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GURE > SEC Filings for GURE > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for GULF RESOURCES, INC.


9-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

The discussion below contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act. We have used words such as "believes," "intends," "anticipates," "expects" and similar expressions to identify forward-looking statements. These statements are based on information currently available to us and are subject to a number of risks and uncertainties that may cause our actual results of operations, financial condition, cash flows, performance, business prospects and opportunities and the timing of certain events to differ materially from those expressed in, or implied by, these statements. These risks, uncertainties and other factors include, without limitation, those matters discussed in Item 1A of Part I of our 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.


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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:

[[Image Removed]] 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.


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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 periods ended March 31, 2013 and 2012.

Comparison of the Three-Month Periods Ended March 31, 2013 and 2012

                                Three-Month Period          Three-Month Period
                               Ended March 31, 2013        Ended March 31, 2012       % Change
Net revenue                  $         22,502,580        $         23,808,674      ?      (5 %)
Cost of net revenue          $        (17,985,472 )      $        (17,115,882 )    ?       5 %
Gross profit                 $          4,517,108        $          6,692,792      ?     (33 %)
Sales, marketing and other
operating expenses           $            (20,303 )      $            (17,764 )           14 %
Research and development
costs                        $            (17,702 )      $            (42,798 )   ?      (59 %)
General and administrative
expenses                     $         (1,969,217 )      $         (2,112,205 )           (7 %)
Other operating income       $             95,562        $             57,074      ?      67 %
Income from operations       $          2,605,448        $          4,577,099      ?     (43 %)
Other income, net            $             19,837        $             44,478      ?     (55 %)
Income before taxes          $          2,625,285        $          4,621,577      ?     (43 %)
Income taxes                 $           (742,320 )      $         (1,334,470 )    ?     (44 %)
Net income                   $          1,882,965        $          3,287,107      ?     (43 %)

Net revenue Net revenue was $22,502,580 for three-month period ended March 31, 2013, a decrease of approximately $1.3 million (or 5%) as compared to the same period in 2012. This decrease was primarily attributable to the reduction of our bromine segment products, which decreased from $13,453,882 for the three-month period ended March 31, 2012 to $11,734,367 for the same period in 2013, a decrease of approximately 13%.

Revenue from the crude salt segment increased from $2,274,924 for the three-month period ended March 31, 2012 to $2,450,786 for the same period in 2013, an increase of approximately 8%. Revenue from the chemical products segment slightly increased from $8,079,868 for the three-month period ended March 31, 2012 to $8,317,427 for the same period in 2013, an increase of approximately 3%.

                                                            Net Revenue by Segment
                                        Three-Month Period Ended               Three-Month Period Ended          Percent Increase/(Decrease)
                                             March 31, 2013                         March 31, 2012                      of Net Revenue
Segment                                                   % of total                             % of total
Bromine                           $      11,734,367              52 %    $      13,453,882              56 %                     (13 %)
Crude Salt                        $       2,450,786              11 %    $       2,274,924              10 %                       8 %
Chemical Products                 $       8,317,427              37 %    $       8,079,868              34 %                       3 %

Total sales                       $      22,502,580             100 %    $      23,808,674             100 %                      (5 %)

                                              Three-Month Period Ended               Percentage Change
Bromine and crude salt segments
product sold in tonnes                  March 31, 2013         March 31, 2012            Increase
Bromine (excluded volume sold to
SYCI)                                             3,843                  3,770                  2 %
Crude Salt                                       62,007                 59,836                  4 %



                                                  Three-Month Period Ended               Percentage Change
Chemical products segment sold in tonnes    March 31, 2013         March 31, 2012       Increase/(Decrease)
Oil and gas exploration additives                     2,491                  2,344                  6 %
Paper manufacturing additives                           839                    482                 74 %
Pesticides manufacturing additives                      684                    798                (14 %)
Overall                                               4,014                  3,624                 11 %


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Bromine segment
The decrease in net revenue from our bromine segment was mainly due to the decrease in the selling price of bromine. The selling price of bromine decreased from $3,569 per tonne for the three-month period ended March 31, 2012 to $3,053 tonnes for the same period in 2013, a decrease of 14%. 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 this quarter increased $99 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.

Due to an increase in the number of our bromine production plants in recent years, the sales volume of bromine increased from 3,770 tonnes for the three-month periods ended March 31, 2012 to 3,843 tonnes for the same period in 2013, an increase of 2%. The table below shows the changes in the average selling price and changes in the sales volume of bromine for three-month period ended March 31, 2013 from the same period in 2012.

                                    Three-Month Period
                                     Ended March 31,
Increase / (Decrease) in net
revenue of bromine as a result
of:                                   2013 vs. 2012
Decrease in average selling
price                              $      (1,962,395 )
Increase in sales volume           $         242,880
Total effect on net revenue of
bromine                            $      (1,719,515 )

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 of crude salt. The average selling price of crude salt increased from $38.02 per tonne for the three-month period ended March 31, 2012 to $39.52 per tonne for the same period in 2013, an increase of 4%, and the sales volume of crude salt also increased by nearly 4% from 59,836 tonnes for the three-month period ended March 31, 2012 to 62,007 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 a 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 $39.52 per tonne in the first quarter of 2013. We expect the average selling price of crude salt to remain at current levels through the end of 2013.

                                                         Three-Month Period
                                                          Ended March 31,
Increase in net revenue of crude salt as a result of:      2013 vs. 2012
Increase in average selling price                       $          91,686
Increase in sales volume                                $          84,176
Total effect on net revenue of crude salt               $         175,862


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Chemical products segment
                                                      Product Mix of Chemical Products Segment                         Percent
                                           Three-Month Period Ended               Three-Month Period Ended            Change of
                                                March 31, 2013                         March 31, 2012                Net Revenue
Chemical Products                                            % of total                             % of total
Oil and gas exploration additives    $      4,621,678               55 %    $      4,161,559               52 %              11 %
Paper manufacturing additives        $        890,672               11 %    $        680,533                8 %              31 %
Pesticides manufacturing additives   $      2,805,077               34 %    $      3,237,776               40 %             (13 %)
Total sales                          $      8,317,427              100 %    $      8,079,868              100 %               3 %

Net revenue from our chemical products segment increased from $8,079,868 for the three-month period ended March 31, 2012 to $8,317,427 for the same period in 2013, an increase of approximately 3%. The increase was mainly attributable to the increase in demand for our oil and gas exploration additives and paper manufacturing additives. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $4,621,678 (or 55%) and $4,161,559 (or 52%) of our chemical segment revenue for the three-month periods ended March 31, 2013 and 2012, respectively, with an increase of $460,119, or 11%. Net revenue from our paper manufacturing additives increased from $680,533 for the three-month period ended March 31, 2012 to $890,672 for the same period in 2013, an increase of approximately 31%.

However, the effect of the increase in net revenue from our chemical products segment was partially offset by the decrease in the sales volume for our pesticides manufacturing additives. The sales volume for our pesticides manufacturing additives decreased by 14% for the three-month period ended March 31, 2013 as compared with the same period in 2012.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 March 31, 2013 from the same period in 2012.

Increase / (Decrease) in net revenue,
for the three-month period ended March         Oil and gas
31,                                            exploration        Paper manufacturing          Pesticides
2013 vs. 2012, as a result of:                  additives              additives         manufacturing additives      Total
Increase / (Decrease) in average selling                                                                           $  (5,792 )
price                                      $      193,258        $     (231,377 )        $        32,327
Increase / (Decrease) in sales volume      $      266,861        $      441,516          $      (465,026 )         $ 243,351
Total effect on net revenue of chemical
products                                   $      460,119        $      210,139          $      (432,699 )         $ 237,559



Cost of Net Revenue

                                                        Cost of Net Revenue by Segment                             % Change
                                        Three-Month Period Ended               Three-Month Period Ended           of Cost of
                                             March 31, 2013                         March 31, 2012                Net Revenue
Segment                                                   % of total                             % of total
Bromine                           $      10,329,842              58 %    $       9,844,496              58 %               5 %
Crude Salt                        $       1,696,679               9 %    $       1,538,741               9 %              10 %
Chemical Products                 $       5,958,951              33 %    $       5,732,645              33 %               4 %
Total                             $      17,985,472             100 %    $      17,115,882             100 %               5 %

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 $17,985,472 for three-month period ended March 31, 2013, an increase of $869,590 (or 5%) as compared to the same period in 2012. The increase in overall cost of net revenue was mainly attributable to the increase depreciation and amortization of manufacturing plant and machinery, which was partially offset by the decrease in purchase price of raw materials


Table of Contents

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                Utilization
                                              (in tonnes)                Ratio (i)
 Three-month period ended March 31,
 2012                                           44,547                         37%
 Three-month period ended March 31,
 2013                                           47,347                         34%
 Variance of the three-month periods
 ended March 31, 2013 and 2012                   2,800  (ii)                   (3% )

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

(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 decreased by 3% for the three-month period ended March 31, 2013 as compared with the same period in 2012. The decrease in utilization was mainly attributable to the low demand for bromine as a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which reduced our production volume since mid-2011.

In view of the trend of a decrease in the bromine concentration of the brine water being extracted at our production facilities as explained in 2012 Form 10-K, and in order to reduce the leakage rate and attempt to recover the annual production capacity of bromine and crude salt to a higher level in the future, we plan to carry out enhancement project for our transmission channels and ducts in Factories No.10 and No 11 in 2013. During the three-month period ended March 31, 2013, no such enhancement work was carried out due to unexpected weather conditions. We expect to resume the enhancement work in the second and third quarters of 2013 when weather conditions permit.

Bromine segment
For the three-month period ended March 31, 2013, the cost of net revenue for the bromine segment was $10,329,842, an increase of $485,346 or 5% 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 $4,607,118 (or 44%), depreciation and amortization of manufacturing plant and machinery of $4,113,259 (or 40%) and electricity of $580,524 (or 6%) for the three-month period ended March 31, 2013. For the three-month period ended March 31, 2012, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $4,849,541 (or 49%), depreciation and amortization of manufacturing plant and machinery of $3,370,515 (or 34%) and electricity of $640,249 (or 7%), the cost structure changed as compared with the same period in 2013 where the contribution from cost of raw materials and finished goods consumed decreased by 5% and depreciation and amortization of manufacturing plant and machinery increased by 7%. The increase in net cost of net revenue was mainly attributable to the increase in depreciation and amortization of manufacturing plant and machinery, which was largely offset by the decrease in raw material prices,. The table below represents the major production cost component of bromine per tonne sold for respective periods:

Per tonne
production cost
component of
bromine segment            Three-Month Period Ended             Three-Month Period Ended
                                March 31, 2013                       March 31, 2012              % Change
                                             % of total                           % of total
Raw materials         $       1,199                44 %    $       1,286                49 %         (7 %)
Depreciation and
amortization          $       1,070                40 %    $         894                34 %         20 %
Electricity           $         151                 6 %    $         170                 7 %        (11 %)
Others                $         268                10 %    $         262                10 %          3 %
Production cost of
bromine per tonne     $       2,688               100 %    $       2,612               100 %          3 %


Table of Contents

Our production cost of bromine per tonne sold was $2,688 for the three-month period ended March 31, 2013, an increase of 3% (or $76) 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 20% was 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 cost of raw materials consumed per tonne slighted decreased by 7% 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.

Crude salt segment
The cost of net revenue for our crude salt segment for the three-month period ended March 31, 2013 was $1,696,679, representing an increase of $157,938, or 10%, compared to $1,538,741 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 three-month period ended March 31, 2013 were depreciation and amortization of $1,221,409 (or 72%), resource taxes calculated based on crude salt sold of $197,518 (or 12%) and electricity of $86,452 (or . . .

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