10-Q 1 e609937_10q-gulf.htm Unassociated Document
 
 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended June 30, 2012
   
 
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.)
     
99 Wenchang Road, Chenming Industrial Park, Shouguang City,
Shandong, China
 
262714
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: +86 (536) 567 0008

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer (Do not check if a smaller reporting company) o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
 
As of August 6, 2012, the registrant had outstanding 34,745,342 shares of common stock.
  
 
 

 
       
 
Part I – Financial Information
 
Item 1. Financial Statements
1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
20
Item 3. Quantitative and Qualitative Disclosures about Market Risk
39
Item 4. Controls and Procedures
40
Part II – Other Information
 
Item 1. Legal Proceedings
40
Item 1A. Risk Factors
41
Item 2. Unregistered Shares of Equity Securities and Use of Proceeds
41
Item 3. Defaults Upon Senior Securities
41
Item 4. Mine Safety Disclosures
41
Item 5. Other Information
41
Item 6. Exhibits
41
Signatures
42
 
 
PART I—FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
GULF RESOURCES, INC.
 AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. dollars)
(UNAUDITED)

   
June 30, 2012
   
December 31, 2011
 
Current Assets
               
Cash
 
$
72,044,771
   
$
78,576,060
 
Accounts receivable
   
41,297,358
     
21,919,828
 
Inventories
   
3,955,232
     
4,437,972
 
Prepayments and deposits
   
346,210
     
307,600
 
Prepaid land leases
   
371,894
     
46,582
 
Deferred tax assets
   
105,583
     
228,702
 
Total Current Assets
   
118,121,048
     
105,516,744
 
Non-Current Assets
               
Property, plant and equipment, net
   
142,496,477
     
147,200,740
 
Property, plant and equipment under capital leases, net
   
2,156,071
     
2,336,920
 
Prepaid land leases, net of current portion
   
752,385
     
763,814
 
Deferred tax assets
   
2,461,863
     
2,509,481
 
Total non-current assets
   
147,866,796
     
152,810,955
 
Total Assets
 
$
265,987,844
   
$
258,327,699
 
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Accounts payable and accrued expenses
 
$
7,556,148
   
$
7,373,643
 
Retention payable
   
97,804
     
556,450
 
Capital lease obligation, current portion
   
90,551
     
189,742
 
Taxes payable
   
4,232,081
     
4,058,550
 
Total Current Liabilities
   
11,976,584
     
12,178,385
 
Non-Current Liabilities
               
Capital lease obligation, net of current portion
   
2,934,527
     
3,036,558
 
Total Liabilities
 
$
14,911,111
   
$
15,214,943
 
 
               
Stockholders’ Equity
               
PREFERRED STOCK; $0.001 par value; 1,000,000 shares authorized; none outstanding
 
$
     
$
   
COMMON STOCK; $0.0005 par value; 100,000,000 shares authorized; 34,745,342 and 34,745,342 shares issued; and 34,560,743 and 34,560,743 shares outstanding as of June 30, 2012 and December 31, 2011, respectively
   
17,373
     
17,373
 
Treasury stock; 184,599 shares as of June 30, 2012 and December 31, 2011 at cost
   
(500,000
)
   
(500,000
)
Additional paid-in capital
   
74,134,279
     
74,107,979
 
Retained earnings unappropriated
   
141,051,006
     
133,314,581
 
Retained earnings appropriated
   
15,648,913
     
14,409,557
 
Cumulative translation adjustment
   
20,725,162
     
21,763,266
 
Total Stockholders’ Equity
   
251,076,733
     
243,112,756
 
Total Liabilities and Stockholders’ Equity
 
$
265,987,844
   
$
258,327,699
 

The accompanying notes are an integral part of these consolidated financial statements.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Expressed in U.S. dollars)
(UNAUDITED)
 
   
Three-Month Period Ended June 30,
   
Six-Month Period Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
NET REVENUE
                       
Net revenue
  $ 31,314,846     $ 51,300,812     $ 55,123,520     $ 96,679,344  
                                 
OPERATING INCOME (EXPENSES)
                               
Cost of net revenue
    (21,389,651 )     (24,994,703 )     (38,505,533 )     (45,586,087 )
Sales, marketing and other operating expenses
    (22,709 )     (23,733 )     (40,473 )     (47,745 )
Research and development cost
    (62,526 )     (133,519 )     (105,324 )     (313,856 )
Exploration cost
    -       (3,867,286 )     -       (3,867,286 )
Write-off/Impairment on property, plant and equipment
    (911,995 )     (7,570,566 )     (911,995 )     (7,570,566 )
General and administrative expenses
    (1,370,866 )     (1,714,694 )     (3,483,071 )     (6,055,985 )
Other operating income
    76,104       392,298       133,178       415,083  
      (23,681,643 )     (37,912,203 )     (42,913,218 )     (63,026,442 )
                                 
INCOME FROM OPERATIONS
    7,633,203       13,388,609       12,210,302       33,652,902  
                                 
OTHER INCOME (EXPENSE)
                               
Interest expense
    (54,255 )     (65,740 )     (108,667 )     (107,956 )
Interest income
    84,915       52,731       183,805       128,775  
INCOME BEFORE TAXES
    7,663,863       13,375,600       12,285,440       33,673,721  
                                 
INCOME TAXES
    (1,975,189 )     (3,352,345 )     (3,309,659 )     (9,285,467 )
NET INCOME
  $ 5,688,674     $ 10,023,255     $ 8,975,781     $ 24,388,254  
                                 
COMPREHENSIVE INCOME:
                               
NET INCOME
  $ 5,688,674     $ 10,023,255     $ 8,975,781     $ 24,388,254  
OTHER COMPREHENSIVE INCOME
                               
- Foreign currency translation adjustments
    (1,316,002 )     2,816,166       (1,038,104 )     4,837,801  
COMPREHENSIVE INCOME
  $ 4,372,672     $ 12,839,421     $ 7,937,677     $ 29,226,055  
                                 
EARNINGS PER SHARE:
                               
BASIC
  $ 0.16     $ 0.29     $ 0.26     $ 0.70  
DILUTED
  $ 0.16     $ 0.29     $ 0.26     $ 0.69  
                                 
WEIGHTED AVERAGE NUMBER OF SHARES:
                               
                                 
BASIC
    34,560,743       34,729,179       34,560,743       34,732,527  
DILUTED
    34,560,743       34,733,188       34,561,394       35,128,273  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
   
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
SIX-MONTH PERIOD ENDED JUNE 30, 2012
(Expressed in U.S. dollars)
(UNAUDITED)
 
   
Common stock
                                     
   
Number
   
Number
   
Number
               
Additional
   
Statutory
         
Cumulative
       
   
of shares
   
of shares
   
of treasury
         
Treasury
   
paid-in
   
common
   
Retained
   
translation
       
   
issued
   
outstanding
   
stock
   
Amount
   
stock
   
capital
   
reserve
   
earnings
   
adjustment
   
Total
 
                      $     $     $     $     $     $     $  
BALANCE AT DECEMBER 31, 2011
    34,745,342       34,560,743       184,599       17,373       (500,000 )     74,107,979       14,409,557       133,314,581       21,763,266       243,112,756  
Translation adjustment
 
- 
      -       -    
- 
           
- 
   
- 
   
- 
      (1,038,104 )     (1,038,104 )
Issuance of stock options to employees
    -       -       -       -       -       26,300       -       -       -       26,300  
Net income for six-month period ended June 30, 2012
 
- 
      -       -    
- 
      -    
- 
   
- 
      8,975,781    
- 
      8,975,781  
Transfer to statutory common reserve fund
    -       -       -       -       -       -       1,239,356       (1,239,356 )     -       -  
BALANCE AT JUNE 30, 2012
    34,745,342       34,560,743       184,599       17,373       (500,000 )     74,134,279       15,648,913       141,051,006       20,725,162       251,076,733  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. dollars)
(UNAUDITED)

   
Six-Month Period Ended June 30,
 
   
2012
   
2011
 
   
 
   
 
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
   
 
 
Net income
 
$
8,975,781
   
$
24,388,254
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Interest on capital lease obligation
   
108,044
     
106,835
 
Amortization of prepaid land leases
   
105,051
     
102,831
 
Depreciation and amortization
   
11,290,588
     
7,468,616
 
Write-off/Impairment loss on property, plant and equipment
   
911,995
     
7,570,566
 
Exchange gain on inter-company balances
   
(92,057
)
   
-
 
Stock-based compensation expense
   
26,300
     
3,169,000
 
Deferred tax asset
   
160,826
   
(1,913,608
)
Changes in assets and liabilities:
             
Accounts receivable
   
(19,514,217
)
   
(14,033,743
)
Inventories
   
467,279
     
(405,227
)
Prepayments and deposits
   
(38,610
)
   
905,669
 
Other receivables
   
-
     
(151,853
)
Accounts payable and accrued expenses
   
206,207
     
1,468,892
 
Retention payable
   
(457,813
)
   
-
 
Taxes payable
   
189,434
     
697,706
 
Net cash provided by operating activities
   
2,338,808
     
29,373,938
 
               
CASH FLOWS USED IN INVESTING ACTIVITIES
             
Additions of prepaid land leases
   
(422,877
)
   
(348,196
)
Purchase of property, plant and equipment
   
-
     
(34,075,105
)
Increase in construction in progress
   
(7,871,130
)
   
(4,609,456
)
Net cash used in investing activities
   
(8,294,007
)
   
(39,032,757
)
               
CASH FLOWS USED IN FINANCING ACTIVITIES
             
Repurchase of common stock
   
-
     
(348,147
)
Repayment of capital lease obligation
   
(297,598
)
   
(288,739
)
Net cash used in financing activities
   
(297,598
)
   
(636,886
)
               
EFFECTS OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
   
(278,492
   
1,539,350
 
NET DECREASE IN CASH AND CASH EQUIVALENTS
   
(6,531,289
   
(8,756,355
)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD
   
78,576,060
     
68,494,480
 
CASH AND CASH EQUIVALENTS - END OF PERIOD
 
$
72,044,771
   
$
59,738,125
 
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
               
Cash paid during the period for:
               
Income taxes
 
$
2,945,542
   
$
10,341,857
 
Interest paid
 
$
-
   
$
1,121
 
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
               
Inception of capital lease obligation for acquiring property, plant and equipment
 
$
-
   
$
3,127,913
 

The accompanying notes are an integral part of these consolidated financial statements.
 
   
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
(Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)           Basis of Presentation

The accompanying condensed financial statements have been prepared by Gulf Resources, Inc. a Delaware corporation and its subsidiaries (collectively, the “Company”), without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of its financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States (“US GAAP”). The balance sheet at December 31, 2011 is derived from the audited balance sheet but does not include all disclosures required by US GAAP. In connection with the consolidated financial statements and notes included in this report, reference is made to the consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the “2011 Form 10-K”).

In the opinion of management, the unaudited financial information for the quarter and six-month period ended June 30, 2012 presented reflects all adjustments, which are only normal and recurring, necessary for a fair statement of results of operations, financial position and cash flows. These condensed financial statements should be read in conjunction with the financial statements included in the Company’s  2011 Form 10-K. Operating results for the interim periods are not necessarily indicative of operating results for an entire fiscal year.
 
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts that are reported in the financial statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. The Company also exercises judgments in the preparation of these condensed financial statements in the areas including classification of leases and related party transactions.

Certain comparative amounts in the accompanying condensed financial statements have been reclassified to conform to the current period’s presentation. These reclassifications had no effect on previously reported condensed net income or stockholders’ equity.
 
(b)           Nature of the Business

The Company manufactures and trades bromine and crude salt through its wholly-owned subsidiary, Shouguang City Haoyuan Chemical Company Limited ("SCHC"), and manufactures chemical products for use in the oil industry and paper manufacturing industry through its wholly-owned subsidiary, Shouguang Yuxin Chemical Industry Co., Limited ("SYCI") in The People’s Republic of China (“PRC”).

(c)           Allowance for Doubtful Accounts

As of June 30, 2012 and December 31, 2011, allowance for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the three-month and six-month periods ended June 30, 2012 and 2011.

(d)           Concentration of Credit Risk

The Company is exposed to credit risk in the normal course of business, primarily related to accounts receivable and cash and cash equivalents. Substantially all of the Company’s cash and cash equivalents are maintained with financial institutions in the PRC, namely, Industrial and Commercial Bank of China Limited and China Merchants Bank Company Limited, which are not insured or otherwise protected. The Company placed $71,994,771 and $78,526,060 with these institutions as of June 30, 2012 and December 31, 2011, respectively.  The Company has not experienced any losses in such accounts in the PRC.

Concentrations of credit risk with respect to accounts receivable exists as the Company sells a substantial portion of its products to a limited number of customers. However, such concentrations of credit risks are limited since the Company performs ongoing credit evaluations of its customers’ financial condition and due to the generally short payment terms.  About 84% and 100% of the balances of accounts receivable as of June 30, 2012 and December 31, 2011, respectively, were outstanding for less than 91 days. For the balances of accounts receivable aged more than 90 days as of June 30, 2012, approximately 76% was settled in July 2012 and the remaining 24% is within the credit term granted to the customers.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
(Expressed in U.S. dollars)
(UNAUDITED)

NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

(e)           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.

Construction in progress primarily represents direct costs of construction of plant, machinery and equipment. Costs incurred are capitalized and transferred to property and equipment upon completion, at which time depreciation commences.

The Company’s 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 (including salt pans)
 
8 - 20
Plant and machinery (including protective shells, transmission channels and ducts)
 
5 - 8
Motor vehicles
 
5
Furniture, fixtures and equipment
 
8
 
Property, plant and equipment under capital leases are depreciated over their expected useful lives on the same basis as owned assets, or where shorter, the term of the lease, which is 20 years.

(f)           Retirement Benefits

Pursuant to the relevant laws and regulations in the PRC, the Company participates in a defined contribution retirement plan for its employees arranged by a governmental organization. The Company makes contributions to the retirement scheme at the applicable rate based on the employees’ salaries.  The required contributions under the retirement plans are charged to the consolidated income statement on an accrual basis when they are due.  The Company’s contributions totaled $112,275 and $105,537 for the three-month periods ended June 30, 2012 and 2011, respectively, and totaled $242,393 and $226,912 for the six-month periods ended June 30, 2012 and 2011, respectively.

(g)           Revenue Recognition

The Company recognizes 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)           Shipping and Handling Fees and Costs

The Company does not charge its customers for shipping and handling as all customers arrange their own transportation of finished goods.  The Company classifies shipping and handling costs for purchase of raw materials as part of the cost of net revenue, which amounted to $0 and $167,657 for the three-month periods ended June 30, 2012 and 2011, respectively, and $80,607 and $281,228 for the six-month periods ended June 30, 2012 and 2011, respectively. There is no such shipping and handling costs for the three-month period ended June 30, 2012 as they are borne by the suppliers since April 2012.
 
  
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)

NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

(i)           Exploration Costs

Exploration costs, which included the cost of researching appropriate places to drill wells and the cost of actual drilling of potential natural brine resources, were charged to the income statement as incurred. For the three-month and six-month periods ended June 30, 2011, the Company incurred exploration costs in the amount of $3,867,286, in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. The Company completed the drilling of exploratory wells in December 2011 and received a testing report in mid-January 2012 which confirmed the underground brine water resources.

(j)           Recoverability of Long-lived Assets

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-35 “Impairment or Disposal of Long-lived Assets”, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable or that the useful lives of those assets are no longer appropriate. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment.

The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the carrying amount of the assets. An impairment loss, if one exists, is then measured as the amount by which the carrying amount of the asset exceeds the discounted estimated future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value of such assets less costs to sell. Asset impairment charges are recorded to reduce the carrying amount of the long-lived asset that will be sold or disposed of to their estimated fair values. Charges for the asset impairment reduce the carrying amount of the long-lived assets to their estimated salvage value in connection with the decision to dispose of such assets.

For the three-month and six-month periods ended June 30, 2012, the Company determined that no further impairment charges were required after going through the impairment testing of the operating long-lived assets (property, plant and equipment, both owned and under capital leases, net). Certain eroded protective shells for transmission channels and ducts, with net book values of $911,995, were replaced during the second phase enhancement project, write-offs of the same amounts, were made in this quarter and included in write-off/impairment on property, plant and equipment for the three-month period ended June 30, 2012. For the three-month and six-month periods ended June 30, 2011, the Company recorded impairment charges of long-lived assets for the relocation of Factory No. 4 and idle plant and machinery in the amount of $3,873,087, and write-off of long-lived assets for certain eroded protective shells for crude salt fields and transmission channels and ducts, at their net book values, in the amount of $3,697,479.

(k)           Basic and Diluted Net Income per Share of Common Stock

Basic earnings per common share are based on the weighted average number of shares outstanding during the periods presented.  Diluted earnings per share are computed using weighted average number of common shares plus dilutive common share equivalents outstanding during the period. Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive, i.e. the exercise prices of the outstanding stock options were greater than the market price of the common stock. Anti-dilutive common stock equivalents which were excluded from the calculation of number of dilutive common stock equivalents amounted to 2,906,971 and 1,378,847 shares for the three-month periods ended June 30, 2012 and 2011, respectively, and amounted to 2,175,548 and 241,002 shares for the six-month periods ended June 30, 2012 and 2011, respectively. These awards could be dilutive in the future if the market price of the common stock increases and is greater than the exercise price of these awards.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

(k)           Basic and Diluted Net Income per Share of Common Stock – Continued

The following table sets forth the computation of basic and diluted earnings per share:
 
  
 
Three-Month Period Ended June 30,
   
Six-Month Period Ended June 30,
   
2012
   
2011
     
2012
     
2011
 
Numerator
                           
Net income
 
$
5,688,674
   
$
10,023,255
   
$
8,975,781
   
$
24,388,254
 
                                 
Denominator
                               
Basic: Weighted-average common shares outstanding during the period
   
34,560,743
     
34,729,179
     
34,560,743
     
34,732,527
 
Add: Dilutive effect of stock options
   
-
     
4,009
     
651
     
395,746
 
Diluted
   
34,560,743
     
34,733,188
     
34,561,394
     
35,128,273
 
                                 
Net income per share
                               
Basic
 
$
0.16
   
$
0.29
   
$
0.26
   
$
0.70
 
Diluted
 
$
0.16
   
$
0.29
   
$
0.26
   
$
0.69
 
 
(l)           New Accounting Pronouncements

No accounting standards and guidance with an effective date during the three-month and six-month periods ended June 30, 2012 or issued during 2012 had or are expected to have a significant impact on the Company’s condensed consolidated financial statements.

NOTE 2 – ASSET ACQUISITIONS
 
Pursuant to the lease contract signed by SCHC on November 5, 2010 with State-Operated Shouguang Qingshuibo Farm (the “Lessor”), the Company recognized in January 2011: (1) a 20-year capital lease of real property adjacent to Factory No. 1, with the related production facility, channels and ducts, other production equipment and the buildings located on the property, with an annual payment of Renminbi (“RMB”) 1,877,000 (approximately $295,365) up to December 31, 2030 to the Lessor, aggregating $3,127,913 (the present value of the minimum lease payments); and (2) a 20-year land lease and rights to new extraction wells on which the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings are situated, with an annual payment of RMB3,123,000 (approximately $495,651) up to December 31, 2030 to the Lessor. The lease was accounted for under FASB ASC 840-10-25 “Leases - Recognition” and the cost of $3,127,913 was included in property, plant equipment under capital lease in the first quarter of 2011.
 
The Company also enhanced the new plant and machinery leased in the first quarter of 2011 by making capital improvements in reconstruction and renovation work at a cost of approximately $3,050,400, which was recorded as buildings and plant and machinery, for the operation of the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings located on the property.

In the second quarter of 2011, the Company carried out enhancement projects to its existing bromine extraction and crude salt production facilities. In particular, the Company incurred reconstruction and renovation works at a cost of approximately $12,379,153 for its crude salt fields in Factory No. 1, 5 to 9, and at a cost of approximately $20,087,600 for its extraction wells and transmission channels and ducts in Factory No. 1 to 9. The above enhancement projects have estimated useful lives of 5 to 8 years and are capitalized as buildings and plant and machinery.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 3 – INVENTORIES
 
Inventories consist of:
 
   
June 30,
2012
   
December 31,
2011
 
             
Raw materials
 
$
780,747
   
$
848,596
 
Finished goods
   
3,189,299
     
3,604,247
 
Allowance for obsolete and slow-moving inventory
   
(14,814
)
   
(14,871
)
   
$
3,955,232
   
$
4,437,972
 
 
NOTE 4 – PREPAID LAND LEASES
 
The Company prepaid for land leases with lease terms for periods ranging from one to fifty years to use the land on which the office premises, production facilities and warehouses of the Company are situated. The prepaid land lease is amortized on a straight line basis.

During the three-month periods ended June 30, 2012 and 2011, amortization of prepaid land lease totaled $50,180 and $72,989, respectively, which were recorded as cost of net revenue. During the six-month periods ended June 30, 2012 and 2011, amortization of prepaid land lease totaled $105,051 and $102,831, respectively, which were recorded as cost of net revenue.

The Company has the rights to use certain parcels of land located in Shouguang, the PRC, through lease agreements signed with local townships. Such parcels of land are collectively owned by local townships and accordingly, the Company could not obtain land use rights certificates on these parcels of land. The parcels of land that the Company could not obtain land use rights certificates cover a total of approximately 52.39 square kilometers with an aggregate carrying value of $1,081,310 and approximately 43.19 square kilometers with an aggregate carrying value of $766,748 as at June 30, 2012 and December 31, 2011, respectively.
 
NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consist of the following:
 
   
June 30,
2012
   
December 31,
2011
 
At cost:
           
Mineral rights
 
$
6,294,862
   
$
6,318,750
 
Buildings
   
40,819,625
     
40,974,528
 
Plant and machinery
   
134,002,545
     
136,862,383
 
Motor vehicles
   
6,998
     
7,024
 
Furniture, fixtures and office equipment
   
4,042,017
     
4,057,356
 
Construction in progress
   
7,849,287
     
-
 
Total
   
193,015,334
     
188,220,041
 
Less: Accumulated depreciation and amortization
   
(50,518,857
)
   
(41,019,301
)
Net book value
 
$
142,496,477
   
$
147,200,740
 
 
The Company has certain buildings and salt pans erected on parcels of land located in Shouguang, PRC, and such parcels of land are collectively owned by local townships. The Company has not been able to obtain property ownership certificates over these buildings and salt pans as the Company could not obtain land use rights certificates on the underlying parcels of land. The aggregate carrying values of these parcels of land are $30,316,834 and $33,108,012 as at June 30, 2012 and December 31, 2011, respectively.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET – Continued

During the three-month period ended June 30, 2012, depreciation and amortization expense totaled $5,521,178, of which $5,403,370 and $117,808 were recorded as cost of net revenue and administrative expenses, respectively. During the three-month period ended June 30, 2011, depreciation and amortization expense totaled $4,027,143, of which $3,830,437 and $196,707 were recorded as cost of net revenue and administrative expenses respectively. During the six-month period ended June 30, 2012, depreciation and amortization expense totaled $11,118,099, of which $10,645,703 and $472,396 were recorded as cost of sales and administrative expenses respectively. During the six-month period ended June 30, 2011, depreciation and amortization expense totaled $7,375,662, of which $6,805,179 and $570,483 were recorded as cost of net revenue and administrative expenses respectively.

Construction in progress as at June 30, 2012 of $7,849,287 represented the second phase enhancement projects to the Company’s existing bromine extraction and crude salt production facilities, which are currently under construction since mid-May 2012. The total contract costs of the enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 are approximately $12,806,910 and $8,139,503, respectively, and the work is expected to be completed by late August 2012. As of June 30, 2012, the percentage of work done is approximately 37%. The above enhancement projects are estimated to have useful lives of 5 to 8 years and will be capitalized as plant and machinery upon completion.

For the three-month periods ended June30, 2012 and 2011, ordinary repair and maintenance expenses were $0 and $38,457, respectively. For the six-month periods ended June 30, 2012 and 2011, ordinary repair and maintenance expenses were $127 and $89,090, respectively.

NOTE 6 – PROPERTY, PLANT AND EQUIPMENT UNDER CAPITAL LEASES, NET

Property, plant and equipment under capital leases, net consist of the following:

   
June 30,
2012
   
December 31,
2011
 
At cost:
           
Buildings
 
$
130,111
   
$
130,605
 
Plant and machinery
   
2,467,099
     
2,476,460
 
Total
   
2,597,210
     
2,607,065
 
Less: Accumulated depreciation and amortization
   
(441,139
)
   
(270,145
)
Net book value
 
$
2,156,071
   
$
2,336,920
 
 
The above buildings erected on parcels of land located in Shouguang, PRC, are collectively owned by local townships.  The Company has not been able to obtain property ownership certificates over these buildings as the Company could not obtain land use rights certificates on the underlying parcels of land.  

During the three-month periods ended June 30, 2012 and 2011, depreciation and amortization expense totaled $86,247 and $92,954, respectively, which was recorded as cost of net revenue. During the six-month periods ended June 30, 2012 and 2011, depreciation and amortization expense totaled $172,489 and $92,954, respectively, which was recorded as cost of net revenue.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 7 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consist of the following:

   
June 30,
   
December 31,
 
   
2012
   
2011
 
Accounts payable
 
$
3,833,602
   
$
3,645,804
 
Salary payable
   
139,024
     
132,454
 
Social security insurance contribution payable
   
50,834
     
39,129
 
Amount due to a contractor
   
762,227
     
1,422,042
 
Price adjustment funds
   
1,396,366
     
1,031,685
 
Other payables
   
1,374,095
     
1,102,529
 
Total
 
$
7,556,148
   
$
7,373,643
 
 
NOTE 8 – RELATED PARTY TRANSACTIONS

During the three-month and six-month periods ended June 30, 2012, the Company borrowed $60,000 and $235,000, respectively, and fully repaid later during the same period, from Jiaxing Lighting Appliance Company Limited (Jiaxing Lighting”), in which Mr. Ming Yang, a shareholder and the Chairman of the Company, had a 100% equity interest in Jiaxing Lighting. The amounts due to Jiaxing Lighting were unsecured, interest free and repayable on demand.

NOTE 9 – TAXES PAYABLE
 
Taxes payable consists of the following:
 
   
June 30,
   
December 31,
 
   
2012
   
2011
 
Income tax payable
 
$
1,957,493
   
$
1,761,452
 
Mineral resource compensation fee payable
   
365,942
     
410,719
 
Value added tax payable
   
793,338
     
540,463
 
Land use tax payable
   
882,821
     
1,081,117
 
Other tax payables
   
232,487
     
264,799
 
Total
 
$
4,232,081
   
$
4,058,550
 
   
NOTE 10 – CAPITAL LEASE OBLIGATIONS
 
The components of capital lease obligations are as follows:
 
 
Imputed
 
June 30,
 
December 31,
 
Interest rate
 
2012
 
2011
Total capital lease obligations
6.7%
 
$
3,025,078
   
$
3,226,300
 
Less: Current portion
     
(90,551
)
   
(189,742
)
Capital lease obligations, net of current portion
   
$
2,934,527
   
$
3,036,558
 

Interest expenses from capital lease obligations amounted to $54,024 and $65,740 for the three-month periods ended June 30, 2012 and 2011, respectively, which were charged to the income statements. Interest expenses from capital lease obligations amounted to $108,044 and $107,956 for the six-month periods ended June 30, 2012 and 2011, respectively, which were charged to the income statements.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 11 – RETAINED EARNINGS - APPROPRIATED

In accordance with the relevant PRC regulations and the PRC subsidiaries’ Articles of Association, the Company’s PRC subsidiaries are required to allocate its profit after tax to the following reserve:
 
Statutory Common Reserve Funds
 
SCHC and SYCI are required each year to transfer 10% of the profit after tax as reported under the PRC statutory financial statements to the Statutory Common Reserve Funds until the balance reaches 50% of the registered share capital.  This reserve can be used to make up any loss incurred or to increase share capital.  Except for the reduction of losses incurred, any other application should not result in this reserve balance falling below 25% of the registered capital. The Statutory Common Reserve Fund as of June 30, 2012 for SCHC and SYCI is 33% and 50% of its registered capital respectively.

NOTE 12 – STOCK-BASED COMPENSATION
 
Pursuant to the Company’s Amended and Restated 2007 Equity Incentive Plan, the aggregate number shares of the Company’s common stock available for grant of stock options and issuance is 4,341,989 shares.

The fair value of each option award below is estimated on the date of grant using the Black-Scholes option-pricing model. The risk free rate is based on the yield-to-maturity in continuous compounding of the US Government Bonds with the time-to-maturity similar to the expected tenor of the option granted, volatility is based on the annualized historical stock price volatility of the Company, and the expected life is based on the estimated average of the life of options using the “simplified” method, as prescribed in FASB ASC 718, due to insufficient historical exercise activity during recent years as a basis from which to estimate future exercise patterns.

In early March 2012, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.77 per share and the options vested immediately. The options were valued at $15,300 fair value, with assumed 95.89% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.21% and no dividend yield. For the three-month and six-month periods ended June 30, 2012, $0 and $15,300 was recognized as general and administrative expenses.

On May 7, 2012, the Company entered into a service agreement with an independent director in which he would be entitled to receive stock option grants of 12,500 shares of common stock on the date of the agreement and on each anniversary date from that date through May 7, 2014. The exercise price of the options which will equal or exceed the fair market value of a share of the Company’s common stock on the day before the grant date, shall be determined by the Board of Directors and the options shall vest immediately upon the grant date. This agreement remains effective as long as the director continues to serve as a non-employee director of the Company. Pursuant to this agreement, on May 7, 2012, the Company granted to this independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.06 per share and the options vested immediately. The options were valued at $11,000 fair value, with assumed 95.21% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.21% and no dividend yield. For the three-month and six-month periods ended June 30, 2012, $11,000 was recognized as general and administrative expenses.
 
The following table summarizes all Company stock option transactions between January 1, 2012 and June 30, 2012.
 
   
Number of Option
and Warrants
Outstanding
   
Number of Option
and Warrants
Vested
   
Range of
Exercise Price per Common Share
 
Balance, January 1, 2012
   
1,144,471
     
1,144,471
     
$2.41 - $12.60
 
Granted and vested during the six-month period ended June 30, 2012
   
25,000
     
25,000
     
$2.06 - $2.77
 
Balance, June 30, 2012
   
1,169,471
     
1,169,471
     
$2.06 - $12.60
 
 
     
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 12 – STOCK-BASED COMPENSATION – Continued

   
Stock and Warrants Options Outstanding
           
Weighted Average
 
Weighted Average
           
Remaining
 
Exercise Price of
   
Outstanding at June 30, 2012
 
Range of
Exercise Prices
 
Contractual Life
 (Years)
 
Options Currently
 Outstanding
Exercisable and outstanding
 
1,169,471
 
$2.06 - $12.60
 
2.42
 
$   6.21
 
The weighted average grant-date fair values as at June 30, 2012 and December 31, 2011 were $7.18 and $7.29, respectively.
 
NOTE 13 – INCOME TAXES

The Company utilizes the asset and liability method of accounting for income taxes in accordance with FASB ASC 740-10.

(a)           United States

Gulf Resources, Inc. is subject to the United States of America Tax law at a tax rate of 34%. No provision for the US federal income taxes has been made as the Company had no US taxable income for the three-month and six-month periods ended June 30, 2012 and 2011, and management believes that its earnings are permanently invested in the PRC.

(b)           BVI

Upper Class Group Limited, a subsidiary of Gulf Resources, Inc., was incorporated in the BVI and, under the current laws of the BVI, it is not subject to tax on income or capital gain in the BVI. Upper Class Group Limited did not generate assessable profit for the three-month and six-month periods ended June 30, 2012 and 2011.

(c)           Hong Kong

Hong Kong Jiaxing Industrial Limited, a subsidiary of Upper Class Group Limited, was incorporated in Hong Kong and is subject to Hong Kong profits tax. The Company is subject to Hong Kong taxation on its activities conducted in Hong Kong and income arising in or derived from Hong Kong.  No provision for profits tax has been made as the Company has no assessable income for the three-month and six-month periods ended June 30, 2012 and 2011.  The applicable statutory tax rates for the three-month and six-month periods ended June 30, 2012 and 2011 are 16.5%.

(d)           PRC
 
Enterprise income tax (“EIT”) for SCHC and SYCI in the PRC is charged at 25% of the assessable profits.

The operating subsidiaries SCHC and SYCI are wholly foreign-owned enterprises (“FIE”) incorporated in the PRC and are subject to PRC Foreign Enterprise Income Tax Law.

On February 22, 2008, the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) jointly issued Cai Shui [2008] Circular 1 (“Circular 1”). According to Article 4 of Circular 1, distributions of accumulated profits earned by a FIE prior to January 1, 2008 to foreign investor(s) in 2008 will be exempted from withholding tax (“WHT”) while distribution of the profit earned by an FIE after January 1, 2008 to its foreign investor(s) shall be subject to WHT at 5% effective tax rate.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 13 – INCOME TAXES – Continued

As of June 30, 2012 and December 31, 2011, the accumulated distributable earnings under the Generally Accepted Accounting Principles (GAAP”) of PRC are $189,972,832 and $180,939,187, respectively. Since the Company intends to reinvest its earnings to further expand its businesses in mainland China, its foreign invested enterprises do not intend to declare dividends to their immediate foreign holding companies in the foreseeable future. Accordingly, as of June 30, 2012 and December 31, 2011, the Company has not recorded any WHT on the cumulative amount of distributable retained earnings of its foreign invested enterprises in China. As of June 30, 2012 and December 31, 2011, the unrecognized WHT are $8,421,768 and $7,965,999, respectively.
 
The components of the provision for income taxes from continuing operations are:

 
Three-Month Period Ended June 30,
 
Six-Month Period Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
 
Current taxes – PRC
  $ 1,892,567     $ 5,285,957     $ 3,148,833     $ 11,211,191  
Deferred taxes – PRC
    82,622       (1,933,612 )     160,826       (1,925,724 )
    $ 1,975,189     $ 3,352,345     $ 3,309,659     $ 9,285,467  
 
The effective income tax expenses differ from the PRC statutory income tax rate of 25% from continuing operations in the PRC as follows:

 
Three-Month Period Ended June 30,
 
Six-Month Period Ended June 30,
Reconciliations
2012
 
2011
 
2012
 
2011
Statutory income tax rate
 
25
%
   
25
%
   
25
%
   
25
%
US federal net operating loss
 
1
%
   
0
%
   
2
%
   
3
%
Effective tax rate
 
26
%
   
25
%
   
27
%
   
28
%

Significant components of the Company’s deferred tax assets and liabilities at June 30, 2012 and December 30, 2011 are as follows:

   
June 30,
   
December 31,
 
 
2012
   
2011
 
Deferred tax liabilities
 
$
-
   
$
-
 
                 
Deferred tax assets:
               
Allowance for obsolete and slow-moving inventories
 
$
3,704
   
$
3,718
 
Impairment on property, plant and equipment
   
636,615
     
639,031
 
Exploration costs
   
1,780,714
     
1,797,391
 
Repair and maintenance costs
   
101,879
     
224,984
 
Property, plant and equipment
   
44,534
     
73,059
 
US federal net operating loss
   
10,442,134
     
10,111,821
 
Total deferred tax assets
   
13,009,580
     
12,850,004
 
Valuation allowance
   
(10,442,134
)
   
(10,111,821
)
Net deferred tax asset
 
$
2,567,446
   
$
2,738,183
 
                 
Current deferred tax asset
 
$
105,583
   
$
228,702
 
Long-term deferred tax asset
 
$
2,461,863
   
$
2,509,481
 

The increase in valuation allowance for each of the three-month periods ended June 30, 2012 and 2011 is $106,382 and $36,752, respectively, and six-month periods ended June 30, 2012 and 2011 is $330,313 and $1,196,983, respectively.

There was no unrecognized tax benefits and accrual for uncertain tax positions as of June 30, 2012 and December 31, 2011.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 14 – BUSINESS SEGMENTS

The Company has three reportable segments:  bromine, crude salt and chemical products. The reportable segments are consistent with how management views the markets served by the Company and the financial information that is reviewed by its chief operating decision maker. The Company manages its sensors and controls businesses as components of an enterprise for which separate information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance.

An operating segment’s performance is primarily evaluated based on segment operating income, which excludes share-based compensation expense, certain corporate costs and other income not associated with the operations of the segment. These corporate costs (income) are separately stated below and also include costs that are related to functional areas such as accounting, treasury, information technology, legal, human resources, and internal audit. The Company believes that segment operating income, as defined above, is an appropriate measure for evaluating the operating performance of its segments.

Three-Month Period Ended June 30, 2012
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
17,539,429
   
$
3,779,658
   
$
9,995,759
   
$
31,314,846
   
$
-
   
$
31,314,846
 
Net revenue
(intersegment)
   
808,596
     
-
     
-
     
808,596
     
-
     
808,596
 
Income (loss) from operations before taxes
   
3,933,561
     
888,555
     
3,007,381
     
7,829,497
     
(196,294
)
   
7,633,203
 
Income taxes
   
1,018,311
     
198,783
     
758,095
     
1,975,189
     
-
     
1,975,189
 
Income (loss) from operations after taxes
   
2,915,250
     
689,772
     
2,249,286
     
5,854,308
     
(196,294
)
   
5,658,014
 
Total assets
   
158,305,734
     
56,621,811
     
50,634,822
     
265,562,367
     
425,477
     
265,987,844
 
Depreciation and amortization
   
3,509,790
     
1,442,179
     
655,456
     
5,607,425
     
-
     
5,607,425
 
Capital expenditures
   
6,567,296
     
1,281,991
     
-
     
7,849,287
     
-
     
7,849,287
 
Write-off / Impairment 
   
763,043
     
148,952
     
-
     
911,995
     
-
     
911,995
 

Three-Month Period Ended June 30, 2011
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
33,230,646
   
$
5,994,384
   
$
12,075,782
   
$
51,300,812
   
$
-
   
$
51,300,812
 
Net revenue
(intersegment)
   
883,150
     
-
     
-
     
883,150
     
-
     
883,150
 
Income (loss) from operations before taxes
   
9,540,474
     
1,926,628
     
2,029,160
     
13,496,262
     
(107,653
)
   
13,388,609
 
Income taxes
   
2,466,262
     
379,478
     
506,605
     
3,352,345
     
-
     
3,352,345
 
Income (loss) from operations after taxes
   
7,074,212
     
1,547,150
     
1,522,555
     
10,143,917
     
(107,653
)
   
10,036,264
 
Total assets
   
146,989,573
     
52,795,615
     
42,676,361
     
242,461,549
     
3,013,131
     
245,474,680
 
Depreciation and amortization
   
2,859,567
     
578,359
     
682,171
     
4,120,097
     
-
     
4,120,097
 
Capital expenditures
   
21,371,074
     
15,667,471
     
37,664
     
37,076,209
     
-
     
37,076,209
 
Write-off / Impairment 
   
3,749,435
     
2,015,533
     
1,805,598
     
7,570,566
     
-
     
7,570,566
 
 
  
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)

NOTE 14 – BUSINESS SEGMENTS – Continued

Six-Month Period Ended June 30, 2012
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
30,993,311
   
$
6,054,582
   
$
18,075,627
   
$
55,123,520
   
$
-
   
$
55,123,520
 
Net revenue
(intersegment)
   
1,563,153
     
-
     
-
     
1,563,153
     
-
     
1,563,153
 
Income (loss) from operations before taxes
   
6,401,865
     
1,437,005
     
5,250,276
     
13,089,146
     
(878,844
)
   
12,210,302
 
Income taxes
   
1,681,209
     
302,649
     
1,325,801
     
3,309,659
     
-
     
3,309,659
 
Income (loss) from operations after taxes
   
4,720,656
     
1,134,356
     
3,924,475
     
9,779,487
     
(878,844
)
   
8,900,643
 
Total assets
   
158,305,734
     
56,621,811
     
50,634,822
     
265,562,367
     
425,477
     
265,987,844
 
Depreciation and amortization
   
7,174,033
     
2,805,685
     
1,310,870
     
11,290,588
     
-
     
11,290,588
 
Capital expenditures
   
6,567,296
     
1,281,991
     
-
     
7,849,287
     
-
     
7,849,287
 
Write-off / Impairment 
   
763,043
     
148,952
     
-
     
911,995
     
-
     
911,995
 

Six-Month Period Ended June 30, 2011
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
63,379,962
   
$
11,028,718
   
$
22,270,664
   
$
96,679,344
   
$
-
   
$
96,679,344
 
Net revenue
(intersegment)
   
1,503,866
     
-
     
-
     
1,503,866
     
-
     
1,503,866
 
Income (loss) from operations before taxes
   
25,913,373
     
5,873,546
     
5,385,697
     
37,172,616
     
(3,519,714
)
   
33,652,902
 
Income taxes
   
6,742,153
     
1,192,917
     
1,350,397
     
9,285,467
     
-
     
9,285,467
 
Income (loss) from operations after taxes
   
19,171,220
     
4,680,629
     
4,035,300
     
27,887,149
     
(3,519,714
)
   
24,367,435
 
Total assets
   
146,989,573
     
52,795,615
     
42,676,361
     
242,461,549
     
3,013,131
     
245,474,680
 
Depreciation and amortization
   
5,014,155
     
1,098,678
     
1,355,783
     
7,468,616
     
-
     
7,468,616
 
Capital expenditures
   
23,933,922
     
19,334,613
     
37,664
     
43,306,199
     
-
     
43,306,199
 
Write-off / Impairment 
   
3,749,435
     
2,015,533
     
1,805,598
     
7,570,566
     
-
     
7,570,566
 

* Certain common production overheads, operating and administrative expenses and asset items (mainly cash and certain office equipment) of bromine and crude salt segments in SCHC were split by reference to the average selling price and production volume of respective segment.

   
Three-Month Period Ended June 30,
   
Six-Month Period Ended June 30,
 
Reconciliations
 
2012
   
2011
   
2012
   
2011
 
Total segment operating income
 
$
7,829,497
   
$
13,496,262
   
$
13,089,146
   
$
37,172,616
 
Corporate costs
   
(196,294
)
   
(107,653
)
   
(878,844
)
   
(3,519,714
)
Income from operations
   
7,633,203
     
13,388,609
     
12,210,302
     
33,652,902
 
Other income (expense)
   
30,660
     
(13,009
)
   
75,138
     
20,819
 
Income before taxes
 
$
7,663,863
   
$
13,375,600
   
$
12,285,440
   
$
33,673,721
 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)

NOTE 14 – BUSINESS SEGMENTS – Continued

The following table shows the major customer(s) (10% or more) for the three-month period ended June 30, 2012.

Number
 
Customer
 
Bromine
(000’s)
   
Crude Salt
(000’s)
   
Chemical Products
(000’s)
   
Total
Revenue
(000’s)
   
Percentage of
Total Revenue (%)
 
  1  
Shandong Morui Chemical Company Limited
 
$
1,904
   
$
727
   
$
1,109
   
$
3,740
     
11.9%
 
  2  
Shouguang City Rongyuan Chemical Company Limited
 
$
2,257
   
$
898
   
$
-
   
$
3,155
     
10.1%
 
TOTAL
     
$
4,161
   
$
1,625
   
$
1,109
   
$
6,895
     
22.0%
 

The following table shows the major customer(s) (10% or more) for the six-month period ended June 30, 2012.

Number
 
Customer
 
Bromine
(000’s)
   
Crude Salt
(000’s)
   
Chemical Products
(000’s)
   
Total
Revenue
(000’s)
   
Percentage of
Total Revenue (%)
 
  1  
Shandong Morui Chemical Company Limited
 
$
3,634
   
$
1,113
   
$
2,107
   
$
6,854
     
12.4%
 
  2  
Shouguang City Rongyuan Chemical Company Limited
 
$
4,278
   
$
1,346
   
$
-
   
$
5,624
     
10.2%
 
TOTAL
     
$
7,912
   
$
2,459
   
$
2,107
   
$
12,478
     
22.6%
 

The following table shows the major customer(s) (10% or more) for the three-month period ended June 30, 2011.

Number
 
Customer
 
Bromine
(000’s)
   
Crude Salt
(000’s)
   
Chemical Products
(000’s)
   
Total
Revenue
(000’s)
   
Percentage of
Total Revenue (%)
 
  1  
Shandong Morui Chemical Company Limited
 
$
3,507
   
$
1,121
   
$
760
   
$
5,388
     
10.5%
 
TOTAL
     
$
3,507
   
$
1,121
   
$
760
   
$
5,388
     
10.5%
 

The following table shows the major customer(s) (10% or more) for the six-month period ended June 30, 2011.

Number
 
Customer
 
Bromine
(000’s)
   
Crude Salt
(000’s)
   
Chemical Products
(000’s)
   
Total
Revenue
(000’s)
   
Percentage of
Total Revenue (%)
 
  1  
Shandong Morui Chemical Company Limited
 
$
9,238
   
$
1,963
   
$
1,329
   
$
12,530
     
13.0%
 
  2  
Shouguang City Rongyuan Chemical Company Limited
 
$
7,285
   
$
2,622
   
$
-
   
$
9,907
     
10.3%
 
TOTAL
     
$
16,523
   
$
4,585
   
$
1,329
   
$
22,437
     
23.3%
 

NOTE 15 – MAJOR SUPPLIERS

During the three-month and six-month periods ended June 30, 2012, the Company purchased 85.7% and 83.5% of its raw materials from its top five suppliers, respectively.  As of June 30, 2012, amounts due to those suppliers included in accounts payable were $3,305,237. During the three-month and six-month periods ended June 30, 2011, the Company purchased 81.1% and 81.6% of its raw materials from its top five suppliers, respectively.  As of June 30, 2011, amounts due to those suppliers included in accounts payable were $5,094,255. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)

NOTE 16 – CUSTOMER CONCENTRATION

The Company sells a substantial portion of its products to a limited number of customers.  During the three-month and six-month periods ended June 30, 2012, the Company sold 42.8% and 43.4% of its products to its top five customers, respectively. As of June 30, 2012, amounts due from these customers were $19,888,840. During the three-month and six-month periods ended June 30, 2011, the Company sold 40.8% and 43.9% of its products to its top five customers, respectively. At June 30, 2011, amounts due from these customers were $16,417,668. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.

NOTE 17 – FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The carrying values of financial instruments, which consist of cash, accounts receivable and accounts payable and other payables, approximate their fair values due to the short-term nature of these instruments.  There were no material unrecognized financial assets and liabilities as of June 30, 2012 and December 31, 2011.

NOTE 18 – RESEARCH AND DEVELOPMENT EXPENSES

The total research and development expenses recognized in the income statements during the three-month and six-month periods ended June 30, 2012 were $62,526 and $105,324, respectively, of which the consumption of bromine produced by the Company amounted to $13,268 and $24,008, respectively. The total research and development expenses recognized in the income statements during the three-month and six-month periods ended June 30, 2011 were $133,519 and 313,856, respectively, of which the consumption of bromine produced by the Company amounted to $13,158 and $43,226, respectively.

NOTE 19 – CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS

As of June 30, 2012, the Company has leased a real property adjacent to Factory No. 1, with the related production facility, channels and ducts, other production equipment and the buildings located on the property, under capital lease. The future minimum lease payments required under capital lease, together with the present value of such payments, are included in the table show below.
 
The Company has leased seven pieces of land under non-cancelable operating leases, which are fixed in rentals and expire through December 2021, December 2030, December 2031, December 2040, February 2059, August 2059 and June 2060, respectively. The Company accounts for the leases as operating leases.

The Company has committed approximately $13,097,126 for the second phase enhancement projects to the Company’s existing bromine extraction and crude salt production facilities as of June 30, 2012.

The following table sets forth the Company’s contractual obligations as of June 30, 2012:

   
Capital Lease Obligations
   
Operating Lease Obligations
   
Construction Project Obligations
 
Payable within: 
                 
the next 12 months
$
296,772
   
$
768,548
   
$
13,097,126
 
the next 13 to 24 months
   
296,772
     
780,865
     
-
 
the next 25 to 36 months
   
296,772
     
790,731
     
-
 
the next 37 to 48 months
   
296,772
     
804,086
     
-
 
the next 49 to 60 months
   
296,772
     
814,891
     
-
 
thereafter
   
3,858,044
     
18,327,069
     
-
 
Total
 
$
5,341,904
   
$
22,286,190
   
$
13,097,126
 
Less: Amount representing interest
   
(2,316,826
)
               
Present value of net minimum lease payments
 
$
3,025,078
                 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
 (Expressed in U.S. dollars)
(UNAUDITED)

NOTE 19 – CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS – Continued

Rental expenses related to operating leases of the Company amounted to $194,450 and $157,480, which were charged to the income statements for the three-month ended June 30, 2012 and 2011, respectively. Rental expenses related to operating leases of the Company amounted to $388,766 and $261,488, which were charged to the income statements for the six-month ended June 30, 2012 and 2011, respectively.

NOTE 20 – CONTINGENCY
 
Class Action
 
The Company and certain of its officers and directors (Ming Yang, Xiaobin Liu, and Min Li, collectively, the Individual Defendants”) have been named as defendants in a putative securities class action lawsuit alleging violations of the federal securities laws.  That action, which is now captioned  Lewy, et al. v. Gulf Resources, Inc., et al., No. 11-cv-3722 ODW (MRWx), was filed on April 29, 2011 in the United States District Court for the Central District of California.  The lead plaintiffs, who seek to represent a class of all purchasers and acquirers of the Company’s common stock between March 16, 2009 and April 26, 2011 inclusive, filed an amended complaint on September 12, 2011.  Lead plaintiffs assert claims for violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder.  The amended complaint alleges the defendants made false or misleading statements in the Company’s Annual Reports on Form 10-K for the years ended December 31, 2008, 2009, and 2010, and in interim quarterly reports by, among other things, overstating revenue and net income and failing to disclose material related party transactions and certain facts about the CEO’s prior employment at another company.  The amended complaint also asserts claims against the Individual Defendants for violations of Section 20(a) of the Securities Exchange Act of 1934. The amended complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. On May 15, 2012, the Court denied the Company’s motion to dismiss the amended complaint. The parties are required to submit a joint report concerning scheduling and other issues on July 30, 2012, in accordance with Federal Rules of Civil Procedure 16 and 26(f). The Company has submitted the required report on July 30, 2012. The Court has also set a scheduling conference for August 12, 2012.  The Company intends to defend vigorously against the lawsuit.  The Company currently cannot estimate the amount or range of possible losses from this litigation. 
 
The legal costs incurred for the three-month and six-month periods ended June 30, 2012 in connection with the above legal case amounted to $100,000 and $511,289, which was included in the income statements as general and administrative expenses. No legal costs were incurred for the three-month and six-month periods ended June 30, 2011 in connection with the above legal case.

NOTE 21 – SUBSEQUENT EVENTS

On July 2, 2012, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $1.22 per share and the options vested immediately. The options were valued at $7,000 fair value, with assumed 94.92% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.24% and no dividend yield, which will be recognized as general and administrative expense in third quarter of 2012.

On July 17, 2012, the Company granted to 3 executive officers and 18 management staff options to purchase 600,000 shares and 218,000 shares of the Company’s common stock, respectively, at an exercise price of $0.952 per share and the options vested immediately. The options to executive officers and management staff were valued at $344,743 and $125,257 fair value, respectively, both with assumed 88.03% volatility, a four-year expiration term with expected tenor of 2 years, a risk free rate of 0.24% and no dividend yield, which will be recognized as general and administrative expense in third quarter of 2012.

In mid-July 2012, the Company commenced two enhancement projects to its existing bromine and chemical products production facilities. The contract cost of the repair and maintenance and enhancement work to the bromine production facilities in Factory No. 2 is approximately $1,280,691. The contract cost of the enhancement work to the chemical products production facilities is approximately $1,502,045. The enhancement works of both contracts are expected to be completed by mid-September 2012. The enhancement portion to the above projects of approximately $2,761,818 is estimated to have useful lives of 5 to 20 years and will be capitalized as plant and machinery upon completion, and the portion of repair and maintenance expenses of approximately $20,918 will be recognized as cost of net revenue in the third quarter of 2012.
 
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements
 
The discussion below contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act.  We have used words such as “believes,” “intends,” “anticipates,” “expects” and similar expressions to identify forward-looking statements. These statements are based on information currently available to us and are subject to a number of risks and uncertainties that may cause our actual results of operations, financial condition, cash flows, performance, business prospects and opportunities and the timing of certain events to differ materially from those expressed in, or implied by, these statements. These risks, uncertainties and other factors include, without limitation, those matters discussed in Item 1A of Part I of our 2011 Form 10-K.  Except as expressly required by the federal securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances, or for any other reason.  The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing in our 2011 Form 10-K and Item 1A, “Risk Factors” for the year ended December 31, 2011.

Overview
 
Gulf Resources conducts operations through its two wholly-owned China subsidiaries, SCHC and SYCI. Our business is also reported in these three segments, Bromine, Crude Salt, and Chemical Products.
 
Through SCHC, we produce and sell 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 brominated compounds used in industry and agriculture. Bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines, and disinfectants.
 
Through SYCI, we manufacture and sell chemical products that are used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals.
 
Our Corporate History
     
We were incorporated in Delaware on February 28, 1989. From November 1993 through August 2006, we were engaged in the business of owning, leasing and operating coin and debit card pay-per copy photocopy machines, fax machines, microfilm reader-printers and accessory equipment under the name “Diversifax, Inc.”. Due to the increased use of internet services, demand for our services declined sharply, and in August 2006, our Board of Directors decided to discontinue our operations.
 
Upper Class Group Limited, incorporated in the British Virgin Islands in July 2006, acquired all the outstanding stock of SCHC, a company incorporated in Shouguang City, Shandong Province, PRC, in May 2005. At the time of the acquisition, members of the family of Mr. Ming Yang, our president and former chief executive officer, owned approximately 63.20% of the outstanding shares of Upper Class Group Limited. Since the ownership of Upper Class Group Limited and SCHC was then substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Upper Class Group Limited recognized the assets and liabilities transferred at their carrying amounts.

On December 12, 2006, we, then known as Diversifax, Inc., a public “shell” company, acquired Upper Class Group Limited and SCHC. Under the terms of the agreement, the stockholders of Upper Class Group Limited received 13,250,000 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of voting common stock of Gulf Resources, Inc. in exchange for all outstanding shares of Upper Class Group Limited. Members of the Yang family received approximately 62% of our common stock as a result of the acquisition.  Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class Group Limited for the net assets of Gulf Resources, Inc., accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange is identical to that resulting from a reverse acquisition, except no goodwill is recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class Group Limited. Share and per share amounts stated have been retroactively adjusted to reflect the share exchange. On February 20, 2007, we changed our corporate name to Gulf Resources, Inc.
 
   
On February 5, 2007, we acquired SYCI, a company incorporated in PRC, in October 2000. Under the terms of the acquisition agreement, the stockholders of SYCI received a total of 8,094,059 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of common stock of Gulf Resources, Inc. in exchange for all outstanding shares of SYCI's common stock. Simultaneously with the completion of the acquisition, a dividend of $2,550,000 was paid to the former stockholders of SYCI. At the time of the acquisition, approximately 49.1% of the outstanding shares of SYCI were owned by Ms. Yu, Mr. Yang’s wife, and the remaining 50.9% of the outstanding shares of SYCI were owned by SCHC, all of whose outstanding shares were owned by Mr. Yang and his wife. Since the ownership of Gulf Resources, Inc. and SYCI are substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Gulf Resources, Inc. recognized the assets and liabilities of SYCI at their carrying amounts. Share and per share amounts have been retroactively adjusted to reflect the acquisition.

To satisfy certain ministerial requirements necessary to confirm certain government approvals required in connection with the acquisition of SCHC by Upper Class Group Limited, all of the equity interest of SCHC were transferred to a newly formed Hong Kong corporation named Hong Kong Jiaxing Industrial Limited (“Hong Kong Jiaxing”) all of the outstanding shares of which are owned by Upper Class Group Limited. The transfer of all of the equity interest of SCHC to Hong Kong Jiaxing received approval from the local State Administration of Industry and Commerce on December 10, 2007.

As a result of the transactions described above, our corporate structure is linear. That is Gulf Resources owns 100% of the outstanding shares of Upper Class Group Limited, which owns 100% of the outstanding shares of Hong Kong Jiaxing, which owns 100% of the outstanding shares of SCHC, which owns 100% of the outstanding shares of SYCI.

On October 12, 2009 we completed a 1-for-4 reverse stock split of our common stock, such that for each four shares outstanding prior to the stock split there was one share outstanding after the reverse stock split. All shares of common stock referenced in this report have been adjusted to reflect the stock split figures. On October 27, 2009 our shares began trading on the NASDAQ Global Select Market under the ticker symbol “GFRE” and on June 30, 2011 we changed our ticker symbol to “GURE” to better reflection of our corporate name.

Our current corporate structure chart is set forth in the following diagram:
 
 
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
 
The following table presents certain information derived from the consolidated statements of operations, cash flows and stockholders equity for the three-month and six-month periods ended June 30, 2012 and 2011. 

Comparison of the Three-Month Periods Ended June 30, 2012 and 2011

 
Three-Month Period
Ended June 30, 2012
 
Three-Month Period
Ended June 30, 2011
 
% Change
Net revenue
$
31,314,846
   
$
51,300,812
 
 
 
(39
%)
Cost of net revenue
$
(21,389,651
 
$
(24,994,703
 
 
(14
%)
Gross profit
$
9,925,195
   
$
26,306,109
 
 
 
(62
%)
Sales, marketing and other operating expenses
$
(22,709
 
$
(23,733
)
   
(4
%)
Research and development costs
$
(62,526
 
$
(133,519
 
 
(53
%)
Exploration cost
$
-
   
$
(3,867,286
 
 
(100
%)
Write-off/Impairment on property, plant and equipment
$
(911,995
 
$
 (7,570,566
 
 
(88
%)
General and administrative expenses
$
(1,370,866
 
$
(1,714,694
)
   
(20
%) 
Other operating income
$
76,104
   
$
392,298
 
 
 
(81
%)
Income from operations
$
7,633,203
   
$
13,388,609
 
 
 
(43
%)
Other income (expense), net
$
30,660
   
$
(13,009
 
 
(336
%)
Income before taxes
$
7,663,863
   
$
13,375,600
 
 
 
(43
%)
Income taxes
$
(1,975,189
 
$
(3,352,345
 
 
(41
%)
Net income
$
5,688,674
   
$
10,023,255
 
 
 
(43
%)

Net revenue.  Net revenue was $31,314,846 for three-month period ended June 30, 2012, a decrease of approximately $20.0 million (or 39%) as compared to the same period in 2011. This decrease was primarily attributable to the reduction of overall demand for all of our segment products, specifically, (i) revenue from the bromine segment decreased from $33,230,646 for the three-month period ended June 30, 2011 to $17,539,429 for the same period in 2012, a decrease of approximately 47%; (ii) revenue from the crude salt segment decreased from $5,994,384 for the three-month period ended June 30, 2011 to $3,779,658 for the same period in 2012, a decrease of approximately 37%; and (iii) revenue from the chemical products segment decreased from $12,075,782 for the three-month period ended June 30, 2011 to $9,995,759 for the same period in 2012, a decrease of approximately 17%.

   
Net Revenue by Segment
   
   
Three-Month Period Ended
 
Three-Month Period Ended
 
Percent Decrease
   
June 30, 2012
 
June 30, 2011
 
of Net Revenue
Segment
       
% of total
       
% of total
     
Bromine
 
$
17,539,429
     
56
%
 
$
33,230,646
     
65
%
   
(47
%)
Crude Salt
 
$
3,779,658
     
12
%
 
$
5,994,384
     
12
%
   
(37
%)
Chemical Products
 
$
9,995,759
     
32
%
 
$
12,075,782
     
23
%
   
(17
%)
Total sales
 
$
31,314,846
     
100
%
 
$
51,300,812
     
100
%
   
(39