do not significantly impact the calculation of fair value, and
determining this input is not highly subjective.
We use annualized historical stock price volatility
which is deemed to be appropriate to serve as the expected volatility of our stock price and is assumed to be constant and prevailing.
The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected life is based
on historical option exercise pattern.
Recent Accounting Pronouncements
See “Note 1 – Nature of Business and
Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and
Supplementary Data for a full description of recent accounting pronouncements including the respective expected dates of adoption and
effects on the consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk.
Pursuant to Item 305(e) of Regulation S-K (§
229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,”
as defined by Rule 229.10(f)(1).