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 September 30, 2013
   
 
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.)
     
Level 11,Vegetable Building, Industrial Park of the East
Shouguang City, Shandong,
 
262700
(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  o
Non-accelerated filer (Do not check if a smaller reporting company) o
Smaller reporting company x
 
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 November 4, 2013, the registrant had outstanding 38,370,801 shares of common stock.
 
 
 
 
 
       
 
 
 
PART I—FINANCIAL INFORMATION
 
 
GULF RESOURCES, INC.
 AND SUBSIDIARIES
 CONDENSED CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. dollars)
(UNAUDITED)

   
September 30, 2013
Unaudited
   
December 31, 2012
Audited
 
Current Assets
               
Cash
 
$
97,204,603
   
$
65,241,035
 
Accounts receivable
   
41,543,015
     
35,969,900
 
Inventories
   
5,805,242
     
5,993,598
 
Prepayments and deposits
   
9,375
     
-
 
Prepaid land leases
   
285,845
     
47,307
 
Deferred tax assets
   
7,129
     
6,973
 
Receivable from relocation
   
2,927,700
     
-
 
Total Current Assets
   
147,782,909
     
107,258,813
 
Non-Current Assets
               
Property, plant and equipment, net
   
149,118,534
     
165,942,542
 
Property, plant and equipment under capital leases, net
   
1,775,595
     
1,996,478
 
Prepaid land leases, net of current portion
   
752,025
     
748,502
 
Deferred tax assets
   
2,296,830
     
2,246,699
 
Total non-current assets
   
153,942,984
     
170,934,221
 
Total Assets
 
$
301,725,893
   
$
278,193,034
 
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Accounts payable and accrued expenses
 
$
6,346,209
   
$
6,533,236
 
Retention payable
   
154,518
     
1,432,690
 
Capital lease obligation, current portion
   
150,101
     
193,164
 
Taxes payable
   
5,456,003
     
2,856,658
 
Total Current Liabilities
   
12,106,831
     
11,015,748
 
Non-Current Liabilities
               
Capital lease obligation, net of current portion
   
2,919,289
     
2,952,902
 
Total Liabilities
 
$
15,026,120
   
$
13,968,650
 
　
               
Stockholders’ Equity
               
PREFERRED STOCK; $0.001 par value; 1,000,000 shares authorized; none outstanding
 
$
     
$
   
COMMON STOCK; $0.0005 par value; 80,000,000 shares authorized; 38,555,400 and 38,552,070 shares issued; and 38,370,801 and 38,367,471 shares outstanding as of September 30, 2013 and December 31, 2012, respectively
   
19,277
     
19,276
 
Treasury stock; 184,599 shares as of September 30, 2013 and December 31, 2012 at cost
   
(500,000
)
   
(500,000
)
Additional paid-in capital
   
80,025,587
     
79,489,188
 
Retained earnings unappropriated
   
161,286,763
     
146,745,754
 
Retained earnings appropriated
   
16,781,471
     
15,973,887
 
Cumulative translation adjustment
   
29,086,675
     
22,496,279
 
Total Stockholders’ Equity
   
286,699,773
     
264,224,384
 
Total Liabilities and Stockholders’ Equity
 
$
301,725,893
   
$
278,193,034
 

See accompanying notes to the condensed consolidated financial statements.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Expressed in U.S. dollars)
(UNAUDITED)
 
   
Three-Month Period Ended September 30,
   
Nine-Month Period Ended September 30,
 
   
2013
   
2012
   
2013
   
2012
 
                         
NET REVENUE
                       
Net revenue
 
$
32,935,277
   
$
24,530,332
   
$
88,291,753
   
$
79,653,852
 
                                 
OPERATING INCOME (EXPENSES)
                               
Cost of net revenue
   
(22,006,256
)
   
(17,099,890
)
   
(63,251,929
)
   
(55,605,423
)
Sales, marketing and other operating expenses
   
(25,378
)
   
(20,327
)
   
(70,796
)
   
(60,800
)
Research and development cost
   
(33,198
)
   
(28,478
)
   
(105,380
)
   
(133,802
)
Write-off/Impairment on property, plant and equipment
   
(214
)
   
(130,143
)
   
(214
)
   
(1,042,138
 
General and administrative expenses
   
(1,962,496
)
   
(1,707,863
)
   
(6,354,165
)
   
(5,190,934
)
Gain on relocation of factory
   
1,877,779
     
-
     
1,877,779
     
-
 
Other operating income
   
107,006
     
85,250
     
489,695
     
218,428
 
     
(22,042,757
)
   
(18,901,451
)
   
(67,415,010
 
)
   
(61,814,669
)
                                 
INCOME FROM OPERATIONS
   
10,892,520
     
5,628,881
     
20,876,743
     
17,839,183
 
                                 
OTHER INCOME (EXPENSE)
                               
Interest expense
   
(50,643
)
   
(50,896
)
   
(157,232
)
   
(159,563
)
Interest income
   
86,296
     
64,557
     
238,568
     
248,362
 
INCOME BEFORE TAXES
   
10,928,173
     
5,642,542
     
20,958,079
     
17,927,982
 
                                 
INCOME TAXES
   
(2,818,444
)
   
(1,529,326
)
   
(5,609,486
)
   
(4,838,985
)
NET INCOME
 
$
8,109,729
   
$
4,113,216
   
$
15,348,593
   
$
13,088,997
 
                                 
COMPREHENSIVE INCOME:
                               
NET INCOME
 
$
8,109,729
   
$
4,113,216
   
$
15,348,593
   
$
13,088,997
 
OTHER COMPREHENSIVE INCOME
                               
- Foreign currency translation adjustments
   
1,524,122
     
(721,067
)
   
6,590,396
     
(1,759,171
)
COMPREHENSIVE INCOME
 
$
9,633,851
   
$
3,392,149
   
$
21,938,989
   
$
11,329,826
 
                                 
EARNINGS PER SHARE:
                               
BASIC
 
$
0.21
   
$
0.12
   
$
0.40
   
$
0.38
 
DILUTED
 
$
0.21
   
$
0.12
   
$
0.40
   
$
0.37
 
                                 
WEIGHTED AVERAGE NUMBER OF SHARES:
                               
                                 
BASIC
   
38,368,267
     
34,560,743
     
38,368,267
     
34,560,743
 
DILUTED
   
38,963,154
     
34,699,989
     
38,685,610
     
34,957,219
 
 
See accompanying notes to the condensed consolidated financial statements.  
 
  
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2013
(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, 2012
    38,552,070       38,367,471       184,599       19,276       (500,000 )     79,489,188       15,973,887       146,745,754       22,496,279       264,2 24,384  
Translation adjustment
 
- 　
      -       -    
- 　
           
- 　
   
- 　
   
- 　
      6,590,396       6,590,396  
Common stock issued for exercising stock options
    3,330       3,330       -       1       -       (1 )     -       -       -       -  
Issuance of stock options to employees
    -       -       -       -       -       536,400       -       -       -       536,400  
Net income for nine-month period ended September 30, 2013
 
- 　
      -       -    
- 　
      -    
- 　
   
- 　
      15,348,593    
- 　
      15,348,593  
Transfer to statutory common reserve fund
    -       -       -       -       -       -       807,584       (807,584       -       -  
BALANCE AT SEPTEMBER 30, 2013
    38,555,400       38,370,801       184,599       19,277       (500,000 )     80,025,587       16,781,471       161,286,763       29,086,675       286,699,773  
 
See accompanying notes to the condensed consolidated financial statements.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONDENED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. dollars)
(UNAUDITED)
 
   
Nine-Month Period Ended September 30,
 
   
2013
   
2012
 
   
　
   
　
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
　
   
　
 
Net income
  $ 15,348,593     $ 13,088,997  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Interest on capital lease obligation
    156,644       158,673  
Amortization of prepaid land leases
    419,180       298,910  
Depreciation and amortization
    20,568,172       16,995,684  
Write-off/Impairment loss on property, plant and equipment
    214       1,042,138  
Currency translation adjustment on inter-company balances
    556,325       (154,998 )
Gain on relocation of factory
    (1,877,779 )     -  
Demolition expenditure net off against gain on relocation of factory
    (733,379 )     -  
Stock-based compensation expense
    536,400       503,300  
Deferred tax asset
    -       271,261  
Changes in assets and liabilities:
               
Accounts receivable
    (4,801,147 )     (20,255,706 )
Inventories
    309,538       (376,048 )
Prepayments and deposits
    (9,375 )     (13,430 )
Accounts payable and accrued expenses
    (310,091 )     (953,261 ) 
Retention payable
    (1,287,006 )     865,769  
Taxes payable
    2,512,686       (728,775 )
Net cash provided by operating activities
    31,388,975       10,742,514  
                 
CASH FLOWS USED IN INVESTING ACTIVITIES
               
Additions of prepaid land leases
    (638,076 )     (477,678 )
Proceeds from sales of property, plant and equipment
    143       -  
Purchase of property, plant and equipment
    (6,072 )     (29,447,905 )
Construction in progress
    (307,635 )     -  
Net cash used in investing activities
    (951,640 )     (29,925,583 )
                 
CASH FLOWS USED IN FINANCING ACTIVITIES
               
Repayment of capital lease obligation
    (302,497 )     (297,598 )
Net cash used in financing activities
    (302,497 )     (297,598 )
                 
EFFECTS OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
    1,828,730       (451,033 )
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS
    31,963,568       (19,931,700 )
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD
    65,241,035       78,576,060  
CASH AND CASH EQUIVALENTS - END OF PERIOD
  $ 97,204,603     $ 58,644,360  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
               
Cash paid during the period for:
               
Income taxes
  $ 3,348,327     $ 4,829,992  
 
See accompanying notes to the condensed consolidated financial statements.
   
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
(Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)           Basis of Presentation and Consolidation

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, 2012 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, 2012 (the “2012 Form 10-K”).

In the opinion of management, the unaudited financial information for the three and nine months ended September 30, 2013 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  2012 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. 


The consolidated financial statements include the accounts of Gulf Resources, Inc. and its wholly-owned subsidiary, Upper Class Group Limited, a company incorporated in the British Virgin Islands, which owns 100% of Hong Kong Jiaxing Industrial Limited, a company incorporated in Hong Kong (“HKJI”). HKJI owns 100% of Shouguang City Haoyuan Chemical Company Limited ("SCHC") which owns 100% of Shouguang Yuxin Chemical Industry Co., Limited (“SYCI”).  All material intercompany transactions have been eliminated on consolidation.. 


Certain comparative amounts in the accompanying condensed financial statements have been reclassified to conform to the current period’s presentation. In the third quarter of 2012, the Company recognized $628,718 related to the legal fees reimbursed by insurance company in other income. We classified and offset such amount in legal expense in the general and administrative expense for the year ended December 31, 2012. These reclassifications had no effect on previously reported consolidated 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 September 30, 2013 and December 31, 2012, allowances for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the three-month and nine-month periods ended September 30, 2013 and 2012.

(d)           Concentration of Credit Risks

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 $97,204,603 and $65,241,035 with these institutions as of September 30, 2013 and December 31, 2012, 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 83.7% and 100% of the balances of accounts receivable as of September 30, 2013 and December 31, 2012, respectively, were outstanding for less than or equal to 90 days. For the balances of accounts receivable aged more than 90 days as of September 30, 2013, all was settled in October 2013. 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
(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 $125,504 and $112,940 for the three-month periods ended September 30, 2013 and 2012, respectively, and totaled $369,417 and $355,333 for the nine-month periods ended September 30, 2013 and 2012, 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 $80,607 for the nine-month periods ended September 30, 2013 and 2012, respectively. There is no such shipping and handling costs for the three-month period ended September 30, 2013 and 2012 as they are borne by the suppliers since April 2012.
 
  
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)

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

(i)           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 nine-month periods ended September 30, 2012, certain property, plant and machinery, with net book values of $130,143 and $1,042,138, respectively, were replaced during the second phase enhancement project to protective shells for transmission channels and ducts and the enhancement work to bromine production facilities in Factory No. 2, write-offs of the same amounts, were made and included in write-off/impairment on property, plant and equipment.

On September 25, 2013, SCHC entered into a relocation compensation agreement with the Transportation Bureau of Dongying City, Shangdong Province (“Transportation Bureau”) and the Government of Liuhu Township of Dongying City, Shandong Province (“Liuhu Government”) in which SCHC will receive relocation compensation in the amount of  $3,875,047 (RMB 23,824,453) for relocating Factory No. 3 due to a railway construction project. Out of this total amount, $2,927,700 (RMB 18,000,000) will be received upon the demolition of the warehouses and facilities of factory No. 3. The remaining balance will be paid after the clearance of all ground fixtures and examination approval by Liuhu Government. As of September 30, 2013, SCHC has completed the demolition work and compensation proceeds of $2,927,700 (RMB 18,000,000) was recorded in other receivable. This amount was received by SCHC from the Liuhu Government in October 2013. For the three-month and nine-month periods ended September 30, 2013, certain property, plant and machinery, with net book value of $307,182 were replaced due to the relocation of the Factory No. 3.  In addition, demolition costs of $733,379 (RMB 4,523,400) were incurred in the same periods. The write-off and demolition costs were offset against the compensation proceeds resulting in a net gain on relocation of factory of $1,877,779 in the three and nine months ended September 30, 2013. This is accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-40 “ Revenue Recognition – Gains and losses ”.

(j)           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 3,601,075 and 5,165,936 shares for the three-month periods ended September 30, 2013 and 2012, respectively, and amounted to 4,660,000 and 2,803,343 shares for the nine-month periods ended September 30, 2013 and 2012, 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
SEPTEMBER 30, 2013
 (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
September 30,
   
Nine-Month Period Ended
September 30,
   
2013
   
2012
     
2013
     
2012
 
Numerator
                           
Net income
 
$
8,109,729
   
$
4,113,216
   
$
15,348,593
   
$
13,088,997
 
                                 
Denominator
                               
Basic: Weighted-average common shares outstanding during the period
   
38,368,267
     
34,560,743
     
38,368,267
     
34,560,743
 
Add: Dilutive effect of stock options
   
594,887
     
139,246
     
317,343
     
396,476
 
Diluted
   
38,963,154
     
34,699,989
     
38,685,610
     
34,957,219
 
                                 
Net income per share
                               
Basic
 
$
0.21
   
$
0.12
   
$
0.40
   
$
0.38
 
Diluted
 
$
0.21
   
$
0.12
   
$
0.40
   
$
0.37
 
 
(l)           New Accounting Pronouncements

No accounting standards and guidance with an effective date during the three-month and nine-month periods ended September 30, 2013 or issued during 2013 had or are expected to have a significant impact on the Company’s condensed consolidated financial statements.

NOTE 2 – ASSET ACQUISITIONS
 
On November 26, 2012, the Company acquired substantially all of the assets owned by Chengyong Zhao in Guantai Village located Shouguang City Yangkou Township area (the “Chengyong Zhao Property” or “Factory No. 11”). The Chengyong Zhao Property includes a 20-year land lease covering approximately 1,727 acres of real property, with the related production facility, wells, pipelines, other production equipment, and the buildings located on the property. The total purchase price for the acquired assets was RMB 62 million (approximately $9.80 million), consisting of RMB 31 million (approximately $4.93million) in cash and 3,806,728 shares of the Company’s Common Stock valued at approximately $4.87 million (fair value). The production line of Factory No. 11 was resumed in March 2013 after certain repair and adjustments.

The Factory No. 11 described above was not in operation when the Company acquired the assets. Production of Factory No. 11 had previously been halted by the government since the owners of the bromine factories did not hold the proper license for the exploration and production of bromine.  The Factories No.11 had not been in operation for more than six months at the time of the acquisition. The Company recorded the above transactions as a purchase of assets.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 3 – INVENTORIES

Inventories consist of:
 
   
September 30, 2013
 
December 31, 2012
             
Raw materials
 
$
666,320
   
$
773,453
 
Finished goods
   
5,167,438
     
5,248,039
 
Allowance for obsolete and slow-moving inventory
   
(28,516
)
   
(27,894
)
   
$
5,805,242
   
$
5,993,598
 
 
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 September 30, 2013 and 2012, amortization of prepaid land lease totaled $229,262 and $193,859, respectively, which were recorded as cost of net revenue. During the nine-month periods ended September 30, 2013 and 2012, amortization of prepaid land lease totaled $419,180 and $298,910, 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 59.39 square kilometers with an aggregate carrying value of $994,985 and approximately 59.39 square kilometers with an aggregate carrying value of $753,086 as at September 30, 2013 and December 31, 2012, respectively.
 
NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consist of the following:
 
   
September 30, 2013
 
December 31, 2012
At cost:
           
Mineral rights
 
$
6,475,614
   
$
6,334,277
 
Buildings
   
51,782,238
     
50,905,337
 
Plant and machinery
   
169,451,661
     
166,121,329
 
Motor vehicles
   
9,344
     
9,140
 
Furniture, fixtures and office equipment
   
4,861,677
     
4,777,044
 
Construction in progress
   
308,622
     
-
 
Total
   
232,889,156
     
228,147,127
 
Less: Accumulated depreciation and amortization
   
(83,770,622
)
   
(62,204,585
)
Net book value
 
$
149,118,534
   
$
165,942,542
 
 
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 properties situated on parcels of the land are $38,652,646 and $35,988,055 as at September 30, 2013 and December 31, 2012, respectively.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET – Continued

During the three-month period ended September 30, 2013, depreciation and amortization expense totaled $6,794,439, of which $6,354,146 and $440,293 were recorded as cost of net revenue and administrative expenses, respectively. During the three-month period ended September 30, 2012, depreciation and amortization expense totaled $5,619,219, of which $5,275,200 and $344,019 were recorded as cost of net revenue and administrative expenses, respectively. During the nine-month period ended September 30, 2013, depreciation and amortization expense totaled $20,305,673, of which $19,069,116 and $1,236,557 were recorded as cost of sales and administrative expenses respectively. During the nine-month period ended September 30, 2012, depreciation and amortization expense totaled $16,737,318, of which $15,920,903 and $816,415 were recorded as cost of sales and administrative expenses respectively.

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

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

   
September 30, 2013
 
December 31, 2012
At cost:
           
Buildings
 
$
133,848
   
$
130,925
 
Plant and machinery
   
2,515,941
     
2,461,028
 
Total
   
2,649,789
     
2,591,953
 
Less: Accumulated depreciation and amortization
   
(874,194
)
   
(595,475
)
Net book value
 
$
1,775,595
   
$
1,996,478
 
 
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 September 30, 2013 and 2012, depreciation and amortization expense totaled $88,194 and $85,877, respectively, which was recorded as cost of net revenue. During the nine-month periods ended September 30, 2013 and 2012, depreciation and amortization expense totaled $262,500 and $258,366, respectively, which was recorded as cost of net revenue.

NOTE 7 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consist of the following:

   
September 30, 2013
 
December 31, 2012
Accounts payable
 
$
4,826,936
   
$
3,797,552
 
Salary payable
   
206,983
     
190,926
 
Social security insurance contribution payable
   
57,099
     
52,399
 
Amount due to a contractor
   
214,838
     
-
 
Price adjustment funds
   
639,094
     
1,758,828
 
Other payables
   
401,259
     
733,531
 
Total
 
$
6,346,209
   
$
6,533,236
 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 8 – RELATED PARTY TRANSACTIONS

During the three-month and nine-month periods ended September 30, 2013, the Company borrowed $245,000 and $665,449, 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:
 
   
September 30, 2013
 
December 31, 2012
Income tax payable
 
$
2,899,678
   
$
606,190
 
Mineral resource compensation fee payable
   
358,646
     
239,776
 
Value added tax payable
   
1,047,238
     
771,673
 
Land use right tax payable
   
945,012
     
888,349
 
Other tax payables
   
205,429
     
350,670
 
Total
 
$
5,456,003
   
$
2,856,658
 
   
NOTE 10 – CAPITAL LEASE OBLIGATIONS
 
The components of capital lease obligations are as follows:
 
 
Imputed
 
September 30,
 
December 31,
 
Interest rate
 
2013
 
2012
Total capital lease obligations
6.7%
 
$
3,069,390
   
$
3,146,066
 
Less: Current portion
     
(150,101
)
   
(193,164
)
Capital lease obligations, net of current portion
   
$
2,919,289
   
$
2,952,902
 

Interest expenses from capital lease obligations amounted to $50,438 and $50,629 for the three-month periods ended September 30, 2013 and 2012, respectively, which were charged to the income statements. Interest expenses from capital lease obligations amounted to $156,644 and $158,673 for the nine-month periods ended September 30, 2013 and 2012, respectively, which were charged to the income statements.

NOTE 11 –EQUITY

(a)  
Authorized shares

During the annual general meeting held on June 18, 2013, the shareholders of the Company approved the amendment to the Certificate of Incorporation to decrease the number of the authorized shares of the Company’s comment stocks to 80,000,000. The Company has completed the filing of the amendment and restatement of the Certificate of Incorporation with the Secretary of the State of Delaware to decrease the number of authorized shares of the Company’s common stock and accordingly 80,000,000 is disclosed as the authorized shares of the Company’s common stock in the consolidated balance sheet as of September 30, 2013.

(b)  
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 at least 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 September 30, 2013 for SCHC and SYCI is 35% and 50% of its registered capital respectively.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
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 2013, 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 $1.12 per share and the options vested immediately. The options were valued at $4,900 fair value, with assumed 74.73% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.19% and no dividend yield. For the three-month period ended March 31, 2013, $4,900 was recognized as general and administrative expenses.

On May 30, 2013, the Company granted to 3 executive officers and 17 management staff options to purchase 600,000 shares and 203,000 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 $394,100 and $133,300 fair value, respectively, both with assumed 80.76% volatility, a four-year expiration term with expected tenor of 2 years, a risk free rate of 0.29% and no dividend yield.

On July 2, 2013, 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 $1.17 per share and the options vested immediately. The options were valued at $4,100 fair value, with assumed 61.56% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.24% and no dividend yield.

 
The following table summarizes all Company stock option transactions between January 1, 2013 and September 30, 2013.
 
   
Number of Option
and Warrants
Outstanding
   
Number of Option
and Warrants
Vested
   
Range of
Exercise Price per
Common Share
 
Balance, January 1, 2013
    1,974,471       1,974,471     $ 0.95 - $12.60  
Granted and vested during the nine-month period ended September 30, 2013
    828,000       828,000     $ 0.95 - $1.17  
Exercised during the nine-month period ended September 30, 2012     (10,000 )     (10,000 )   $ 0.95  
Balance, September 30, 2013
    2,792,471       2,792,471     $ 0.95 - $12.60  
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 12 – STOCK-BASED COMPENSATION – Continued

   
Stock and Warrants Options Exercisable and Outstanding
 
   
Outstanding at September 30, 2013
   
Range of
Exercise Prices
   
Weighted Average
Remaining
Contractual Life
 (Years)
   
Weighted Average
Exercise Price of
Options Currently
 Outstanding
 
Exercisable and outstanding
    2,792,471     $ 0.95 - $12.60       2.50     $ 3.11  
 
The weighted average grant-date fair values as at September 30, 2013 and December 31, 2012 were $3.64 and $4.62, 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 35%. No provision for the US federal income taxes has been made as the Company had no US taxable income for the three-month and nine-month periods ended September 30, 2013 and 2012, 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 nine-month periods ended September 30, 2013 and 2012.

(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 nine-month periods ended September 30, 2013 and 2012.  The applicable statutory tax rates for the three-month and nine-month periods ended September 30, 2013 and 2012 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.

As of September 30, 2013 and December 31, 2012, the accumulated distributable earnings under the Generally Accepted Accounting Principles (GAAP”) of PRC are $215,872,042 and $197,042,047, 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 September 30, 2013 and December 31, 2012, the Company has not recorded any WHT on the cumulative amount of distributable retained earnings of its foreign invested enterprises in China. As of September 30, 2013 and December 31, 2012, the unrecognized WHT are $9,685,807 and $8,768,486, respectively.
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 13 – INCOME TAXES – Continued

The Company’s tax returns are subject to the various tax authorities’ examination. The federal, state and local authorities of the United States may examine the Company’s tax returns filed in the United States for three years from the date of filing. The Company’s US tax returns since 2010 are currently subject to examination. Inland Revenue Department of Hong Kong may examine the Company’s tax returns filed in Hong Kong for seven years from date of filing. The Company’s Hong Kong tax returns since incorporation are currently subject to examination. The tax authorities of the PRC may examine the Company’s PRC tax returns for three years from the date of filing. The Company’s PRC tax returns since 2010 are currently subject to examination.
 
The components of the provision for income taxes from continuing operations are:

 
Three-Month Period
Ended September 30,
 
Nine-Month Period
Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
 
Current taxes – PRC
 
$
2,818,444
   
$
1,418,892
   
$
5,609,486
   
$
4,567,725
 
Deferred taxes – PRC
   
-
     
110,434
     
-
     
271,260
 
   
$
2,818,444
   
$
1,529,326
   
$
5,609,486
   
$
4,838,985
 
 
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 September 30,
   
Nine-Month Period
Ended September 30,
 
Reconciliations
 
2013
   
2012
   
2013
   
2012
 
Statutory income tax rate
    25 %     25 %     25 %     25 %
Non-deductible expenses
    0 %     0 %     1 %     0 %
Change in valuation allowance - US federal net operating loss
    1 %     2 %     1 %     2 %
Effective tax rate
    26 %     27 %     27 %     27 %

Significant components of the Company’s deferred tax assets and liabilities at September 30, 2013 and December 30, 2012 are as follows:

   
September 30, 2013
   
December 31, 2012
 
Deferred tax liabilities
  $ -     $ -  
                 
Deferred tax assets:
               
Allowance for obsolete and slow-moving inventories
  $ 7,129     $ 6,973  
Impairment on property, plant and equipment
    475,149       464,778  
Exploration costs
    1,821,681       1,781,921  
Compensation costs of unexercised stock options
    1,991,754       1,809,378  
US federal net operating loss
    8,953,846       8,809,935  
Total deferred tax assets
    13,249,559       12,872,985  
Valuation allowance
    (10,945,600 )     (10,619,313  
Net deferred tax asset
  $ 2,303,959     $ 2,253,672  
                 
Current deferred tax asset
  $ 7,129     $ 6,973  
Long-term deferred tax asset
  $ 2,296,830     $ 2,246,699  
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)
 
NOTE 13 – INCOME TAXES – Continued

The increase in valuation allowance for each of the three-month periods ended September 30, 2013 and 2012 is $78,594 and $127,541, respectively, and nine-month periods ended September 30, 2013 and 2012 is $326,287 and $457,854, respectively.

There were no unrecognized tax benefits and accrual for uncertain tax positions as of September 30, 2013 and December 31, 2012.

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.

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. All the customers are located in PRC.

Three-Month
Period Ended September 30, 2013
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
17,093,087
   
$
3,902,979
   
$
11,939,211
   
$
32,935,277
   
$
-
   
$
32,935,277
 
Net revenue
(intersegment)
   
781,866
     
-
     
-
     
781,866
     
-
     
781,866
 
Income (loss) from operations before taxes
   
5,876,150
     
1,635,755
     
3,740,278
     
11,252,183
     
(359,663
)
   
10,892,520
 
Income taxes
   
1,452,755
     
425,640
     
940,049
     
2,818,444
     
-
     
2,818,444
 
Income (loss) from operations after taxes
   
4,423,395
     
1,210,115
     
2,800,229
     
8,433,739
     
(359,663
)
   
8,074,076
 
Total assets
   
180,313,532
     
58,306,651
     
63,073,106
     
301,693,289
     
32,604
     
301,725,893
 
Depreciation and amortization
   
4,123,370
     
1,873,318
     
885,945
     
6,882,633
     
-
     
6,882,633
 
Capital expenditures
   
238,689
     
69,933
     
6,091
     
314,713
     
-
     
314,713
 
Write-off / Impairment
   
-
     
-
     
214
     
214
     
-
     
214
 

Three-Month
Period Ended September 30, 2012
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
13,960,118
   
$
2,360,905
   
$
8,209,309
   
$
24,530,332
   
$
-
   
$
24,530,332
 
Net revenue
(intersegment)
   
593,035
     
-
     
-
     
593,035
     
-
     
593,035
 
Income (loss) from operations before taxes
   
3,134,709
     
549,446
     
2,258,624
     
5,942,779
     
(313,898
)
   
5,628,881
 
Income taxes
   
720,469
     
239,204
     
569,653
     
1,529,326
     
-
     
1,529,326
 
Income (loss) from operations after taxes
   
2,414,240
     
310,242
     
1,688,971
     
4,413,453
     
(313,898
)
   
4,099,555
 
Total assets
   
147,781,415
     
69,333,330
     
51,659,755
     
268,774,500
     
344,202
     
269,118,702
 
Depreciation and amortization
   
3,309,109
     
1,743,342
     
652,645
     
5,705,096
     
-
     
5,705,096
 
Capital expenditures
   
10,947,478
     
3,372,192
     
7,233,871
     
21,553,541
     
-
     
21,553,541
 
Write-off / Impairment
   
128,562
     
1,581
     
-
     
130,143
     
-
     
130,143
 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (Expressed in U.S. dollars)
(UNAUDITED)

NOTE 14 – BUSINESS SEGMENTS – Continued

Nine-Month
Period Ended September 30, 2013
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
46,300,730
   
$
9,983,741
   
$
32,007,282
   
$
88,291,753
   
$
-
   
$
88,291,753
 
Net revenue
(intersegment)
   
2,174,342
     
-
     
-
     
2,174,342
     
-
     
2,174,342
 
Income (loss) from operations before taxes
   
10,086,575
     
2,902,613
     
9,408,993
     
22,398,181
     
(1,521,438
)
   
20,876,743
 
Income taxes
   
2,574,710
     
668,660
     
2,366,116
     
5,609,486
     
-
     
5,609,486
 
Income (loss) from operations after taxes
   
7,511,866
     
2,233,952
     
7,042,877
     
16,788,695
     
(1,521,438
)
   
15,267,257
 
Total assets
   
180,313,532
     
58,306,651
     
63,073,106
     
301,693,289
     
32,604
     
301,725,893
 
Depreciation and amortization
   
12,811,261
     
5,120,004
     
2,636,907
     
20,568,172
     
-
     
20,568,172
 
Capital expenditures
   
238,689
     
69,933
     
6,091
     
314,713
     
-
     
314,713
 
Write-off / Impairment
   
-
     
-
     
214
     
214
     
-
     
214
 

Nine-Month
Period Ended September 30, 2012
 
Bromine*
   
Crude
 Salt*
   
Chemical
 Products
   
Segment
 Total
   
Corporate
   
Total
 
Net revenue
(external customers)
 
$
44,953,429
   
$
8,415,487
   
$
26,284,936
   
$
79,653,852
   
$
-
   
$
79,653,852
 
Net revenue
(intersegment)
   
2,156,188
     
-
     
-
     
2,156,188
     
-
     
2,156,188
 
Income (loss) from operations before taxes
   
9,536,574
     
1,986,451
     
7,508,900
     
19,031,925
     
(1,192,742
)
   
17,839,183
 
Income taxes
   
2,401,678
     
541,853
     
1,895,454
     
4,838,985
     
-
     
4,838,985
 
Income (loss) from operations after taxes
   
7,134,896
     
1,444,598
     
5,613,446
     
14,192,940
     
(1,192,742
)
   
13,000,198
 
Total assets
   
147,781,415
     
69,333,330
     
51,659,755
     
268,774,500
     
344,202
     
269,118,702
 
Depreciation and amortization
   
10,483,142
     
4,549,027
     
1,963,515
     
16,995,684
     
-
     
16,995,684
 
Capital expenditures
   
17,514,773
     
4,654,183
     
7,233,871
     
29,402,827
     
-
     
29,402,827
 
Write-off / Impairment
   
891,605
     
150,533
     
-
     
1,042,138
     
-
     
1,042,138
 

* 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 September 30,
   
Nine-Month Period
Ended September 30,
 
Reconciliations
 
2013
   
2012
   
2013
   
2012
 
Total segment operating income
 
$
11,252,183
   
$
5,942,779
   
$
22,398,181
   
$
19,031,925
 
Corporate costs
   
(359,663
)
   
(313,898
)
   
(1,521,438
)
   
(1,192,742
)
Income from operations
   
10,892,520
     
5,628,881
     
20,876,743
     
17,839,183
 
Other income, net
   
35,653
     
13,661
     
81,336
     
88,799
 
Income before taxes
 
$
10,928,173
   
$
5,642,542
   
$
20,958,079
   
$
17,927,982
 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (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 September 30, 2013.

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
 
$
2,078
   
$
934
   
$
1,223
   
$
4,235
     
12.9%
 
TOTAL
   
$
2,078
   
$
934
   
$
1,223
   
$
4,235
     
12.9%
 

The following table shows the major customer(s) (10% or more) for the nine-month period ended September 30, 2013.

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
 
$
5,425
   
$
2,428
   
$
3,278
   
$
11,131
     
12.6%
 
TOTAL
   
$
5,425
   
$
2,428
   
$
3,278
   
$
11,131
     
12.6%
 

The following table shows the major customer(s) (10% or more) for the three-month period ended September 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
 
$
1,383
   
$
511
   
$
947
   
$
2,841
     
11.6%
 
TOTAL
   
$
1,383
   
$
511
   
$
947
   
$
2,841
     
11.6%
 

The following table shows the major customer(s) (10% or more) for the nine-month period ended September 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
 
$
5,017
   
$
1,623
   
$
3,055
   
$
9,695
     
12.2%
 
TOTAL
   
$
5,017
   
$
1,623
   
$
3,055
   
$
9,695
     
12.2%
 

NOTE 15 – MAJOR SUPPLIERS

During the three-month and nine-month periods ended September 30, 2013, the Company purchased 89.9% and 85.5% of its raw materials from its top five suppliers, respectively.  As of September 30, 2013, amounts due to those suppliers included in accounts payable were $4,381,537. During the three-month and nine-month periods ended September 30, 2012, the Company purchased 83.6% and 83.5% of its raw materials from its top five suppliers, respectively.  As of September 30, 2012, amounts due to those suppliers included in accounts payable were $2,979,273. 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
SEPTEMBER 30, 2013
 (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 nine-month periods ended September 30, 2013, the Company sold 40.2% and 40.2% of its products to its top five customers, respectively. As of September 30, 2013, amounts due from these customers were $19,028,426. During the three-month and nine-month periods ended September 30, 2012, the Company sold 42.5% and 43.1% of its products to its top five customers, respectively. As of September 30, 2012, amounts due from these customers were $21,704,048.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 September 30, 2013 and December 31, 2012.

NOTE 18 – RESEARCH AND DEVELOPMENT EXPENSES

The total research and development expenses recognized in the income statements during the three-month and nine-month periods ended September 30, 2013 were $33,198 and $105,380, respectively, of which the consumption of bromine produced by the Company amounted to $8,803 and $27,385, respectively. The total research and development expenses recognized in the income statements during the three-month and nine-month periods ended September 30, 2012 were $28,478 and $133,802, respectively, of which the consumption of bromine produced by the Company amounted to $8,701 and $32,709, respectively.

NOTE 19 – CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS

As of September 30, 2013, 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 nine pieces of land under non-cancelable operating leases, which are fixed in rentals and expired through December 2021, December 2030, December 2031, December 2032, December 2040, February 2059, August 2059 and June 2060, respectively. The Company accounts for the leases as operating leases.

The following table sets forth the Company’s contractual obligations as of September 30, 2013:

   
Capital Lease Obligations
   
Operating Lease Obligations
   
Capital Commitment
 
Payable within: 
                 
the next 12 months
$
305,294
   
$
960,200
   
$
3,103,222
 
the next 13 to 24 months
   
305,294
     
981,162
     
-
 
the next 25 to 36 months
   
305,294
     
1,000,175
     
-
 
the next 37 to 48 months
   
305,294
     
1,023,051
     
-
 
the next 49 to 60 months
   
305,294
     
1,043,926
     
-
 
thereafter
   
3,663,529
     
21,859,733
     
-
 
Total
 
$
5,189,999
   
$
26,868,247
   
$
3,103,222
 
Less: Amount representing interest
   
(2,120,609
)
               
Present value of net minimum lease payments
 
$
3,069,390
                 
 
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
 (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 $239,111 and $193,859, which were charged to the income statements for the three-month ended September 30, 2013 and 2012, respectively. Rental expenses related to operating leases of the Company amounted to $710,643 and $582,625, which were charged to the income statements for the nine-month ended September 30, 2013 and 2012, 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. 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. On April 30, 2013, the parties executed a stipulation and agreement of settlement (“Proposed Settlement”). The Proposed Settlement is subject to review and approval of the Court. In the event that the Proposed Settlement is approved and accepted, the Company does not expect it to have any impact on the financial statements as such cost as stated in the Proposed Settlement will be reimbursed by the insurance company.
 
 

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 2012 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 2012 Form 10-K and Item 1A, “Risk Factors” for the year ended December 31, 2012.

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 nine-month periods ended September 30, 2013 and 2012. 

Comparison of the Three-Month Periods Ended September 30, 2013 and 2012

   
Three-Month
Period Ended
September 30, 2013
   
Three-Month
Period Ended
September 30, 2012
   
% Change
 
Net revenue
  $ 32,935,277     $ 24,530,332       34%  
Cost of net revenue
  $ (22,006,256 )   $ (17,099,890 )     29%  
Gross profit
  $ 10,929,021     $ 7,430,442       47%  
Sales, marketing and other operating expenses
  $ (25,378 )   $ (20,327 )     25%  
Research and development costs
  $ (33,198 )   $ (28,478 )     17%  
Write-off/Impairment on property, plant and equipment
  $ (214 )   $ (130,143 )      (99.8%)  
General and administrative expenses
  $ (1,962,496 )   $ (1,707,863 )     15%  
Gain on relocation of factory
  $ 1,877,779     $ -       100%  
Other operating income
  $ 107,006     $ 85,250       26%  
Income from operations
  $ 10,892,520     $ 5,628,881       94%  
Other income, net
  $ 35,653     $ 13,661       161%  
Income before taxes
  $ 10,928,173     $ 5,642,542       94%  
Income taxes
  $ (2,818,444 )   $ (1,529,326 )     84%  
Net income
  $ 8,109,729     $ 4,113,216       97%  

Net revenue.   Net revenue was $32,935,277 for three-month period ended September 30, 2013, an increase of approximately 8.4 million (or 34%) as compared to the same period in 2012. This increase was primarily attributable to the increase of revenues from all of our segments, specifically, including (i) the increase of revenue from the bromine segment from $13,960,118 for the three-month period ended September 30, 2012 to $17,093,087 for the same period in 2013, an increase of approximately 22%; (ii) the increase of revenue from the crude salt segment from $2,360,905 for the three-month period ended September 30, 2012 to $3,902,979 for the same period in 2013, an increase of approximately 65%; and (iii) the increase of revenue from the chemical products segment from $8,209,309 for the three-month period ended September 30, 2012 to 11,939,211 for the same period in 2013, an increase of approximately 45%.

   
Net Revenue by Segment
   
   
Three-Month Period Ended
 
Three-Month Period Ended
 
Percent Increase
   
September 30, 2013
 
September 30, 2012
 
of Net Revenue
Segment
     
% of total
       
% of total
     
Bromine
  $ 17,093,087       52 %   $ 13,960,118       57 %     22 %
Crude Salt
  $ 3,902,979       12 %   $ 2,360,905       10 %     65 %
Chemical Products
  $ 11,939,211       36 %   $ 8,209,309       33 %     45 %
Total sales
  $ 32,935,277       100 %   $ 24,530,332       100 %     34 %

Bromine and crude salt segments 
 
Three-Month Period Ended
   
Percentage Change
product sold in tonnes
 
September 30, 2013
   
September 30, 2012
   
Increase
Bromine (excluded volume sold to SYCI)
    5,797       4,815       20 %
Crude Salt
    90,092       62,568       44 %
 
   
Three-Month Period Ended
   
Percentage Change
Chemical products segment sold in tonnes
 
September 30, 2013
   
September 30, 2012
   
Increase
Oil and gas exploration additives
    3,529       2,502       41 %
Paper manufacturing additives
    1,079       772       40 %
Pesticides manufacturing additives
    813       724       12 %
Overall
    5,421       3,998       36 %
 
 
Bromine segment

The table below shows the changes in the average selling price and changes in the sales volume of bromine for three-month period ended September 30, 2013 from the same period in 2012.

   
Three-Month Period
Ended September 30,
 
Increase in net revenue of bromine as a result of:
 
2013 vs. 2012
 
Increase in average selling price
  $ 260,368  
Increase in sales volume
  $ 2,872,600  
Total effect on net revenue of bromine
  $ 3,132,969  
 
The increase in net revenue from our bromine segment was mainly due to the increase in both the sales volume and selling price. The sales volume of bromine increased from 4,815 tonnes for the three-month period ended September 30, 2012 to 5,797 tonnes for the same period in 2013, an increase of 20%. The major reason for the increase in the sales volume of bromine was mainly attributable to the bromine price being currently at a lower level, and our customers increased their bromine inventories.

 
The average selling price of bromine increased from $2,900 per tonne for the three-month period ended September 30, 2012 to $2,949 per tonne for the same period in 2013, an increase of 2%. We expect the average selling price of brmoine to remain at current levels through the end of 2013.


Crude salt segment
The table below shows the changes in the average selling price and changes in the sales volume of crude salt for three-month period ended September 30, 2013 from the same period in 2012.

   
Three-Month Period
Ended September 30,
 
Increase in net revenue of crude salt as a result of:
 
2013 vs. 2012
 
Increase in average selling price
  $ 426,599  
Increase in sales volume
  $ 1,115,475  
Total effect on net revenue of crude salt
  $ 1,542,074  

The increase in net revenue from our crude salt segment was mainly due to the increase in both the average selling price and sales volume. The average selling price of crude salt increased from $37.73 per tonne for the three-month period ended September 30, 2012 to $43.32 per tonne for the same period in 2013, an increase of 15%, and the sales volume also increased by 44% from 62,568 tonnes for the three-month period ended September 30, 2012 to 90,092 tonnes for the same period in 2013. The increase in both the average selling price and sales volume was mainly due to the stable demand as crude salt is a basic and elementary material for chemical industry.

We noted an upward trend in the average selling price of crude salt since the third quarter of 2011 as due to the stable demand of the crude salt. The average selling price increased from $37.19 per tonne in the third quarter of 2011 to $43.32 per tonne in the third quarter of 2013. We expect the average selling price of crude salt to remain at current levels through the end of 2013.
 
 
Chemical products segment
 
   
Product Mix of Chemical Products Segment
 
Percent
   
Three-Month Period Ended
 
Three-Month Period Ended
 
Change of
   
September 30, 2013
 
September 30, 2012
 
Net Revenue
Chemical Products
       
% of total
       
% of total
     
Oil and gas exploration additives
 
$
6,828,309
     
57
%
 
$
4,531,296
     
55
%
   
51
%
Paper manufacturing additives
 
$
1,263,919
     
11
%
 
$
843,854
     
10
%
   
50
%
Pesticides manufacturing additives
 
$
3,846,983
     
32
%
 
$
2,834,159
     
35
%
   
36
%
Total sales
 
$
11,939,211
     
100
%
 
$
8,209,309
     
100
%
   
45
%
 
Net revenue from our chemical products segment increased from $8,209,309 for the three-month period ended September 30, 2012 to $11,939,211 for the same period in 2013, an increase of approximately 45%. The increase was mainly attributable to the strong demand for all of our chemical products. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $6,828,309 (or 57%) and $4,531,296 (or 55%) of our chemical segment revenue for the three-month periods ended September 30, 2013 and 2012, respectively, with an increase of $2,297,013, or 51%. Net revenue from our paper manufacturing additives increased from $843,854 for the three-month period ended September 30, 2012 to $1,263,919 for the same period in 2013, an increase of approximately 50%. Net revenue from our pesticides manufacturing additives increased from $2,834,159 for the three-month period ended September 30, 2012 to $3,846,983 for the same period in 2013, an increase of approximately 36%.
 
The table below shows the changes in the average selling price and changes in the sales volume of major chemical products for three-month period ended September 30, 2013 from the same period in 2012.
 
Increase in net revenue,
for the three-month period ended September 30,
2013 vs. 2012, as a result of:
 
Oil and gas exploration additives
 
Paper manufacturing additives
 
Pesticides manufacturing additives
 
Total
Increase in average selling price
 
$
373,451
   
$
72,471
   
$
628,058
   
$
1,073,980
 
Increase in sales volume
 
$
1,923,562
   
$
347,594
   
$
384,766
   
$
2,655,922
 
Total effect on net revenue of chemical products
 
$
2,297,013
   
$
420,065
   
$
1,012,824
   
$
3,729,902
 
 
 
Cost of Net Revenue.
 
   
Cost of Net Revenue by Segment
 
% Change
   
Three-Month Period Ended
 
Three-Month Period Ended
 
of Cost of
   
September 30, 2013
 
September 30, 2012
 
Net Revenue
Segment
       
% of total
       
% of total
     
Bromine
 
$
11,710,778
     
53
%
 
$
9,770,880
     
57
%
   
20
%
Crude Salt
 
$
2,380,562
     
11
%
 
$
1,474,142
     
9
%
   
61
%
Chemical Products
 
$
7,914,916
     
36
%
 
$
5,854,868
     
34
%
   
35
%
Total
 
$
22,006,256
     
100
%
 
$
17,099,890
     
100
%
   
29
%
 
Cost   of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $22,006,256 for three-month period ended September 30, 2013, an increase of $4,906,366 (or 29%) as compared to the same period in 2012. The increase in overall cost of net revenue was mainly attributable to the increase in volume of products sold and the increase in depreciation and amortization of manufacturing plant and machinery.

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)
Three-month period ended September 30, 2012
   
44,547
     
48%
 
Three-month period ended September 30, 2013
   
47,347
     
55%
 
Variance of the three-month periods ended September 30, 2013 and 2012
   
2,800
 (ii)
   
7%
 

(i) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the period divided by the annual production capacity in tonnes.

(ii) The increase in 2,800 tonnes production capacity represents the management’s estimate of the capacity of Factory No. 11 acquired in late November 2012.

Our utilization ratio increased by 7% for the three-month period ended September 30, 2013 as compared with the same period in 2012. The increase in utilization was mainly attributable to the increase in overall demand for bromine due to the lower level of bromine prices, our customers increased their bromine inventories.
 
 
Bromine segment
For the three-month period ended September 30, 2013, the cost of net revenue for the bromine segment was $11,710,778, an increase of $1,939,898 or 20% over the same period in 2012. The most significant components of the costs of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $5,696,274 (or 49%), depreciation and amortization of manufacturing plant and machinery of $3,920,453 (or 33%) and electricity of $871,597 (or 7%) for the three-month period ended September 30, 2013. For the three-month period ended September 30, 2012, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $5,040,884 (or 52%), depreciation and amortization of manufacturing plant and machinery of $3,061,931 (or 31%) and electricity of $695,121 (or 7%). The cost structure changed as compared with the same period in 2012 where the contribution from cost of raw materials and finished goods consumed decreased by 3% and depreciation and amortization of manufacturing plant and machinery increased by 2%. The increase in net cost of net revenue was attributable mainly to the increase in volume of products sold and the increase in depreciation and amortization of manufacturing plant and machinery.
 
The table below represents the major production cost component of bromine per tonne for respective periods:

 
Per tonne production cost
 
Three-Month Period Ended
 
Three-Month Period Ended
   
component of bromine segment
 
September 30, 2013
 
September 30, 2012
 
% Change
       
% of total
     
% of total
     
Raw materials
 
$
983
     
49
%
 
$
1,047
     
52
%
   
(6
%)
Depreciation and amortization
 
$
676
     
34
%
 
$
636
     
31
%
   
6
%
Electricity
 
$
150
     
7
%
 
$
144
     
7
%
   
4
%
Others
 
$
211
     
10
%
 
$
202
     
10
%
   
4
%
Production cost of bromine per tonne
 
$
2,020
     
100
%
 
$
2,029
     
100
%
   
(0.5
%)
 
Our production cost of bromine per tonne was $2,020 for the three-month period ended September 30, 2013, a decrease of 0.5% (or $9) as compared to the same period in 2012, which was attributable mainly to the component of cost of raw materials consumed. The cost of raw materials consumed per tonne decreased by 6% as compared to the last comparison period, which was mainly attributable to the decrease in the purchase price of raw materials due to the macro-economic tightening policy imposed by the PRC government since January 2011. The significant percentage increase in depreciation and amortization per tonne by 6% was due to the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012, which accelerated the depreciation and amortization of the plant and machinery.

Crude salt segment
The cost of net revenue for our crude salt segment for the three-month period ended September 30, 2013 was $2,380,562, representing an increase of $906,420, or 61%, compared to $1,474,142 for the same period in 2012. The increase in cost was mainly due to the enhancement projects in second quarter of 2012 to our extraction wells and transmission channels and ducts, which accelerated the depreciation and amortization of the plant and machinery. The significant cost components for the three-month period ended September 30, 2013 were depreciation and amortization of $1,580,599 (or 67%), resource taxes calculated based on crude salt sold of $292,131 (or 12%) and electricity of $222,527 (or 9%). The significant cost components for the three-month period ended September 30, 2012 were depreciation and amortization of $968,088 (or 66%), resource taxes calculated based on crude salt sold of $197,552 (or 13%) and electricity of $134,489 (or 9%). The table below represents the major production cost component of crude salt per ton for respective periods:

 
Per tonne production cost
 
Three-Month Period Ended
 
Three-Month Period Ended
   
component of crude salt segment
 
September 30, 2013
 
September 30, 2012
 
% Change
       
% of total
     
% of total
     
Depreciation and amortization
 
$
17.5
     
67
%
 
$
15.5
     
66
%
   
13
%
Resource tax
 
$
3.2
     
12
%
 
$
3.2
     
13
%
   
-
 
Electricity
 
$
2.5
     
9
%
 
$
2.1
     
9
%
   
2
%
Others
 
$
3.2
     
12
%
 
$
2.8
     
12
%
   
14
%
Production cost of crude salt per tonne
 
$
26.4
     
100
%
 
$
23.6
     
100
%
   
12
%
 
 
Our production cost of crude salt per tonne was $26.4 for the three-month period ended September 30, 2013, an increase of 12% (or $2.8) as compared to the same period in 2012, which was attributable mainly to the components of depreciation and amortization of manufacturing plant and machinery. The significant percentage increase in depreciation and amortization per tonne by 13% was due to the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012, which accelerated the depreciation and amortization of the plant and machinery. Other production costs represented mainly salaries and welfare of labor for the crude salt fields.

Chemical products segment
Cost of net revenue for our chemical products segment for the three-month period ended September 30, 2013, was $7,914,916, representing an increase of $2,060,048 or 35% over the same period in 2012. The significant costs were cost of raw material and finished goods consumed of $6,870,302 (or 87%) and $5,004,590 (or 85%) and depreciation and amortization of manufacturing plant and machinery of $708,022 (or 9%) and $637,870 (or 11%) for each of the three-month periods ended September 30, 2013 and 2012, respectively.

Gross Profit. Gross profit was $10,929,021, or 33%, of net revenue for three-month period ended September 30, 2013 compared to $7,430,442, or 30%, of net revenue for the same period in 2012. The increase in gross profit percentage was primarily attributable to an increase in the margin percentage in all of our three segments.
 
   
Gross Profit by Segment
 
% Point Change
   
Three-Month Period Ended
 
Three-Month Period Ended
 
of Gross
   
September 30, 2013
 
September 30, 2012
 
Profit Margin
Segment
       
Gross Profit Margin
       
Gross Profit Margin
     
Bromine
 
$
5,382,309
     
32
%
 
$
4,189,238
     
30
%
   
2
%
Crude Salt
 
$
1,522,417
     
39
%
 
$
886,763
     
38
%
   
1
%
Chemical Products
 
$
4,024,295
     
34
%
 
$
2,354,441
     
29
%
   
5
%
Total Gross Profit
 
$
10,929,021
     
33
%
 
$
7,430,442
     
30
%
   
3
%
 
Bromine segment
For the three-month period ended September 30, 2013, the gross profit margin for our bromine segment was 32% compared to 30% for the same period in 2012. This 2% increase is mainly due to the increase in both the sales volume and selling price, which was partially offset by the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.

Crude salt segment
For the three-month period ended September 30, 2013 the gross profit margin for our crude salt segment was 39% compared to 38% for the same period in 2012. This 1% increase is attributable to the increase in both the sales volume and selling price, which was partially offset by the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.
 
 
Chemical products segment
The gross profit margin for our chemical products segment for the three-month period ended September 30, 2013 was 34% compared to 29% for the same period in 2012, an increase of 5%. As previously mentioned, this increase in gross profit margin was a result of the increase in both the sales volume and selling price for all of our chemical products. As sales of oil and gas exploration additives contributed more than 57% of our total chemical products segment’s net revenue, the increase in demand largely increased the gross profit margin of our chemical products segment.

Research and Development Costs. The total research and development costs incurred for the three-month periods ended September 30, 2013 and 2012 were $33,198 and $28,478, respectively, an increase of 17%. Research and development costs for the three-month periods ended September 30, 2013 and 2012 represented raw materials used by SYCI for testing the manufacturing routine.

Write-off/Impairment on property, plant and equipment. Write-off on property, plant and equipment for the three-month period ended September 30, 2013 and 2012 were $214 and $130,143, respectively, a decrease of 99.8%. Write-off on property, plant and equipment of $130,143 for the three-month period ended September 30, 2012 represented the write-off of certain machinery and equipment replaced during the enhancement work to our bromine production facilities in Factory No. 2 completed in September 2012.

General and Administrative Expenses. General and administrative expenses were $1,962,496 for the three-month period ended September 30, 2013, an increase of $254,633 (or 15%) as compared to $1,707,863 for the same period in 2012. This increase in general and administrative expenses was primarily due to a sum of $628,718 for insurance compensation received for a legal case in 2012, which offset legal fee included in general and administrative expense, partially offset by a non-cash expense related to stock options granted to employees which decreased to $4,100 for the three-month period ended September 30, 2013 from $477,000 in the same period of 2012.

Gain on relocation of factory. Gain on relocation of factory was $1,877,779 for the three-month period ended September 30, 2013. In late September 2013, the Transportation Bureau of Dongying City and other local government agencies requested to requisition the land where the original Factory No. 3 was located for railway construction. We recognized such amount in this quarter in 2013.

Other Operating Income. Other operating income was $107,006 for the three-month period ended September 30, 2013 an increase of $21,756(or 26%) as compared to $85,250 for the same period in 2012 for sales of wastewater. Wastewater is generated from the production of bromine and eventually becomes crude salt when it evaporates. Not all of our bromine production plants have sufficient area on the property to allow for evaporation of wastewater to produce crude salt. Certain of our customers who have facilities located adjacent to our bromine production plants have agreed to channel our wastewater into brine pans on their properties for evaporation. These customers then are able to sell the resulting crude salt themselves. We have signed agreements with four of our customers to sell them our wastewater at market prices.

Income from Operations. Income from operations was $10,892,520 for the three-month period ended September 30, 2013 (or 33% of net revenue), an increase of $5,263,639, or approximately 94%, over the income from operations for the same period in 2012. The increase resulted primarily from the increase in the demand for all of our segment products.

   
Income from Operations by Segment
   
Three-Month Period Ended
September 30, 2013
 
Three-Month Period Ended
September 30, 2012
Segment:
       
% of total
       
% of total
Bromine
 
$
5,876,150
   
  52%
 
$
3,134,709
   
  53%
Crude Salt
   
1,635,755
   
  15%
   
549,446
   
  9%
Chemical Products
   
3,740,278
   
  33%
   
2,258,624
   
  38%
Income from operations before corporate costs
   
11,252,183
   
100%
   
5,942,779
   
100%
Corporate costs
   
(359,663
)
       
(313,898
)
   
Income from operations
 
$
10,892,520
       
$
5,628,881
     
 
 
Bromine segment
Income from operations from our bromine segment was $5,876,150 for the three-month period ended September 30, 2013, an increase of $2,741,441 (or approximately 88%) compared to the same period in 2012. This significant increase resulted primarily from the increase in sales volume (contributed an increase of approximately $2.9 million) and gain on relocation of original Factory No.3 of approximately $1.45million, which was partially offset by the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.

Crude salt segment
Income from operations from our crude salt segment was $1,635,755 for the three-month period ended September 30, 2013, an increase of $1,086,309 (or approximately 198%) compared to the same period in 2012. This significant increase was mainly due to the increase in sales volume (contributed an aggregate increase of approximately $1.1 million) and in average selling price (contributed an increase of approximately $0.4 million) and gain on relocation of original Factory No.3 of approximately $0.43million , which was partially offset by the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.
 
Chemical products segment
Income from operations from our chemical products segment was $3,740,278 for the three-month period ended September 30, 2013, an increase of $1,481,654 (or approximately 66%) compared to the same period in 2012. This significant increase was primarily due to the increase in the demand for our oil and gas exploration additives and paper manufacturing additives, which was largely offset by the increase in cost of net revenue of approximately $2.1 million due to the increase in the quantity of raw materials purchased as a result of the overall demand in quantity of chemical products sold.

Other Income, Net Other income, net of $35,653 represented bank interest income, net of capital lease interest expense for the three -month period ended September 30, 2013, an increase of $21,992 (or approximately 161%) as compared to the same period in 2012, mainly due to higher average bank balance held during the three months period ended September 30, 2013 compared to the same period ended September 30, 2012.

Net Income. Net income was $8,109,729 for the three-month period ended September 30, 2013, an increase of $3,996,513 (or approximately 97%) compared to the same period in 2012. This significant increase was primarily attributable to the overall increase in demand for our products and gain on relocation of original Factory No.3.

Effective Tax Rate. Our effective tax rate for the three-month periods ended September 30, 2013 and 2012 was 26% and 27%, respectively. The effective tax rate of 26% for the three-month period ended September 30, 2013 differs from the PRC statutory income tax rate of 25% due to the US federal net operating loss incurred by the Company. The effective tax rate of 27% for the same period in 2012 differs from the PRC statutory income tax rate of 25% due to the US federal net operating loss incurred by the Company.

Comparison of the Nine-Month Periods Ended September 30, 2013 and 2012
 
   
Nine-Month
Period Ended
September 30, 2013
   
Nine-Month
Period Ended
September 30, 2012
   
% Change
Net revenue
  $ 88,291,753     $ 79,653,852       11 %
Cost of net revenue
  $ (63,251,929 )   $ (55,605,423 )     14 %
Gross profit
  $ 25,039,824     $ 24,048,429       4 %
Sales, marketing and other operating expenses
  $ (70,796 )   $ (60,800 )     16 %
Research and development costs
  $ (105,380 )   $ (133,802 )     (21 %)
Write-off/Impairment on property, plant and equipment
  $ (214 )   $ (1,042,138 )     (99.98 %)
General and administrative expenses
  $ (6,354,165 )   $ (5,190,934 )     22 %
Gain on relocation on factory
  $ (1,877,779 )   $ -       100 % 
Other operating income
  $ 489,695     $ 218,428       124 %
Income from operations
  $ 20,876,743     $ 17,839,183       17 %
Other income, net
  $ 81,336     $ 88,799       (8 %)
Income before taxes
  $ 20,958,079     $ 17,927,982       17 %
Income taxes
  $ (5,609,486 )   $ (4,838,985 )     16 %
Net income
  $ 15,348,593     $ 13,088,997       17 %
 
 
Net revenue.   Net revenue for nine-month period ended September 30, 2013 was $88,291,753, representing an increase of approximately $8.6 million (or 11%) over the same period in 2012. This increase was primarily attributable to the increase of revenues from all of our segments, specifically, including (i) the increase of revenue from the bromine segment from $44,953,429 for the nine-month period ended September 30, 2012 to $46,300,730 for the same period in 2013, an increase of approximately 3%; (ii) the increase of revenue from the crude salt segment from $8,415,487 for the nine-month period ended September 30, 2012 to $9,983,741 for the same period in 2013, an increase of approximately 19%; and (iii) the increase of revenue from the chemical products segment from $26,284,936 for the nine-month period ended September 30, 2012 to $32,007,282 for the same period in 2013, an increase of approximately22%.

   
Net Revenue by Segment
   
   
Nine-Month Period Ended
 
Nine-Month Period Ended
 
Percent Increase
   
September 30, 2013
 
September 30, 2012
 
of Net Revenue
Segment
       
% of total
       
% of total
     
Bromine
 
$
46,300,730
     
53
%
 
$
44,953,429
     
56
%
   
3
%
Crude Salt
 
$
9,983,741
     
11
%
 
$
8,415,487
     
11
%
   
19
%
Chemical Products
 
$
32,007,282
     
36
%
 
$
26,284,936
     
33
%
   
22
%
Total sales
 
$
88,291,753
     
100
%
 
$
79,653,852
     
100
%
   
11
%

Bromine and crude salt segments 
 
Nine-Month Period Ended
   
Percentage Change
product sold in tonnes
 
September 30, 2013
 
September 30, 2012
 
Increase
Bromine (excluded volume sold to SYCI)
   
15,306
     
13,615
     
12
%
Crude Salt
   
241,239
     
223,149
     
8
%
 
   
Nine-Month Period Ended
   
Percentage Change
Chemical products segment sold in tonnes
 
September 30, 2013
 
September 30, 2012
 
Increase/(Decrease)
Oil and gas exploration additives
   
9,513
     
7,903
     
20
%
Paper manufacturing additives
   
3,125
     
2,025
     
54
%
Pesticides manufacturing additives
   
2,297
     
2,352
     
(2
%)
Overall
   
14,935
     
12,280
     
22
%

Bromine segment
The increase in net revenue from our bromine segment was mainly due to the increase in the sales volume. The sales volume of bromine increase from 13,615 tonnes for the nine-month period ended September 30, 2012 to 15,306 tonnes for the same period in 2013, an increase of 12%. As mentioned hereinbefore, the major reason for the increase in the sales volume of bromine was mainly due to the lower level of bromine price, and our customers increased their bromine inventories.
 
The selling price of bromine decreased from $3,302 per tonne for the nine-month period ended September 30, 2012 to $3,025 tonnes for the same period in 2013, a decrease of 8%. The major reason for the decrease in the selling price of bromine was mainly attributable to the macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy, which has affected our customers’ industries. As a result, we needed to offer competitive selling prices to our customers to compete with other bromine manufacturers. The average selling price for the three-month period ended September 30, 2013 increased $71 per tonne, as compared with the three-month period ended December 31, 2012, which was $2,954 per tonne. We expect the average selling price of bromine to remain at the current level through the end of 2013 should the PRC government’s macro-economic tightening policy remain in place. The table below shows the changes in the average selling price and changes in the sales volume of bromine for nine-month period ended September 30, 2013 from the same period in 2012.
 
   
Nine-Month Period
Ended September 30,
Increase / (Decrease) in net revenue of bromine as a result of:
 
2013 vs. 2012
Decrease in average selling price
 
$
(4,002,086
)
Increase in sales volume
 
$
5,349,386
 
Total effect on net revenue of bromine
 
$
1,347,300
 
 
 
Crude salt segment
The increase in net revenue from our crude salt segment was mainly due to the increase in both the average selling price and sales volume. The average selling price of crude salt increase from $37.71 per tonne for the nine-month period ended September 30, 2012 to $41.39 per tonne for the same period in 2013, an increase of 10%, and the sales volume also increased by 8% from 223,149 tonnes for the nine-month period ended September 30, 2012 to 241,239 tonnes for the same period in 2013. The increase in both the average selling price and sales volume was mainly due to the stable demand as crude salt is a basic and elementary material for chemical industry.

We noted an upward trend in the average selling price of crude salt since the third quarter of 2011 due to the stable demand of the crude salt. The average selling price increased from $37.19 per tonne in the third quarter of 2011 to $41.39 per tonne in the third quarter of 2013. We expect the average selling price of crude salt to remain at current levels through the end of 2013.

The table below shows the changes in the average selling price and changes in the sales volume of crude salt for nine-month period ended September 30, 2013 from the same period in 2012.

   
Nine-Month Period
Ended September 30,
Increase in net revenue of crude salt as a result of:
 
2013 vs. 2012
Increase in average selling price
 
$
852,831
 
Increase in sales volume
 
$
715,423
 
Total effect on net revenue of crude salt
 
$
1,568,254
 


Chemical products segment

   
Product Mix of Chemical Products Segment
 
Percent
   
Nine-Month Period Ended
 
Nine-Month Period Ended
 
Change of
   
September 30, 2013
 
September 30, 2012
 
Net Revenue
Chemical Products
       
% of total
       
% of total
     
Oil and gas exploration additives
 
$
18,126,509
     
57
%
 
$
14,261,944
     
54
%
   
27
%
Paper manufacturing additives
 
$
3,547,763
     
11
%
 
$
2,509,455
     
10
%
   
41
%
Pesticides manufacturing additives
 
$
10,333,010
     
32
%
 
$
9,513,537
     
36
%
   
9
%
Total sales
 
$
32,007,283
     
100
%
 
$
26,284,936
     
100
%
   
22
%

Net revenue from our chemical products segment increased from $26,284,936 for the nine-month period ended September 30, 2012 to $32,007,283 for the same period in 2013, an increase of approximately 22%. The increase was mainly attributable to the increase in demand for all of our chemical products. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $18,126,509 (or 57%) and $14,261,944 (or 54%) of our chemical segment revenue for the nine-month periods ended September 30, 2013 and 2012, respectively, with an increase of $3,864,566, or 27%. Net revenue from our paper manufacturing additives increased from $2,509,455 for the nine-month period ended September 30, 2012 to $3,547,763 for the same period in 2013, an increase of approximately 41%. Net revenue from our pesticides manufacturing additives increased from $9,513,537 for the nine-month period ended September 30, 2012 to $10,333,010 for the same period in 2013, an increase of approximately 9%.
 
 
The table below shows the changes in the average selling price and changes in the sales volume of major chemical products for nine-month period ended September 30, 2013 from the same period in 2012.
 
Increase / (Decrease) in net revenue,
for the nine-month period ended September 30,
2013 vs. 2012, as a result of:
 
Oil and gas exploration additives
 
Paper manufacturing additives
 
Pesticides manufacturing additives
 
Total
Increase / (Decrease) in average selling price
 
$
877,959
   
$
(267,679
)
 
$
1,054,415
   
$
1,664,695
 
Increase / (Decrease) in sales volume
 
$
2,986,607
   
$
1,305,987
   
$
(234,942
)
 
$
4,057,652
 
Total effect on net revenue of chemical products
 
$
3,864,566
   
$
1,038,308
   
$
819,473
   
$
5,722,347
 
 
Cost of Net Revenue.
 
     
Cost of Net Revenue by Segment
   
% Change
     
Nine-Month Period Ended
     
Nine-Month Period Ended
     
of Cost of
     
September 30, 2013
     
September 30, 2012
     
Net Revenue
Segment
           
% of total
           
% of total
       
Bromine
 
$
34,745,832
     
55
%
 
$
31,584,700
     
57
%
   
10
%
Crude Salt
 
$
6,755,418
     
11
%
 
$
5,569,663
     
10
%
   
21
%
Chemical Products
 
$
21,750,679
     
34
%
 
$
18,451,060
     
33
%
   
18
%
Total
 
$
63,251,929
     
100
%
 
$
55,605,423
     
100
%
   
14
%

Cost   of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $63,251,929 for nine-month period ended September 30, 2013, an increase of $7,646,506 (or 14%) over the same period in 2012. The increase in overall cost of net revenue was mainly attributable to the increase in volume of products sold and the increase in depreciation and amortization of manufacturing plant and machinery, which was partially offset by the decrease in purchase price of raw materials.

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)
Nine-month period ended September 30, 2012
   
44,547
     
43%
 
Nine-month period ended September 30, 2013
   
47,347
     
46%
 
Variance of the nine-month periods ended September 30, 2013 and 2012
   
2,800
 (ii)
   
3%
 

(i) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the period divided by the annual production capacity in tonnes.

(ii) The increase in 2,800 tonnes production capacity represents the management’s estimate of the capacity of Factory No. 11 acquired in late November 2012.

Our utilization ratio increased by 3% for the nine-month period ended September 30, 2013 as compared with the same period in 2012. The increase in utilization was mainly attributable to the increasing demand of bromine from the downstream industrial customers.
 
 
Bromine segment
For the nine-month period ended September 30, 2013, the cost of net revenue for the bromine segment was $34,745,832, an increase of $3,161,132 or 10% over the same period in 2012. The most significant components of the costs of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $16,625,563 (or 48%), depreciation and amortization of manufacturing plant and machinery of $12,236,373 (or 35%) and electricity of $2,370,825 (or 7%) for the nine-month period ended September 30, 2013. For the nine-month period ended September 30, 2012, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $16,506,930 (or 52%), depreciation and amortization of manufacturing plant and machinery of $9,856,084 (or 31%) and electricity of $2,134,871 (or 7%). The cost structure changed as compared with the same period in 2012 where the contribution from cost of raw materials and finished goods consumed decreased by 4% and depreciation and amortization of manufacturing plant and machinery increased by 4%. The increase in net cost of net revenue was attributable mainly to the increase in volume of products sold and the increase in depreciation and amortization of manufacturing plant and machinery, which was partially offset by the decrease in purchase price of raw materials.

Per tonne production cost
 
Nine-Month Period Ended
 
Nine-Month Period Ended
   
component of bromine segment
 
September 30, 2013
 
September 30, 2012
 
% Change
       
% of total
     
% of total
     
Raw materials
 
$
1,086
     
48
%
 
$
1,212
     
52
%
   
(10
%)
Depreciation and amortization
 
$
799
     
35
%
 
$
724
     
31
%
   
10
%
Electricity
 
$
155
     
7
%
 
$
157
     
7
%
   
(1
%)
Others
 
$
230
     
10
%
 
$
227
     
10
%
   
1
%
Production cost of bromine per tonne
 
$
2,270
     
100
%
 
$
2,320
     
100
%
   
(2
%)
 
Our production cost of bromine per tonne was $2,270 for the nine-month period ended September 30, 2013, a decrease of 2% (or $50) over the same period in 2012, which was attributable mainly to the component of cost of raw materials consumed. The cost of raw materials consumed per tonne decreased by 10% as compared to the last comparison period, which was mainly attributable to the decrease in the purchase price of raw materials due to the macro-economic tightening policy imposed by the PRC government since January 2011. The significant percentage increase in depreciation and amortization per tonne by 10% was due to the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012, which accelerated the depreciation and amortization of the plant and machinery.

Crude salt segment
For the nine-month period ended September 30, 2013, the cost of net revenue for our crude salt segment was $6,755,418, representing an increase of $1,185,755, or 21%, compared to $5,569,663 for the same period in 2012. The increase in cost was mainly due to the increase in the number of enhancement projects performed in second quarter of 2012, which in turn resulted in an increase in the depreciation and amortization of manufacturing plant and machinery. The significant cost components for the nine-month period ended September 30, 2013 were depreciation and amortization of $4,656,245 (or 69%), resource taxes calculated based on crude salt sold of $776,965 (or 12%) and electricity of $537,154 (or 8%). The significant cost components for the nine-month period ended September 30, 2012 were depreciation and amortization of $3,842,957 (or 69%), resource tax of $706,743 (or 13%) and electricity of $412,456 (or 7%). The table below represents the major production cost component of crude salt per ton for respective periods:

Per tonne production cost
 
Nine-Month Period Ended
 
Nine-Month Period Ended
   
component of crude salt segment
 
September 30, 2013
 
September 30, 2012
 
% Change
       
% of total
     
% of total
     
Depreciation and amortization
 
$
19.3
     
69
%
 
$
17.2
     
69
%
   
12
%
Resource tax
 
$
3.2
     
12
%
 
$
3.2
     
13
%
   
-
 
Electricity
 
$
2.2
     
8
%
 
$
1.8
     
7
%
   
22
%
Others
 
$
3.3
     
11
%
 
$
2.8
     
11
%
   
18
%
Production cost of crude salt per tonne
 
$
28.0
     
100
%
 
$
25.0
     
100
%
   
12
%
 
 
Our production cost of crude salt per tonne was $28.0 for the nine-month period ended September 30, 2013, an increase of 12% (or $3.0) as compared to the same period in 2012, which was attributable mainly to the component of depreciation and amortization of manufacturing plant and machinery. The significant percentage increase in depreciation and amortization per tonne by 12% was due to the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012, which accelerated the depreciation and amortization of the plant and machinery. Other production costs represented mainly salaries and welfare of labor for the crude salt fields.

Chemical products segment
For the nine-month period ended September 30, 2013, cost of net revenue for our chemical products segment was $21,750,679, representing an increase of $3,299,619 or 18% over the same period in 2012. The costs were cost of raw material and finished goods consumed of $18,693,141 (or 86%) and $15,801,059 (or 86%) and depreciation and amortization of manufacturing plant and machinery of $2,107,340 (or 10%) and $1,919,064 (or 10%) for each of the nine-month periods ended September 30, 2013 and 2012, respectively. As the components of our cost of net revenue are fixed levels of depreciation and amortization of our manufacturing plant and machinery, the rate of increase for the cost of net revenue for our chemical products segment was less than that of net revenue.

Gross Profit. Gross profit was $25,039,824, or 28%, of net revenue for nine-month period ended September 30, 2013 compared to $24,048,429, or 30%, of net revenue for the same period in 2012. The decrease in gross profit percentage was primarily attributable to a drop in the margin percentage of bromine and crude salt segments.
 
   
Gross Profit by Segment
 
% Point Change
   
Nine-Month Period Ended
 
Nine-Month Period Ended
 
of Gross
   
September 30, 2013
 
September 30, 2012
 
Profit Margin
Segment
       
Gross Profit Margin
       
Gross Profit Margin
     
Bromine
 
$
11,554,898
     
25
%
 
$
13,368,729
     
30
%
   
(5
%)
Crude Salt
 
$
3,228,323
     
32
%
 
$
2,845,824
     
34
%
   
(2
%)
Chemical Products
 
$
10,256,603
     
32
%
 
$
7,833,876
     
30
%
   
2
%
Total Gross Profit
 
$
25,039,824
     
28
%
 
$
24,048,429
     
30
%
   
(2
%)
 
Bromine segment
The gross profit margin for our bromine segment for the nine-month period ended September 30, 2013 was 25% compared to 30% for the same period in 2012. As mentioned in the net revenue discussion above, due to the PRC government’s macro-economic tightening policy to slow down the economy, our selling price in the nine-month ended September 30, 2013 was affected. We cut the average selling price of bromine from $3,302 per tonne for the nine-month period ended September 30, 2012 to $3,025 per tonne for the same period in 2013, a decrease of 8%, in order to compete with other bromine manufacturers. Also, the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012, which accelerated the depreciation and amortization of the plant and machinery. We expect that the average selling price and gross profit margin of bromine will remain at current level towards the end of 2013 should the PRC government’s macro-economic tightening policy remain in place.

Crude salt segment
For the nine-month period ended September 30, 2013, the gross profit margin for our crude salt segment was 32% compared to 34% for the same period in 2012. This 2% is attributable to the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.
 
 
Chemical products segment
The gross profit margin for our chemical products segment for the nine-month period ended September 30, 2013 was 32% compared to 30% for the same period in 2012, an increase of 2%. As previously mentioned, this increase in gross profit margin was a result of the increase in both the sales volume and selling price for our oil and gas exploration additives. As sales of oil and gas exploration additives contributed more than 57% of our total chemical products segment’s net revenue, the increase in demand and selling price largely increased the gross profit margin of our chemical products segment.

Research and Development Costs. For the nine-month periods ended September 30, 2013 and 2012, the total research and development costs incurred were $105,380 and $133,802, respectively, a decrease of 21%. Research and development costs for the nine-month periods ended September 30, 2013 and 2012 represented raw materials used by SYCI for testing the manufacturing routine.

Write-off/Impairment on property, plant and equipment. Write-off on property, plant and equipment of $1,042,138 for the nine-month period ended September 30, 2012 represented the write-off of (i) certain protective shells to transmission pipelines and ducts replaced of $911,995 during the second phase enhancement project that started in June 2012 and completed in August 2012 ; and (ii) certain machinery and equipment replaced during the enhancement work to our bromine production facilities in Factory No. 2 of $130,143 that started in July 2012 and completed in September 2012.

General and Administrative Expenses. General and administrative expenses were $6,354,165 for the nine-month period ended September 30, 2013, an increase of $1,163,231 (or 22%) as compared to $5,190,934 for the same period in 2012. The significant increase was primarily due to (i) the unrealized exchange loss in relation to the translation difference of inter-company balances in USD and RMB for the nine-month period ended September 30, 2013 amounted to $556,325, as compared to the unrealized exchange loss for the same period in 2012 amounted to $154,998 and (ii) an increase in the depreciation of the newly acquired office units in a commercial building in September 2012 amount to $529,566 for the nine-month periods ended September 30,2013 compared to the same period in 2012.

Gain on relocation of factory. Gain on relocation of factory was $1,877,779 for the nine-month period ended September 30, 2013. In late September 2013, the Transportation Bureau of Dongying City and other local government agencies requested to requisition the land where the original Factory No. 3 was located for railway construction.

Other Operating Income. Other operating income was $489,695 for the nine-month period ended September 30, 2013, which represented (i) a sum of $318,603for sales of wastewater; (ii) a sum of $171,092 for insurance compensation received in 2013 for legal fees incurred in 2012. Other operating income was $218,428 for the nine-month period ended September 30, 2012, which represented the sales of wastewater to some of our customers.
 
 
Income from Operations. Income from operations was $20,876,743 for the nine-month period ended September 30, 2013 (or 24% of net revenue), an increase of $3,037,560, or approximately 17%, over income from operations for the same period in 2012. The increase resulted primarily from the increase in the demand for all of our segment products and gain on relocation of original Factory No.3.

   
Income from Operations by Segment
   
Nine-Month Period Ended
September 30, 2013
 
Nine-Month Period Ended
September 30, 2012
Segment:
       
% of total
         
% of total
Bromine
 
$
10,086,575
   
  45%
 
$
9,536,574
   
  50%
Crude Salt
   
2,902,613
   
  13%
   
1,986,451
   
  10%
Chemical Products
   
9,408,993
   
  42%
   
7,508,900
   
  40%
Income from operations before corporate costs
   
22,398,181
   
100%
   
19,031,925
   
100%
Corporate costs
   
(1,521,438
)
       
(1,192,742
)
   
Income from operations
 
$
20,876,743
       
$
17,839,183
     
 
Bromine segment
Income from operations from our bromine segment was $10,086,575 for the nine-month period ended September 30, 2013, an increase of $550,001 (or approximately 6%) compared to the same period in 2012. This increase resulted primarily from the increase in sales volume (contributed an increase of approximately $5.3 million) and gain on relocation of original Factory No.3 of approximately $1.45million, which was partially offset by the decrease in the average selling price (contributed a decrease of approximately $4.0 million) as a result of the PRC government’s macro-economic tightening policy and the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.

Crude salt segment
For the nine-month period ended September 30, 2013, income from operations from our crude salt segment was $2,902,613, an increase of $916,162 (or approximately 46%) compared to the same period in 2012. This significant increase was mainly due to the increase in both the average selling price and sales volume (contributed an aggregate increase of approximately $1.57 million) and gain on relocation of original Factory No.3 of approximately $0.43million, which was partially offset by the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects to our extraction wells and transmission channels and ducts which commenced in June 2012 and completed in August 2012 and the depreciation of these enhancement projects commenced in September 2012.

Chemical products segment
For the nine-month period ended September 30, 2013, income from operations from our chemical products segment was $9,408,993, an increase of $1,900,093 (or approximately 25%) over same period in 2012. This increase was primarily due to (i) the increase in net revenue of our oil and gas exploration additives and paper manufacturing additives of approximately $4.9 million due to increase in the demand, which was largely offset by the increase in cost of net revenue of approximately $3.3 million due to the increase in the quantity of raw materials purchased as a result of the overall demand in quantity of chemical products sold.

Other Income, Net. Other income, net of $81,336 represented bank interest income, net of capital lease interest expense for the nine -month period ended September 30, 2013, a decrease of $7,463 (or approximately 8%) as compared to the same period in 2013, mainly due to lower average bank balance held during the nine months period ended September 30, 2013 compared to the same period ended September 30, 2012.

Net Income. Net income was $15,348,593 for the nine-month period ended September 30, 2013, an increase of $2,259,596 (or approximately 17%) compared to the same period in 2012. This increase was primarily attributable to the overall increase in demand for our products and gain on relocation of original Factory No.3.

Effective Tax Rate. Our effective tax rate for the nine-month periods ended September 30, 2013 and 2012 was 27% and 27%, respectively. The effective tax rate of 27% for the nine-month period ended September 30, 2013 differs from the PRC statutory income tax rate of 25% due to the US federal net operating loss incurred by the Company. The effective tax rate of 27% for the same period in 2012 differs from the PRC statutory income tax rate of 25% due to the US federal net operating loss incurred by the Company.
 
 
LIQUIDITY AND CAPITAL RESOURCES
 
As of September 30, 2013, cash and cash equivalents were $97,204,603 as compared to $65,241,035 as of December 31, 2012. The components of this increase of $31,963,568 are reflected below.
 
Statement of Cash Flows
  
   
Nine-Month Period Ended September 30,
 
   
2013
   
2012
 
Net cash provided by operating activities
 
$
31,388,975
   
$
10,742,514
 
Net cash used in investing activities
 
$
(951,640
)
 
$
(29,925,583
)
Net cash used in financing activities
 
$
(302,497
)
 
$
(297,598
)
Effects of exchange rate changes on cash and cash equivalents
 
$
1,828,730
   
$
(451,033
)
Net (decrease)/increase in cash and cash equivalents
 
$
31,963,568
   
$
(19,931,700
)

For the nine-month period ended September 30, 2013, we met our working capital and capital investment requirements mainly by using cash flow from operations and cash on hand. The Company intends to continue to explore opportunities relating to bromine asset purchases and new bromine resource development. 

Net Cash Provided by Operating Activities
 
During the nine-month periods ended September 30, 2013 and 2012, we had positive cash flow from operating activities of $31.4 million and $10.7 million, respectively, primarily attributable to net income.
   
During the nine-month period ended September 30, 2013, cash flow from operating activities of $31.4 million exceeded our net income of $15.3 million, mainly due to (i) substantial non-cash charges of $19.6 million, mainly in the form of depreciation and amortization of property, plant and equipment, exchange loss on intercompany balances and stock-based compensation; partially offset by (ii) cash used in working capital of $3.6 million, which mainly consisted of increase in accounts receivable and decrease in retention payable, partially offset by the increase in taxes payable and decrease in inventories.

During the nine-month period ended September 30, 2012, net income of $13.1 million exceeded our cash flow from operating activities of $10.7 million, which was caused by (i) cash used in working capital of $21.4 million, which mainly consisted of increase in accounts receivable; which was partially offset by (ii) our net income, which included substantial non-cash charges of $19.1 million, mainly in the form of depreciation and amortization of property, plant and equipment, and write-off/impairment loss on property, plant and equipment.

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 September 30, 2013 and December 31, 2012.
 
   
September 30, 2013
 
December 31, 2012
         
% of total
         
% of total
 
Aged 1-30 days
 
$
12,092,903
     
29
%
 
$
9,226,030
     
26
%
Aged 31-60 days
 
$
11,907,825
     
29
%
 
$
8,668,189
     
24
%
Aged 61-90 days
 
$
10,765,274
     
26
%
 
$
6,758,020
     
19
%
Aged 91-120 days
 
$
6,777,013
     
16
%
 
$
6,535,738
     
18
%
Aged 121-150 days
 
$
-
     
-
   
$
4,781,923
     
13
%
Total
 
$
41,543,014
     
100
%
 
$
35,969,900
     
100
%
 
The overall accounts receivable balance as of September 30, 2013 increased by $5,573,114 (or 15%), as compared to those as of December 31, 2012. Such increase is mainly attributable to the increase in net revenues as a result of the increased demand for our products in all segments. We are not aware of any allowances for doubtful debts required for the nine-month period ended September 30, 2013 as we have policies in place to ensure that sales are made to customers with an appropriate credit history. For the balances of accounts receivable as of September 30, 2013 aged more than 90 days, all was settled in October 2013. We perform ongoing credit evaluation on the financial condition of our customers.
 
 
Inventory
 
Our inventory consists of the following:
 
   
September 30, 2013
 
December 31, 2012
         
% of total
       
% of total
Raw materials
 
$
666,320
     
11.5
%
 
$
773,453
     
12.9
%
Finished goods
 
$
5,167,438
     
89.0
%
 
$
5,248,039
     
87.6
%
   
$
5,833,758
     
100.5
%
 
$
6,021,492
     
100.5
%
Allowance for obsolete and slowing-moving inventory
 
$
(28,516
)
   
(0.5
%)
 
$
(27,894
)
   
(0.5
%)
Total
 
$
5,805,242
     
100.0
%
 
$
5,993,598
     
100.0
%
 
The net inventory level as of September 30, 2013 decreased by $188,356 (or 3%), as compared to the net inventory level as of December 31, 2012.
 
Raw materials decreased by 14% as of September 30, 2013 as compared to December 31, 2012. All of the raw materials are basic chemical industry materials, few of which have a possibility of loss over time, or major fluctuations in their prices. So, we concluded that all of our raw materials as of September 30, 2013 are fully realizable for production of finished goods without any impairment.
 
Our finished goods mainly composed of bromine, crude salt and chemical products. Our chemical products are similar to raw materials, as there is no loss over time and there is a stable market price with a positive gross profit margin of 32% for the nine-month period ended September 30, 2013 (30% for fiscal year 2012). Therefore, we believe that the realization of the chemical products is 100%. Similarly, as there is no depletion of bromine, we believe that the realization of it is also 100%.
 
The annual loss of crude salt due to evaporation is around 3%. As the market price of crude salt per ton increased from $37.7 in the third quarter of 2012 to $43.3 in the third quarter of 2013, and the relative cost of production is low, we believe that there will be no realization problem for crude salt and its selling price should not be lower than its cost.

Net Cash Used in Investing Activities

In the nine-month period ended September 30, 2013, we used approximately $0.6 million cash for the prepayment of land leases.

We also used approximately $0.3 million cash for the construction of our new Factory No.3 due to the resumption of leased land by the Transportation Bureau of Dongying City and other local government agencies for railway construction.

In the nine-month period ended September 30, 2012, we used approximately $0.5 million cash for the prepayment of land leases. In the same period, we also used approximately $29.4 million cash to acquire property, plant and equipment, which included (i) the second phase enhancement project to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 in the amount of approximately $12.8 million and $8.1 million, respectively; (ii) the enhancement work to the bromine production facilities in Factory No. 2 at a cost of approximately $1.3 million; (iii) the enhancement work to the chemical products production facilities at a cost of approximately $1.5 million; and (iv) the purchase of five stories of offices in a commercial building, from a company in which Mr. Ming Yang, the Chairman of the Company, had a 99% equity interest, for our new headquarters at a cost of approximately $5.7 million.

The above investing activities were financed by the opening cash balances as of December 31, 2012, and 2011, and cash generated from operation during the nine-month period ended September 30, 2013.

Net Cash Used in Financing Activities
 
We repaid approximately $0.3 million cash for our capital lease obligation for the nine-month period ended September 30, 2013.

We believe that our available funds and cash flows generated from operations will be sufficient to meet our anticipated ongoing operating needs for the next twelve (12) months. However we will likely need to raise additional capital in order to fund the ongoing program of acquiring unlicensed bromine properties, increasing our chemical production capacity and developing new bromine and crude salt production line in Sichuan Province, PRC. We expect to raise those funds through issuing additional shares of our capital stock and credit facilities obtained with lending institutions. There can be no guarantee that we will be able to obtain such funding, whether through the issuance of debt or equity, on terms satisfactory to management and our board of directors.
 
 
Working capital was approximately $135.7 million at September 30, 2013 as compared to approximately $96.2 million at December 31, 2012. The increase was mainly attributable to the cash provided by operating activities and the increase in accounts receivable during the nine-month period ended September 30, 2013.
 
We had available cash of approximately $97.2 million at September 30, 2013, most of which is in highly liquid current deposits which earn no or little interest. We intend to retain the cash for future expansion of our bromine and crude salt businesses through acquisition, enhancement works to our existing bromine and crude salt business, and exploration cost of new brine water resources in Sichuan Province, and we do not anticipate paying cash dividends in the foreseeable future.
 
In the future we intend to focus our efforts on the activities of SCHC and SYCI as these segments continue to expand within the Chinese market. We also intend to explore the possibility of cooperation with overseas large-scale bromine manufacturers for expansion into overseas markets. As a result, we may issue additional shares of our capital stock and incur new debt in order to raise cash for acquisitions and other capital expenditures during the next twelve months.

We may not be able to identify, successfully integrate or profitably manage any businesses or business segment we may acquire, or any expansion of our business. An expansion may involve a number of risks, including possible adverse effects on our operating results, diversion of management attention, inability to retain key personnel, risks associated with unanticipated events and the financial statement effect of potential impairment of acquired intangible assets, any of which could have a materially adverse effect on our condition and results of operations. In addition, if competition for acquisition candidates or operations were to increase, the cost of acquiring businesses could increase materially. We may effect an acquisition with a target business which may be financially unstable, under-managed, or in its early stages of development or growth. In addition, if competition for acquisition candidates or operations were to increase, the cost of acquiring businesses could increase materially. Our inability to implement and manage our expansion strategy successfully may have a material adverse effect on our business and future prospects.
 
Contractual Obligations and Commitments

We have no significant contractual obligations not fully recorded on our condensed consolidated balance sheets or fully disclosed in the notes to our condensed consolidated financial statements. Additional information regarding our contractual obligations and commitments at September 30, 2013 is provided in the notes to our condensed consolidated financial statements. See “Notes to Condensed Consolidated Financial Statements, Note 19 – Capital Commitment and Operating Lease Commitments”.

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 have been prepared in accordance with accounting principles generally accepted in the United States of America and this requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ significantly from these estimates under different assumptions or conditions. We have identified the following critical accounting policies and estimates used by us in the preparation of our financial statements: accounts receivable and allowance for doubtful accounts, assets retirement obligation, property, plant and equipment, recoverability of long lived assets, mineral rights, revenue recognition, income taxes, and stock-based compensation. These policies and estimates are described in the Company’s 2012 Form 10-K.
 
 
 
Pursuant to Item 301(c) of Regulation S-K (§ 229.301(c)), 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).
 
Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures
 
We maintain disclosure controls and procedures (as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, regulations and related forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.
 
Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Form 10-Q.
 
(b) Changes in internal controls
 
There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) under the Exchange Act) during our most recently completed fiscal quarter, which is the subject of this report, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We are not a party to any legal proceedings other than the following.

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. 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. On April 30, 2013, the parties executed a stipulation and agreement of settlement (“Proposed Settlement”). The Proposed Settlement is subject to review and approval of the Court. In the event that the Proposed Settlement is approved and accepted, the Company does not expect it to have any impact on the financial statements. The Company believes that the overall cost in connection with this litigation will be reimbursed by the insurance company to the extent covered by the insurance policies.
   
      

There have been no changes with respect to risk factors as previously disclosed in our 2012 Form 10-K.  Investing in our common stock involves a high degree of risk. Before you invest you should carefully consider the risks and uncertainties described below and in our 2012 Form 10-K, under the caption “Risk Factors”, our Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 2 of Part I of this Quarterly Report on Form 10-Q, our consolidated financial statements and related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and our consolidated financial statements and related notes, as well as our Management’s Discussion and Analysis of Financial Condition and Results of Operations and the other information in our 2012 Form 10-K. Readers should carefully review those risks, as well as additional risks described in other documents we file from time to time with the Securities and Exchange Commission.

Item 2. Unregistered Shares of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

No applicable.

Item 5. Other Information

None.
 
Item 6. Exhibits
 
Exhibit No.
Description
 
31.1                         
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
31.2                         
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  
32.1                         
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101.1                         
The following financial statements from Gulf Resources, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2013 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations and Other Comprehensive Income (Loss); (iii) the Consolidated Statements of Changes in Equity; (iv) the Consolidated Statement of Cash Flows; and, (v) the Notes to Consolidated Financial Statements, tagged as blocks of text.
 
 
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
GULF RESOURCES, INC.
     
Dated: November 8, 2013
By:
/s/ Xiaobin Liu
   
Xiaobin Liu
   
Chief Executive Officer
   
(principal executive officer)
     
Dated: November 8, 2013
By:
/s/ Min Li
   
Min Li
   
Chief Financial Officer
   
(principal financial and accounting officer)
 
42
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