UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q10-Q/A
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
 
For the quarterly period ended September 30, 2011March 31, 2012
  
 Or
  
oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
 For the transition period from _________ to _________

Commission File Number: 000-20936

GULF RESOURCES, INC.
(Exact name of registrant as specified in its charter)
 
Delaware 13-3637458
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
   
99 Wenchang Road, Chenming Industrial Park, Shouguang City,
Shandong, China
 262714
(Address of principal executive offices) (Zip Code)
 
Registrant’s telephone number, including area code: +86 (536) 567 0008

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer (Do not check if a smaller reporting company) o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

As of November 9, 2011,May 1, 2012, the registrant had outstanding 34,745,34234,560,743 shares of common stock.
 
1
 
This Amendment No. 1 (“Amendment No. 1”) to the Quarterly Report on Form 10-Q of Gulf Resources, Inc. (together with its wholly-owned subsidiaries, the “Company,” “we,” “our” or “us”) for the fiscal quarter ended March 31, 2012 as filed with the Securities and Exchange Commission (the “SEC”) on May 7, 2012 (the “First Quarter 10-Q”) is being filed to amend the First Quarter 10-Q as follows:
(i) to amend Item 4 to provide updated disclosure regarding the effectiveness of our disclosure controls and procedures in response to certain comments we received from the SEC relating to failure to include unaudited financial information for fiscal years 2010 and 2009 in Schedule I (Parent Only Financial Information) to our audited financial statements contained in our 2011 Annual Report on Form 10-K.
This Amendment No. 1 does not affect any other portion of the First Quarter 10-Q. Additionally, except as specifically referenced herein, this Amendment No. 1 does not reflect any event occurring after May 7, 2012, the filing date of the First Quarter 10-Q. Unless otherwise indicated herein, each capitalized term used and not defined herein shall have the meaning ascribed to such term in the First Quarter 10-Q.
Table of Contents
 
Part I – Financial Information 
Item 1. Financial Statements
1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
22
Item 3. Quantitative and Qualitative Disclosures about Market Risk
38
Item 4. Controls and Procedures
383
Part II – Other InformationSignatures
Item 1. Legal Proceedings
39
Item 1A. Risk Factors
39
Item 2. Unregistered Shares of Equity Securities and Use of Proceeds
44
Item 3. Defaults Upon Senior Securities
44
Item 4. Reserved and Removed
44
Item 5. Other Information
44
Item 6. Exhibits
44
5
 
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
GULF RESOURCES, INC.
 AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. dollars)
(UNAUDITED)
  September 30, 2011  December 31, 2010 
Current Assets        
Cash $85,821,856  $68,494,480 
Accounts receivable  24,283,055   21,542,229 
Inventories  3,150,965   2,679,899 
Prepayments and deposits  970,403   939,940 
Prepaid land leases  203,466   42,761 
Deferred tax assets  1,744   99,694 
Other receivable  300,000   - 
Total Current Assets  114,731,489   93,799,003 
Non-Current Assets        
Property, plant and equipment, net  138,917,025   112,178,999 
Property, plant and equipment under capital leases, net  2,402,643   - 
Prepaid land leases, net of current portion  761,567   743,022 
Deferred tax assets  1,966,760   - 
Total non-current assets  144,047,995   112,922,021 
Total Assets $258,779,484  $206,721,024 
         
Liabilities and Stockholders’ Equity        
Current Liabilities        
Accounts payable and accrued expenses $10,195,667  $6,419,735 
Retention payable  1,668,517   453,000 
Capital lease obligation, current portion  136,249   - 
Taxes payable  5,137,084   7,163,095 
Total Current Liabilities  17,137,517   14,035,830 
Non-Current Liabilities        
Capital lease obligation, net of current portion  3,010,728   - 
Total Liabilities $20,148,245  $14,035,830 
　        
Stockholders’ Equity        
PREFERRED STOCK ; $0.001 par value; 1,000,000 shares authorized; none outstanding $-  $- 
COMMON STOCK; $0.0005 par value; 100,000,000 shares authorized; 34,745,342 and 34,735,912 shares issued; and 34,560,743 and 34,735,912 shares outstanding as of September 30, 2011 and December 31, 2010, respectively  17,373   17,368 
Treasury stock; 184,599 shares as of September 30, 2011 at cost  (500,000)  - 
Additional paid-in capital  74,093,579   66,626,584 
Retained earnings unappropriated  136,472,685   106,500,085 
Retained earnings appropriated  10,271,293  
　10,271,293
 
Cumulative translation adjustment  18,276,309   9,269,864 
Total Stockholders’ Equity  238,631,239   192,685,194 
Total Liabilities and Stockholders’ Equity $258,779,484  $206,721,024 

The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Expressed in U.S. dollars)
(UNAUDITED)

 
Three-Month Period Ended
September 30,
  
Nine-Month Period Ended
September 30,
 
 2011  2010  2011  2010 
           
NET REVENUE          
Net revenue $37,761,975  $44,758,294  $134,441,319  $121,203,521 
                 
OPERATING EXPENSES/INCOME                
Cost of net revenue  (23,823,944)  (23,002,703)  (69,410,031)  (62,709,174)
Sales, marketing and other operating expenses  (20,116)  (18,789)  (67,861)  (115,174)
Research and development cost  (33,565)  (891,509)  (347,421)  (1,612,862)
Exploration costs  (1,047,110)  -   (4,914,396)  - 
Write-off / Impairment on property,
plant and equipment
  -   -   (7,570,566)  - 
General and administrative expenses  (5,459,069)  (1,003,129)  (11,515,054)  (3,991,515)
Other operating income  1,368,074   66,555   1,783,157   88,553 
   (29,015,730)  (24,849,575)  (92,042,172)  (68,340,172)
                 
INCOME FROM OPERATIONS  8,746,245   19,908,719   42,399,147   52,863,349 
                 
OTHER INCOME (EXPENSE)                
Interest expense  (51,994)  (394)  (159,950)  (620)
Interest income  69,641   67,083   198,416   180,667 
INCOME BEFORE TAXES  8,763,892   19,975,408   42,437,613   53,043,396 
                 
INCOME TAXES  (3,179,546)  (5,110,306)  (12,465,013)  (13,759,713)
NET INCOME $5,584,346  $14,865,102  $29,972,600  $39,283,683 
                 
COMPREHENSIVE INCOME:                
NET INCOME $5,584,346  $14,865,102  $29,972,600  $39,283,683 
OTHER COMPREHENSIVE INCOME                
- Foreign currency translation adjustments  4,168,644   2,818,766   9,006,445   3,481,428 
COMPREHENSIVE INCOME $9,752,990  $17,683,868  $38,979,045  $42,765,111 
                 
EARNINGS PER SHARE:                
BASIC $0.16  $0.43  $0.86  $1.14 
DILUTED $0.16  $0.43  $0.86  $1.13 
                 
WEIGHTED AVERAGE NUMBER OF SHARES:                
                 
BASIC  34,620,004   34,640,007   34,694,607   34,596,825 
DILUTED  34,620,004   34,742,327   34,695,664   34,744,914 
The accompanying notes are an integral part of these consolidated financial statements.
 
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2011
(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, 2010  34,735,912   34,735,912   -   17,368   -   66,626,584   10,271,293   106,500,085   9,269,864   192,685,194 
                                         
Translation adjustment 
-　
   -   -  
-　
      
-　
  
-　
  
-　
   9,006,445   9,006,445 
Common stock repurchased
  -   (184,599)  184,599   -   (500,000)  -   -   -   -   (500,000) 
Common stock issued for exercising stock options 
9,430　
   9,430   -  
5　
       (5)  
-　
  
-　
   -   - 
Issuance of warrants to non-employees  -   -   -   -   -   452,000   -   -   -   452,000 
Issuance of stock options to employees  -   -   -   -   -   7,015,000   -   -   -   7,015,000 
Net income for nine-month period ended September 30, 2011 
-　
   -   -  
-　
   -  
-　
  
-　
   29,972,600  
-　
   29,972,600 
BALANCE AT SEPTEMBER 30, 2011  34,745,342   34,560,743   184,599   17,373   (500,000)  74,093,579   10,271,293   136,472,685   18,276,309   238,631,239 
The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. dollars)
(UNAUDITED)

  Nine-Month Period Ended September 30, 
  2011  2010 
  　  　 
CASH FLOWS FROM OPERATING ACTIVITIES 　  　 
Net income $29,972,600  $39,283,683 
Adjustments to reconcile net income to net cash provided by operating activities:       
Interest on capital lease obligation  159,950   - 
Amortization of prepaid land leases  262,567   75,436 
Depreciation and amortization  12,543,179   7,867,568 
Write-off / Impairment loss on property, plant and equipment  7,570,566   - 
Compensation income from local government for demolition of factory  (1,340,026)  - 
Stock-based compensation expense  7,467,000   1,188,966 
Deferred tax asset  (1,823,019) (18,331)
Changes in assets and liabilities:       
Accounts receivable  (1,792,588)  1,719,870 
Inventories  (350,201)  (581,346)
Prepayments and deposits  3,005   (290,968)
Other receivables  (300,000)  2,296 
Accounts payable and accrued expenses  3,444,367   1,182,100 
Taxes payable  (2,275,794)  2,015,614 
Net cash provided by operating activities  53,541,606   52,444,888 
        
CASH FLOWS USED IN INVESTING ACTIVITIES       
Additions of prepaid land leases  (403,834)  (99,733)
Compensation received for demolition of factory  1,340,026   - 
Purchase of property, plant and equipment  (34,457,775)  (28,096,333)
Increase in construction in progress  (5,230,232)  - 
Net cash used in investing activities  (38,751,815)  (28,196,066)
        
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES       
Proceeds from exercising stock options  -   18,000 
Proceeds from private placement  -  2,192,919 
Repurchase of common stock  (500,000) - 
Repayment of capital lease obligation  (288,739) - 
Repayment to a related party  -  (1,190)
Net cash (used in)/provided by financing activities  (788,739)  2,209,729 
        
EFFECTS OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS  3,326,324   1,403,085 
NET INCREASE IN CASH AND CASH EQUIVALENTS  17,327,376   27,861,636 
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD  68,494,480   45,536,735 
CASH AND CASH EQUIVALENTS - END OF PERIOD $
 
85,821,856
  $73,398,371 
The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Expressed in U.S. dollars)
(UNAUDITED)
  Nine-Month Period Ended September 30, 
  2011  2010 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION 　  　 
Cash paid during the period for: 　  　 
Income taxes $16,893,973  $11,698,528 
Interest paid $ 1,743  $ 620 
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
      
Inception of capital lease obligation for acquiring property, plant and equipment $3,127,913  $ - 
         
Issuance of common stock for exercising stock options $5  $ - 
         
Issuance of common stock for exercising warrants $-  $ 8 
         
Issuance of common stock for acquiring property, plant and equipment $-  $ 608,227 

The accompanying notes are an integral part of these consolidated financial statements.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)           Basis of Presentation

The accompanying condensed financial statements have been prepared by Gulf Resources, Inc. a Delaware corporation and its subsidiaries (collectively, the “Company”), without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of its financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States (“US GAAP”). The balance sheet at December 31, 2010 is derived from the audited balance sheet at that date which is not presented herein.

In the opinion of management, the unaudited financial information for the quarter ended and nine-month period ended September 30, 2011 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 2010 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.

(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, 2011 and December 31, 2010, allowance 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, 2011 and 2010.

(d)           Concentration of Credit Risk

The Company is exposed to credit risk in the normal course of business, primarily related to accounts receivable and cash and cash equivalents. Substantially all of the Company’s cash and cash equivalents are maintained with financial institutions in the PRC, namely, Industrial and Commercial Bank of China Limited and China Merchants Bank Company Limited, which are not insured or otherwise protected. The Company placed $85,771,856 and $68,444,480 with these institutions as of September 30, 2011 and December 31, 2010, 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.  The balances of accounts receivable as of September 30, 2011 and December 31, 2010 are all amounts outstanding for less than three months.

(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 expenditures that extend the useful lives 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.

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.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 (Expressed in U.S. dollars)
(UNAUDITED)

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

(e)           Property, Plant and Equipment – Continued

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. Cost of repairs and maintenance is expensed as incurred.

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)15 - 20
Plant and machinery5 - 8
Motor vehicles5
Furniture, fixtures and equipment8
In April 2011, the Company changed the estimated useful life of certain protective shells and transmission channels and ducts included in plant and machinery from 8 years to 5 years, resulting in an increase of depreciation in the amounts of $359,715 and $908,574 for the three-month and nine-month periods ended September 30, 2011.
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 $107,035 and $122,584 for the three-month periods ended September 30, 2011 and 2010, respectively, and totaled $333,947 and $365,623 for the nine-month periods ended September 30, 2011 and 2010, respectively.

(g)           Mineral Rights

The Company follows the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805 Business Combinations that certain mineral rights are considered tangible assets and that mineral rights should be accounted for based on their substance. Mineral rights are included in property, plant and equipment.

(h)           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.

(i)           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. For the three-month periods ended September 30, 2011 and 2010, shipping and handling costs for purchase of raw materials were $123,103 and $162,261, respectively. For the nine-month periods ended September 30, 2011 and 2010, shipping and handling costs for purchase of raw materials were $404,331 and $447,572, respectively.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
 (Expressed in U.S. dollars)
(UNAUDITED)

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

(j)           Exploration Costs

Exploration costs, which included the cost of researching appropriate places to drill wells and the cost of actual drilling of potential natural brine resources, were charged to the income statement as incurred. For the three-month and nine-month periods ended September 30, 2011, the Company incurred exploration costs in the amounts of $1,047,110 and $4,914,396, respectively, in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. The exploratory wells are still under construction and are expected to be completed by end of 2011.
(k)           Cash and Cash Equivalents

Cash and cash equivalents consist of all cash balances and highly liquid investments with original maturities of three months or less.  Because of short maturity of these investments, the carrying amounts approximate their fair values.

(l)           Impairment or Disposal of Long-lived Assets

In accordance with 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 period ended September 30, 2011, the Company determined that no impairment was required after going through the impairment testing to the operating long-lived assets. For the nine-month period ended and as of September 30, 2011, the Company impaired long-lived assets for idle plant and machinery, both owned assets and assets under capital lease, in the amounts of $1,805,598 and $683,046, respectively. The Company determined that there was no impairment indication to the long-lived assets as of December 31, 2010.
(m)           Income Taxes
The Company accounts for income taxes in accordance with the Income Taxes Topic of the FASB ASC, which requires the use of the liability method of accounting for deferred income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences on future years of temporary differences between the tax basis of assets and liabilities and their reported amounts at each period end. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. The guidance also provides criteria for the recognition, measurement, presentation and disclosures of uncertain tax positions. A tax benefit from an uncertain tax position may be recognized if it is “more likely than not” that the position is sustainable based solely on its technical merits.
(n)           Leasing arrangements
Rentals payable under operating leases are charged to the statements of income on a straight line basis over the term of the relevant lease. For capital leases, the present value of future minimum lease payments at the inception of the lease is reflected as an asset and a liability in the statement of financial position. Amounts due within one year are classified as short-term liabilities and the remaining balance as long-term liabilities.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)

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

(o)           Contingencies
The Company accrues for costs relating to litigation, including litigation defense costs, claims and other contingent matters, including liquidated damage liabilities, when such liabilities become probable and reasonably estimable.  Such estimates may be based on advice from third parties or on management’s judgment, as appropriate.  Revisions to accruals are reflected in earnings (loss) in the period in which different facts or information become known or circumstances change that affect the Company’s previous assumptions with respect to the likelihood or amount of loss.  Amounts paid upon the ultimate resolution of such liabilities may be materially different from previous estimates.
(p)           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. Anti-dilutive common stock equivalents which were excluded from the calculation of number of dilutive common stock equivalents amounted to 1,481,786 and 54,222 shares for the three-month periods ended September 30, 2011 and 2010, respectively, and amounted to 1,111,634 and 10,946 shares for the nine-month periods ended September 30, 2011 and 2010, respectively.

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,
  2011  2010   2011   2010 
Numerator              
Net income $5,584,346  $14,865,102  $29,972,600  $39,283,683 
                 
Denominator                
Basic: Weighted-average common shares outstanding during the period  34,620,004   34,640,007   34,694,607   34,596,825 
Add: Dilutive effect of stock options  -   102,320   1,057   148,089 
Diluted  34,620,004   34,742,327   34,695,664   34,744,914 
                 
Net income per share                
Basic $0.16  $0.43  $0.86  $1.14 
Diluted $0.16  $0.43  $0.86  $1.13 
(q)           Foreign Currency Translations and Transactions

The Company’s operations in the PRC use the local currency, Renminbi (“RMB”), as their functional currency, whereas amounts reported in the accompanying condensed consolidated financial statements and disclosures are stated in the United States dollar (“USD” or “$”), the functional currency and the reporting currency of the Company.

As such, the Company uses the “current rate method” to translate its PRC operations from RMB into USD, as required under ASC 830 “Foreign Currency Matters”. The assets and liabilities of its PRC operations are translated into USD using the rate of exchange prevailing at the balance sheet date. The capital accounts are translated at the historical rate. Adjustments resulting from the translation of the balance sheets of the Company’s PRC subsidiaries from RMB into USD are recorded in stockholders’ equity as part of accumulated comprehensive income. The consolidated statement of income and comprehensive income is translated at average rates during the reporting period. Gains or losses resulting from transactions in currencies other than the functional currencies are recognized in net income for the reporting periods. The consolidated statement of cash flows is translated at average rates during the reporting period, with the exception of issuance of shares and payment of dividends which are translated at historical rates.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

(r)           New Accounting Pronouncements

No accounting standards and guidance with an effective date during the nine-month period ended September 30, 2011 or issued during 2011 had or are expected to have a significant impact on the Company’s condensed consolidated financial statements.
NOTE 2 – ASSETS ACQUISITIONS
Pursuant to the lease contract signed by SCHC on November 5, 2010 with State-Operated Shouguan Qingshuibo Farm (the “Lessor”), the Company recognized in January 2011 (1) a 20-year capital lease of 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, with an annual payment of Renminbi (“RMB”)1,877,000 (approximately $295,365) up to December 31, 2030 to the Lessor, aggregating $3,127,913 (the present value of the minimum lease payments); and (2) a 20-year land lease and rights to new extraction wells on which the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings are situated, with an annual payment of RMB3,123,000 (approximately $491,435) up to December 31, 2030 to the Lessor.  The lease was accounted for under FASB ASC 840-10-25 “Leases – Recognition” and $3,127,913 was included in property, plant equipment under capital lease as of September 30, 2011.
The Company also enhanced the new plant and machinery in the first quarter of 2011 by making capital improvement in reconstruction and renovation work at a cost of approximately $3,050,400, which was recorded as buildings and plant and machinery, for the operation of the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings located on the property.

In the second quarter of 2011, the Company carried out enhancement projects to its existing bromine extraction and crude salt production facilities.  In particular, the Company incurred reconstruction and renovation works at a cost of approximately $12,379,153 for its crude salt fields in Factory No. 1, 5 to 9, and at a cost of approximately $20,087,600 for its extraction wells and transmission channels and ducts in Factory No. 1 to 9.  The above enhancement projects have estimated useful lives of 5 to 8 years and are capitalized as buildings and plant and machinery.

NOTE 3 – INVENTORIES

Inventory consists of:
  
September 30,
2011
  
December 31,
2010
 
       
Raw materials $747,099  $769,817 
Finished goods  2,410,842   1,916,775 
Allowance for obsolete and slow moving inventory  (6,976)  (6,693)
  $3,150,965  $2,679,899 
NOTE 4 – PREPAID LAND LEASES
The Company prepaid for land leases with lease terms for periods ranging from twenty 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.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 4 – PREPAID LAND LEASES – Continued
During the three-month period ended September 30, 2011, amortization of prepaid land lease totaled $159,735, which was recorded as cost of net revenue.  During the three-month period ended September 30, 2010, amortization of prepaid land lease totaled $29,056, of which $28,908 and $148 were recorded as cost of revenue and administrative expenses respectively. During the nine-month period ended September 30, 2011, amortization of prepaid land lease totaled $262,567, which was recorded as cost of net revenue.  During the nine-month period ended September 30, 2010, amortization of prepaid land lease totaled $75,436, of which $74,994 and $442 were recorded as cost of net revenue and administrative expenses respectively.

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 of which the Company could not obtain land use rights certificates covers a total of approximately 94.64 square kilometers of aggregate carrying value of $921,501 and approximately 92.32 square kilometers of aggregate carrying value of $743,275 as at September 30, 2011 and December 31, 2010, respectively.

NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consist of the following:
  
September 30,
2011
  
December 31,
2010
 
At cost:      
Mineral rights $6,265,002  $6,011,790 
Buildings (including salt pans)  40,654,836   41,082,825 
Plant and machinery  118,228,887   85,944,460 
Motor vehicles  6,963   6,683 
Furniture, fixtures and equipment  4,022,702   3,850,525 
Construction in progress  5,352,128   - 
Total  174,530,518   136,896,283 
Less: Accumulated depreciation and amortization  (35,613,493)  (24,717,284)
Net book value $138,917,025  $112,178,999 
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 Company could not obtain property ownership certificates covering certain properties of aggregate carrying value of $31,989,045 and aggregate carrying value of $33,868,298 as at September 30, 2011 and December 31, 2010, respectively.

During the three-month period ended September 30, 2011, depreciation and amortization expense totaled $4,988,255, of which $4,657,093 and $331,162 were recorded as cost of net revenue and administrative expenses respectively. During the three-month period ended September 30, 2010, depreciation and amortization expense totaled $3,048,776, of which $2,947,862 and $100,914 were recorded as cost of sales and administrative expenses respectively.  During the nine-month period ended September 30, 2011, depreciation and amortization expense totaled $12,363,918, of which $11,462,272 and $901,646 were recorded as cost of net revenue and administrative expenses respectively. During the nine-month period ended September 30, 2010, depreciation and amortization expense totaled $7,867,568, of which $7,643,938 and $223,630 were recorded as cost of sales and administrative expenses respectively.
Construction in progress as of September 30, 2011 represented the construction and renovation costs incurred for new Factory No. 4, which is currently under construction.  In mid-May 2011, the local PRC government requested to take the leased land of original Factory No. 4 for redevelopment and agreed to lease another parcel of land to the Company nearby to the existing Factory No. 4. The total construction cost of the new Factory No. 4 is approximately $6,845,160, which is expected to be completed and start operations on a trial basis in November 2011.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)

NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET – Continued

The operations of the original Factory No. 4 were stopped in early July 2011 to cooperate with the demolition of the factory and the relocation of useful plant and machinery to the new factory. For those fixed assets that could not be relocated to the new factory, the Company recognized write-offs of $1,384,443 in the second quarter of 2011 and included the impairment loss in write-off / impairment on property, plant and equipment. A sum of $1,340,026 was received from the local PRC government for the three-month period ended September 30, 2011 as compensation for the demolition of original Factory No. 4 and included in the income statement as other operating income.  

In June 2010, the Company completed the construction of a production line for wastewater treatment chemical additives at a total cost of RMB60,000,000 (equivalent to $8,838,000). A retention payable of $453,000 as at December 31, 2010, representing 5% of the total cost, will be paid to Shouguang City Shengkun Construction Co., Ltd. one year after the completion date. The Company switched this aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as the Company experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. An impairment of $1,805,598 was made in the second quarter of 2011 and included in write-off / impairment on property, plant and equipment.

In late June 2011, the Company completed enhancement projects to its crude salt fields, extraction wells and transmission channels and ducts at a total cost of RMB210,113,600 (equivalent to $32,466,753). Retention payables of $1,668,517 as at September 30, 2011, representing 5% of the total costs, will be paid to Shouguang City Shengdou Construction Group Co., Ltd. and Shouguang City Shengkun Construction Co., Ltd. upon six months after the completion date. Certain protective shells for crude salt fields and transmission channels and ducts were replaced during the enhancement projects, write-offs of $1,632,004 and $2,065,475, respectively, which were made in the second quarter of 2011 and included in write-off / impairment on property, plant and equipment.

For the three-month periods ended September 30, 2011 and 2010, repair and maintenance expenses were $12,985 and $61,625, respectively. For the nine-month periods ended September 30, 2011 and 2010, repair and maintenance expense were $102,076 and $123,438, 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,
2011
  
December 31,
2010
 
At cost:      
Buildings $129,494  $- 
Plant and machinery  2,455,396   - 
Total  2,584,890   - 
Less: Accumulated depreciation and amortization  (182,247)  - 
Net book value $2,402,643  $- 
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 period ended September 30, 2011, depreciation and amortization expense totaled $86,308, which was recorded as cost of net revenue. During the nine-month period ended September 30, 2011, depreciation and amortization expense totaled $179,261, of which $86,308 and $92,954 were recorded as cost of sales and administrative expenses respectively.
An impairment of $683,046 was made in the second quarter of 2011 and included in write-off / impairment on property, plant and equipment.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 7 – OTHER RECEIVABLE

Other receivable represents unused deposit with a broker-dealer for the Company’s stock repurchase program in third quarter of 2011. The unused deposit was returned to the Company in cash in October 2011.

NOTE 8 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consist of the following:

  September 30,  December 31, 
  2011  2010 
Accounts payable $8,438,687  $5,661,329 
Salary payable  126,182   121,121 
Social security insurance contribution payable  48,656   30,946 
Amount due to a contractor  342,258   - 
Other payable  1,239,884   606,339 
Total $10,195,667  $6,419,735 
NOTE 9 – TAXES PAYABLE
Taxes payable consists of the following:
  September 30,  December 31, 
  2011  2010 
Income tax payable $1,960,519  $4,377,314 
Mineral resource compensation fee payable  515,797   486,585 
Value added tax payable  1,568,691   1,031,525 
Land use tax payable  803,941   966,397 
Other tax payables  288,136   301,274 
Total $5,137,084  $7,163,095 
NOTE 10 – CAPITAL LEASE OBLIGATIONS
The components of capital lease obligations are as follows:
 Imputed September 30,  December 31, 
 Interest rate 2011  2010 
Total capital lease obligations6.7% $3,146,977  $- 
Less: Current portion   (136,249)  - 
Capital lease obligations, net of current portion  $3,010,728  $- 

Interest expenses from capital lease obligations amounted to $51,994 and $159,950 were charged to the income statements for the three-month and nine-month periods ended September 30, 2011, respectively.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 11 – COMMON STOCK

In the fourth quarter of 2008, the Company granted to one Board member options to purchase a total of 12,500 shares of the Company’s common stock at an exercise price of $1.44 per share and the options vested immediately.  In February 2010, the Company issued 12,500 shares of its common stock upon the exercise of such stock options by the Board member.

In June 2010, the Company issued 70,560 shares of its common stock, valued at $608,227, to acquire assets owned by Mr Jinjin Li, Ms Qiuzhen Wang, Yueliang Wang, Kunming Tian, Gaoming Tian and Zhiqiang Wei.

In the second quarter of 2011, the Company issued 9,430 shares of its common stock based on the fair market price of $3.42 upon the cashless exercise of 12,500 stock options granted to a Board member.

NOTE 12 – TREASURY STOCK

In June 2011, the Company repurchased 100,500 shares of common stock of the Company at an average price of $3.46 per share for a total cost of $348,147 under the approval of the Board of Directors.  In September 2011, the Company repurchased 84,099 common stock of the Company at an average price of $1.81 per share for a total cost of $151,853 under the approval of the Board of Directors. The Company recorded the entire purchase price of the treasury stock as a reduction of equity.

NOTE 13 – 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.

In February 2011, the Company granted to the investor relations firm a warrant to purchase 50,000 shares of the Company’s common stock at an exercise price of $12.6 per share and the warrants vested immediately. The warrant was valued at $452,000 fair value, using the Black-Scholes option pricing model with assumed 193.42% volatility, a five-year expiration term, a risk free rate of 2.30% and no dividend yield. For the three-month and nine-month periods ended September 30, 2011, $0 and $452,000 were recognized as general and administrative expenses, respectively.

In early March 2011, 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 $9.16 per share and the options vested immediately. The options were valued at $35,000 fair value, using the Black-Scholes option pricing model with assumed 64.5% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.46% and no dividend yield. For the three-month and nine-month periods ended September 30, 2011, $0 and $35,000 were recognized as general and administrative expenses, respectively.

In late March 2011, the Company granted to 3 executive officers options to purchase 1,200,000 shares of the Company’s common stock at an exercise price of $4.97 per share and the options are exercisable in equal installments over periods of two years. The options were valued at $4,317,000 fair value, using the Black-Scholes option pricing model with assumed 77.22% to 94.36% volatility, a four-year expiration term with expected tenors of 2 to 2.49 years, risk free rates of 0.81% to 1.05% and no dividend yield. For the three-month and nine-month periods ended September 30, 2011, $0 and $1,945,000 was recognized as general and administrative expenses, respectively.

In late March 2011, the Company also granted to 18 management staff options to purchase 654,000 shares of the Company’s common stock at an exercise price of $4.97 per share and the options are exercisable in equal installments over periods of three years. The options were valued at $2,632,000 fair value, using the Black-Scholes option pricing model with assumed 77.22% to 118.84% volatility, a four-year expiration term with expected tenors of 2 to 3 years, risk free rates of 0.81% to 1.29% and no dividend yield. For the three-month and nine-month periods ended September 30, 2011, $0 and $706,000 were recognized as general and administrative expenses, respectively.

In early May 2011, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.93 per share and the option vested immediately. The option was valued at $15,800 fair value, using the Black-Scholes option pricing model with assumed 79.91% volatility, a four-year expiration term with expected tenor of 2 years, a risk free rate of 0.57% and no dividend yield. For the three-month and nine-month periods ended September 30, 2011, $15,800 was recognized as general and administrative expenses.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 13 – STOCK-BASED COMPENSATION – Continued

In late June 2011, 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 $3.10 per share and the option vested immediately. The option was valued at $15,200 fair value, using the Black-Scholes option pricing model with assumed 86.36% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.32% and no dividend yield. For the three-month and nine-month periods ended September 30, 2011, $15,200 was recognized as general and administrative expenses.

In late September 2011, the Company and certain management staff and directors mutually agreed to cancel certain unexercised and all non-vested stock options previously granted for an aggregate of 1,181,000 shares of the Company’s common stock, having exercise prices between $4.97 to $8.25 per share, without consideration. In accordance with ASC 718-20-35-9, Awards Classified as Equity — Cancellation and Replacement, the Company accelerated the remaining expense on these cancelled awards that resulted in $4,298,000 recorded in general and administrative expense during the three-month period ended September 30, 2011.

The following table summarizes all Company stock option transactions between January 1, 2011 and September 30, 2011.
  
Number of Option
and Warrants
Outstanding
  
Number of Option
and Warrants
Non-vested
  
Number of Option
and Warrants
Vested
  
Range of
Exercise Price per Common Share
 
Balance, January 1, 2011  458,971   -   458,971   $0.84 - $12.00 
Granted during the nine-month
period ended September 30, 2011
  1,941,500   1,941,500   -   $2.93 - $12.60 
Vested during the nine-month period
ended September 30, 2011
  -   (905,500)  905,500   $2.93 - $12.60 
Exercised during the nine-month
period ended September 30, 2011
  (12,500)  -   (12,500)  $0.84 
Forfeited, canceled or expired
during the nine-month period
ended September 30, 2011
  (1,256,000)  (1,036,000)  (220,000)  $4.80 - $10.43 
Balance, September 30, 2011  1,131,971   -   1,131,971   $2.93 - $12.60 

  Stock and Warrants Options Outstanding
      Weighted Average Weighted Average
  Outstanding   Remaining Exercise Price of
  
at September 30,
 2011
 
Range of
Exercise Prices
 
Contractual Life
 (Years)
 
Options Currently
 Outstanding
Exercisable and outstanding 1,131,971 $2.93 - $12.60 3.17 $   6.34
The weighted average grant-date fair values as at September 30, 2011 and December 31, 2010 were $7.34 and $8.83, respectively.

At September 30, 2011, the aggregate intrinsic value of the stock options and warrants was $1,380,987.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 14 – 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 tax rate of 34%. No provision for the US federal income taxes has been made as the Company had no US taxable income for the periods ended September 30, 2011 and 2010, 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 periods ended September 30, 2011 and 2010.

(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 period.  The applicable statutory tax rates for the periods ended September 30, 2011 and 2010 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, 2011 and December 31, 2010, the accumulated undistributed PRC earnings are $190,521,758 and $141,781,942, 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, 2011, the Company has not recorded any WHT on the cumulative amount of undistributed retained earnings of its foreign invested enterprises in China.  As of September 30, 2011 and December 31, 2010, the unrecognized WHT are $8,178,272 and $5,795,755, respectively.

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  Nine-Month Period 
  Ended September 30,  Ended September 30 
Reconciliations 2011  2010  2011  2010 
             
Statutory income tax rate  25%  25%  25%  25%
Non-taxable items  (1%)  0%  (1%)  0%
US federal net operating loss  12%  1%  5%  1%
Effective tax rate  36%  26%  29%  26%
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)
NOTE 14 – INCOME TAXES – Continued

Significant components of the Company’s deferred tax assets and liabilities at September 30, 2011 and December 30, 2010 are as follows:

  September 30,  December 31, 
  2011  2010 
Deferred tax liabilities $-  $- 
         
Deferred tax assets:        
Allowance for obsolete and slow-moving inventories $1,744  $1,674 
Impairment on property, plant and equipment  633,596   - 
Exploration costs  1,253,372   - 
Property, plant and equipment  92,289   98,020 
Property, plant and equipment under capital leases  (12,497)  - 
US federal net operating loss  10,473,378   7,698,225 
         
Total deferred tax assets  12,441,882   7,797,919 
         
Valuation allowance  (10,473,378)  (7,698,225)
         
Net deferred tax asset $1,968,504  $99,694 
         
Current deferred tax asset $1,744  $99,694 
         
Long-term deferred tax asset $1,966,760  $- 

There was no unrecognized tax benefits and accrual for uncertain tax positions as of September 30, 2011 and December 31, 2010.
NOTE 15 – BUSINESS SEGMENTS

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

An operating segment’s performance is primarily evaluated based on segment operating income, which excludes share-based compensation expense, certain corporate costs and other income not associated with the operations of the segment. These corporate costs (income) are separately stated below and also include costs that are related to functional areas such as accounting, treasury, information technology, legal, human resources, and internal audit. The Company believes that segment operating income, as defined above, is an appropriate measure for evaluating the operating performance of its segments.
Three-Month Period Ended
September 30, 2011
 Bromine *  
Crude
 Salt *
  
Chemical
 Products
  
Segment
 Total
  Corporate  Total 
Net revenue
(external customers)
 $24,820,194  $2,455,307  $10,486,474  $37,761,975  $-  $37,761,975 
Net revenue
(intersegment)
  717,251   -   -   717,251   -   717,251 
Income (loss) from operations before taxes  9,408,923   1,317,015   2,661,362   13,387,300   (4,641,055)  8,746,245 
Income taxes  2,290,082   230,105   659,359   3,179,546   -   3,179,546 
Income (loss) from operations after taxes  7,118,841   1,086,910   2,002,003   10,207,754   (4,641,055)  5,566,699 
Total assets  165,546,613   45,291,380   45,346,872   256,184,865   2,594,619   258,779,484 
Depreciation and amortization  3,287,677   1,161,077   625,809   5,074,563   -   5,074,563 
Capital expenditures  573,820   57,657   153,426   784,903   -   784,903 
Write-off / Impairment   -   -   -   -   -   - 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)

NOTE 15 – BUSINESS SEGMENTS – Continued
Three-Month Period Ended
September 30, 2010
 Bromine *  
Crude
 Salt *
  
Chemical
 Products
  
Segment
 Total
  Corporate  Total 
Net revenue
(external customers)
 $28,180,884  $4,579,876  $11,997,534  $44,758,294  $-  $44,758,294 
Net revenue
(intersegment)
  1,177,850   -   -   1,177,850   -   1,177,850 
Income (loss) from operations before taxes  13,901,242   3,265,430   3,206,300   20,372,972   (464,253)  19,908,719 
Income taxes  3,547,794   756,857   805,655   5,110,306   -   5,110,306 
Income (loss) from operations after taxes  10,353,448   2,508,573   2,400,645   15,262,666   (464,253)  14,798,413 
Total assets  124,765,055   31,989,512   37,408,781   194,163,348   106,978   194,270,326 
Depreciation and amortization  1,952,001   403,729   693,046   3,048,776   -   3,048,776 
Capital expenditures      5,451,211   1,124,423   -   6,575,634   -   6,575,634 
Nine-Month
Period Ended
September 30, 2011
 Bromine *  
Crude
 Salt *
  
Chemical
 Products
  
Segment
 Total
  Corporate  Total 
Net revenue
(external customers)
 $88,200,156  $13,484,025  $32,757,138  $134,441,319  $-  $134,441,319 
Net revenue
(intersegment)
  2,221,117   -   -   2,221,117   -   2,221,117 
Income (loss) from operations before taxes  35,322,297   7,190,560   8,047,059   50,559,916   (8,160,769)  42,399,147 
Income taxes  9,032,235   1,423,022   2,009,756   12,465,013   -   12,465,013 
Income (loss) from operations after taxes  26,290,062   5,767,538   6,037,303   38,094,903   (8,160,769)  29,934,134 
Total assets  165,546,613   45,291,380   45,346,872   256,184,865   2,594,619   258,779,484 
Depreciation and amortization  8,301,833   2,259,754   1,981,592   12,543,179   -   12,543,179 
Capital expenditures  32,222,899   16,243,142   191,090   48,657,131   -   48,657,131 
Write-off / Impairment   3,749,435   2,015,533   1,805,598   7,570,566   -    7,570,566 
Nine-Month
Period Ended
September 30, 2010
 Bromine *  
Crude
 Salt *
  
Chemical
 Products
  
Segment
 Total
  Corporate  Total 
Net revenue
(external customers)
 $76,183,791  $11,457,497  $33,562,233  $121,203,521  $-  $121,203,521 
Net revenue
(intersegment)
  2,803,882   -   -   2,803,882   -   2,803,882 
Income (loss) from operations before taxes  36,751,337   8,241,849   9,959,587   54,952,773   (2,089,424)  52,863,349 
Income taxes  9,605,196   1,653,622   2,500,895   13,759,713   -   13,759,713 
Income (loss) from operations after taxes  27,146,141   6,588,227   7,458,692   41,193,060   (2,089,424)  39,103,636 
Total assets  124,765,055   31,989,512   37,408,781   194,163,348   106,978   194,270,326 
Depreciation and amortization  5,407,728   923,334   1,536,506   7,867,568   -   7,867,568 
Capital expenditures        15,662,259   5,338,431   7,483,230   28,483,920   -   28,483,920 

* 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.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)

NOTE 15 – BUSINESS SEGMENTS – Continued
  Three-Month Period  Nine-Month Period 
  Ended September 30,  Ended September 30 
Reconciliations 2011  2010  2011  2010 
                 
Total segment operating income $13,387,300  $20,372,972  $50,559,916  $54,952,773 
Corporate costs  (4,641,055)  (464,253)  (8,160,769)  (2,089,424) 
Income from operations  8,746,245   19,908,719   42,399,147   52,863,349 
Other income  17,647   66,689   38,466   180,047 
Income before taxes $8,763,892  $19,975,408  $42,437,613  $53,043,396 
The following table shows the major customer(s) (10% or more) for the three-month period ended September 30, 2011.

Number Customer 
Bromine
(000’s)
  
Crude Salt
(000’s)
  
Chemical Products
(000’s)
  
Total
Revenue
(000’s)
  
Percentage of
Total Revenue (%)
 
 1 Shandong Morui Chemical Company Limited $2,713  $554  $590  $3,857   10.2% 
TOTAL   $2,713  $554  $590  $3,857   10.2% 

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

Number Customer 
Bromine
(000’s)
  
Crude Salt
(000’s)
  
Chemical Products
(000’s)
  
Total
Revenue
(000’s)
  
Percentage of
Total Revenue (%)
 
 1 Shandong Morui Chemical Company Limited $11,951  $2,517  $1,919  $16,387   12.2% 
 2 Shouguang City Rongyuan Chemical Company Limited $10,320  $3,203  $-  $13,523   10.1% 
TOTAL   $22,271  $5,720  $1,919  $29,910   22.3% 

The following table shows the major customer(s) (10% or more) for the three-month period ended September 30, 2010.
Number Customer 
Bromine
(000’s)
  
Crude Salt
(000’s)
  
Chemical Products
(000’s)
  
Total
Revenue
(000’s)
  
Percentage of
Total Revenue (%)
 
 1 Shouguang City Rongyuan Chemical Company Limited $3,379  $1,108  $-  $4,487   10.0% 
TOTAL   $3,379  $1,108  $-  $4,487   10.0% 

The following table shows the major customer(s) (10% or more) for the nine-month period ended September 30, 2010.

Number Customer 
Bromine
(000’s)
  
Crude Salt
(000’s)
  
Chemical Products
(000’s)
  
Total
Revenue
(000’s)
  
Percentage of
Total Revenue (%)
 
 1 Shouguang City Rongyuan Chemical Company Limited $10,091  $2,654  $-  $12,745   10.5% 
TOTAL   $10,091  $2,654  $-  $12,745   10.5% 
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)

NOTE 16 – MAJOR SUPPLIERS

During the three-month and nine-month periods ended September 30, 2011, the Company purchased 80.0% and 81.1% of its raw materials from its top five suppliers, respectively.  At September 30, 2011, amounts due to those suppliers included in accounts payable were $6,927,770. During the three-month and nine-month periods ended September 30, 2010, the Company purchased 91.6% and 88.5% of its raw material from top five suppliers, respectively.  At September 30, 2010, amounts due to those suppliers included in accounts payable were $5,977,531. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.

NOTE 17 – 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, 2011, the Company sold 40.1% and 42.9% of its products to its top five customers, respectively. At September 30, 2011, amounts due from these customers were $10,919,450. During the three-month and nine-month periods ended September 30, 2010, the Company sold 42.0% and 41.4% of its products to its top five customers, respectively.  At September 30, 2010, amounts due from these customers were $5,984,753. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.

NOTE 18 – FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of financial instruments, which consist of cash, accounts receivable and accounts payable, other receivables 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, 2011 and December 31, 2010.

NOTE 19 – RESEARCH AND DEVELOPMENT EXPENSES

On September 6, 2007, SYCI and East China University of Science and Technology formally opened a Co-Op Research and Development Center. The research center is equipped with state of the art chemical engineering instruments for the purpose of pursuing targeted research and development of refined bromide compounds and end products. According to the Co-Op Research Agreement, any research achievement or patents will become assets of the Company. Originally, the Company will provide $500,000 annually until June 2012 to East China University of Science and Technology for research. On June 7, 2011, the Company and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for the Company.

Since the second quarter of 2010, SYCI conducted research for the new production line of wastewater treatment additives, the purpose of which is for the testing of the manufacturing routine and samples. The new production line was started operation and normal production in April 2011. However, the Company switched the aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as the Company experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. The research and development expense incurred for the new production line of wastewater treatment additives from outside parties and the consumption of bromine produced by the Company during the three-month period ended September 30, 2011 were $10,135 and $23,429, respectively. The research and development expense incurred for the new production line of wastewater treatment additives from outside parties and the consumption of bromine produced by the Company during the nine-month period ended September 30, 2011 were $43,949 and $66,655, respectively.

The total research and development expense recognized in the income statements during the three-month periods ended September 30, 2011 and 2010 were $33,565 and $891,509, respectively. The total research and development expense recognized in the income statements during the nine-month periods ended September 30, 2011 and 2010 were $347,420 and $1,612,862, respectively.
GULF RESOURCES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(Expressed in U.S. dollars)
(UNAUDITED)

NOTE 20 – CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS

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 five pieces of land under non-cancelable operating leases, which are fixed in rentals and expired through December 2030, December 2040, February 2059, August 2059 and June 2060, respectively. The Company accounts for the leases as operating leases.

The Company has committed (i) approximately $1,026,774 for the relocation and construction of new Factory No. 4 and (ii) approximately $1,409,946 for the drilling of exploratory wells and their associated facilities in Sichuan province as of September 30, 2011.

The following table sets forth the Company’s contractual obligations as of September 30, 2011:

  Capital Lease Obligations  Operating Lease Obligations  Purchase Obligations 
Payable within:          
  the next 12 months $295,364  $434,283  $2,436,720 
  the next 13 to 24 months  295,365   633,612   - 
  the next 25 to 36 months  295,365   634,155   - 
the next 37 to 48 months  295,365   637,892   - 
the next 49 to 60 months  295,365   642,921   - 
  thereafter  4,135,106   17,637,271   - 
Total $5,611,930  $20,620,134  $2,436,720 
Less: Amount representing interest  (2,464,953)        
Present value of net minimum lease payments $3,146,977         

Rental expenses related to operating leases of the Company amounted to $159,735 and $29,056 were charged to the income statements for the three-month ended September 30, 2011 and 2010, respectively. Rental expenses related to operating leases of the Company amounted to $421,223 and $75,436 were charged to the income statements for the nine-month ended September 30, 2011 and 2010, respectively.

NOTE 21 – CONTINGENCY
The Company and certain of its officers and directors (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 plaintiff asserts 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 complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. The Company intends to defend vigorously against the lawsuit.  The Company currently cannot estimate the amount or range of possible losses from this litigation.       

The legal costs incurred for the three-month and nine-month periods ended September 30, 2011 in connection with the above legal cases amounted to $58,751, which was included in the income statements as general and administrative expenses.
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 Annual Report on Form 10-K for the year ended December 31, 2010 (“2010 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 2010 Form 10-K and Item 1A, “Risk Factors” for the year ended December 31, 2010.

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 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.  Chinese laws and regulations currently do not prohibit or restrict foreign ownership in crude salt, bromine and brominated specialty chemicals businesses.
In January 2007, stockholders holding approximately 62% of the then outstanding shares of our common stock consented in writing to change our corporate name from Diversifax, Inc. to Gulf Resources, Inc.  On February 20, 2007, we changed our corporate name to Gulf Resources, Inc.
On November 28, 2007, we amended our certificate of incorporation to increase our authorized shares of common stock from 70,000,000 to 400,000,000 and to effect a 2-for-1 forward stock split of our outstanding shares of common stock.

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, the 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, 2011 and 2010. 

Comparison of the Three-Month Periods Ended September 30, 2011 and 2010

 
Three-Month Period
Ended September 30, 2011
 
Three-Month Period
Ended September 30, 2010
 % Change
Net revenue$37,761,975  $44,758,294 　 (16%)
Cost of net revenue$(23,823,944)  $(23,002,703) 　 4%
Gross profit$13,938,031  $21,755,591 　 (36%)
Sales, marketing and other operating expenses$(20,116)  $(18,789)  7%
Research and development costs$(33,565)  $(891,509) 　 (96%)
Exploration costs$(1,047,110) $- 　 - 
General and administrative expenses$(5,459,069)  $(1,003,129)  444% 
Other operating income$1,368,074  $66,555 　 1,956%
Income from operations$8,746,245  $19,908,719 　 (56%)
Other income, net$17,647  $66,689 　 (74%)
Income before taxes$8,763,892  $19,975,408 　 (56%)
Income taxes$(3,179,546)  $(5,110,306) 　 (38%)
Net income$5,584,346  $14,865,102 　 (62%)

All of our operations are located in PRC and all of our net revenue and expenditures, including purchases of raw materials, are denominated in RMB, the functional currency of the Company’s PRC operating subsidiaries. Accordingly, we believe that any foreign exchange rate variances will not have an impact on our net revenue, cost of net revenue, and operating income

Net revenue Net revenue was $37,761,975 for three-month period ended September 30, 2011, a decrease of approximately $7.0 million (or 16%) as compared to the same period in 2010. This decrease was primarily attributable to the reduce of overall demand for all of our segment products, in which, (i) revenue from bromine segment decreased from $28,180,884 for the three-month period ended September 30, 2010 to $24,820,194 for the same period in 2011, a decrease of approximately 12%; (ii) revenue from crude salt segment decreased from $4,579,876 for the three-month period ended September 30, 2010 to $2,455,307 for the same period in 2011, a decrease of approximately 46%; and (iii) revenue from chemical products segment decreased from 11,997,534 for the three-month period ended September 30, 2010 to $10,486,474 for the same period in 2011, a decrease of approximately 13%.

  Net Revenue by Segment  
  Three-Month Period Ended Three-Month Period Ended Percent Decrease
  September 30, 2011 September 30, 2010 of Net Revenue
Segment    Percent of total    Percent of total   
Bromine $24,820,194   66% $28,180,884   63%  (12%)
Crude Salt $2,455,307   6% $4,579,876   10%  (46%)
Chemical Products $10,486,474   28% $11,997,534   27%  (13%)
Total sales $37,761,975   100% $44,758,294   100%  (16%)

  Three-Month Period Ended  Percentage Change
Bromine and crude salt segments product sold in tonnes September 30, 2011  September 30, 2010  Increase/(Decrease)
Bromine  6,900   10,003   (31%)
Crude Salt  66,014   109,930   (40%)
  Three-Month Period Ended  Percentage Change
Chemical products segment sold in tonnes September 30, 2011  September 30, 2010  Increase/(Decrease)
Oil and gas exploration additives  3,890   5,736   (32%)
Paper manufacturing additives  1,075   1414   (24%)
Pesticides manufacturing additives  610   862   (29%)
Wastewater treatment chemical additives  5   -   - 
Overall  5,580   8,012   (30%)
Bromine segment
The decrease in net revenue from our bromine segment was mainly due to the decrease in sales volume of bromine, decreased from 10,003 tonnes for the three-month period ended September 30, 2010 to 6,900 tonnes for the same period in 2011, a decrease of approximately 31%. Despite an increase in the number of our bromine production plants in recent years, sales volume of bromine decreased. The decrease in the sales volume of bromine was mainly attributable to (i) the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy; (ii) and less bromine being extracted from brine water during the production process due to the trend of a decrease in the bromine concentration of brine water being extracted at our facilities; and (iii) the suspension of operations of our original Factory No. 4 in early July 2011 to cooperate with the demolition of the factory and construction of new factory, which was still under construction as of September 30, 2011.

The effect of the decrease in net revenue from our bromine segment for the three-month period ended September 30, 2011 was partially offset by the increase in the average selling price of bromine compared to the same period in 2010. The average selling price of bromine increased from $2,817 per tonne for the three-month period ended September 30, 2010 to $3,597 per tonne for the same period in 2011, an increase of 28%. As opposite to last quarter, the effect of the increase in the average selling price was diminished due to the macro-economic tightening policy imposed by the PRC government which reduced the demand and average selling price of bromine during the three-month period ended September 30, 2011. The average selling price for this quarter decreased by 17% (or $736 per tonne) as compared with the three-month period ended June 30, 2011 ($4,333 per tonne). We expect the average selling price of bromine will remain constant at current level towards the end of 2011 should the macro-economic tightening policy remains enforced by the PRC government. 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, 2011 from the same period in 2010.

  
Three-Month Period
Ended September 30
Increase / (Decrease) in net revenue of bromine as a result of: 2011 vs. 2010
Increase in average selling price $6,591,437 
Decrease in sales volume $(9,952,127) 
Total effect on net revenue of bromine $(3,360,690) 

In an effort to address the trend of a decrease in the bromine concentration of brine water being extracted at our facilities, we carried out enhancement projects to our extraction wells in June 2011 by increasing the depth of our brine water wells to extract brine water from a lower second layer which we believe will have a higher bromine concentration. The result of the enhancement projects was not reflected in this quarter of 2011 as the overall demand of bromine decreased due to the macro-economic tightening policy imposed by the PRC government.

Crude salt segment
The decrease in net revenue from our crude salt segment was mainly due to the decrease in both the average selling price and sales volume of crude salt. The average selling price of crude salt decreased from $41.70 per tonne for the three-month period ended September 30, 2010 to $37.20 per tonne for the same period in 2011, a decrease of 11%, and the sales volume of crude salt also decreased by nearly 40% from 109,930 tonnes for the three-month period ended September 30, 2010 to 66,014 tonnes for the same period in 2011. The decrease in both the average selling price and sales volume was a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which decreased the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. The decrease in sales volume also was a result of the decrease in sales volume of bromine in this quarter, which reduced the wastewater available for the production of crude salt. 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, 2011 from the same period in 2010.

  
Three-Month Period
Ended September 30
Increase / (Decrease) in net revenue of crude salt as a result of: 2011 vs. 2010
Decrease in average selling price $(393,047)
Decrease in sales volume $(1,731,522) 
Total effect on net revenue of crude salt $(2,124,569) 
Chemical products segment
  Product Mix of Chemical Products Segment Percent
  Three-Month Period Ended Three-Month Period Ended Change of
  September 30, 2011 September 30, 2010 Net Revenue
Chemical Products    Percent of total    Percent of total   
Oil and gas exploration additives $6,589,900   63% $8,477,869   71%  (22%)
Paper manufacturing additives $1,402,234   13% $1,655,924   14%  (15%)
Pesticides manufacturing additives $2,478,345   24% $1,863,741   15%  33%
Wastewater treatment
chemical additives
 $15,995   0% $-   -   - 
Total sales $10,486,474   100% $11,997,534   100%  (13%)

Revenues from our chemical products segment decreased from $11,997,534 for three-month period ended September 30, 2010 to $10,486,474 for the same period in 2011, a decrease of approximately 13%. The decrease was mainly attributable to the drop in demand for 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 $6,589,900 (or 63%) and $8,477,869 (or 71%) of our chemical segment revenue for the three-month period ended September 30, 2011 and 2010, respectively, with a decrease of $1,887,969, or 22%. Revenue from our agricultural intermediates increased from $1,863,741 for the three-month period ended September 30, 2010 to $2,478,345 for the same period in 2011, an increase of $614,604, or approximately 33%. As result of the macro-economic tightening policy imposed by the PRC government since the second half of 2010 to slow down the economy, the overall demand for chemical additives was reduced, which in turn reduced the sale of our chemical products in terms of volume in 2011. The sales volume of chemical products decreased by 30% from 8,012 tonnes for the three-month period ended September 30, 2010 to 5,580 tonnes for the same period in 2011.

However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price for all of our chemical products due to the continuing high price levels of oil. The average selling price per tonne for our chemical products increased by a range of 11.4% to 88% for the three-month period ended September 30, 2011 as compared with the same period in 2010. In particular, the PRC government continued to support the expansion of agricultural related products and we successfully converted certain of our production equipment from wastewater treatment chemical additives to pharmaceutical and agricultural chemical additives in July of 2011, which supported the growth in sales of our pesticides manufacturing additives since then. 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, 2011 from the same period in 2010.
Increase / (Decrease) in net revenue, for the three-month period ended September 30, 2011 vs. 2010, as a result of: Oil and gas exploration additives  Paper manufacturing additives  Agricultural intermediates
Increase in average selling price $1,039,854  $165,907  $1,400,532 
Decrease in sales volume $(2,927,823) $(419,597) $(785,928)
Total effect on net revenue of chemical products $(1,887,969) $(253,690) $614,604 
Cost of Net Revenue
  Cost of Net Revenue by Segment % Change
  Three-Month Period Ended Three-Month Period Ended of Cost of
  September 30, 2011 September 30, 2010 Net Revenue
Segment    
% of Segment
Net Revenue
    
% of Segment
Net Revenue
   
Bromine $15,003,570   60% $13,932,803   49%  8%
Crude Salt $1,094,508   45% $1,226,256   27%  (11%)
Chemical Products $7,725,866   74% $7,843,644   65%  (2%)
Total $23,823,944   63% $23,002,703   51%  4%

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 $23,823,944 for three-month period ended September 30, 2011, an increase of $821,241 (or 4%) as compared to the same period in 2010. Despite the decrease in net revenue for the three-month period ended September 30, 2011 over the same period in 2010, the increase in the purchase price of raw materials and the fixed level of depreciation and amortization of manufacturing plant and machinery increased the overall cost of net revenue as compared to last comparison period.
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 tons)  
Utilization
Ratio
 
Three-month period ended September 30, 2010  46,300   94% 
Three-month period ended September 30, 2011  41,547   66% 
Variance of the three-month periods ended September 30, 2011 and 2010  (4,753)  (28%)

Our utilization ratio is calculated based on the annualized actual production volume in tons for the three-month period divided by the annual production capacity in tons

Our utilization ratio decreased by 28% for the three-month period ended September 30, 2011 as compared with the same period in 2010. The decrease in utilization and hence the sales volume of bromine was mainly attributable to (i) the suspension of operations of our original Factory No. 4 in early July 2011 to cooperate with the demolition of the factory and construction of a new factory, which was still under construction as of September 30, 2011; and (ii) the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, which reduced our production volume in this quarter.

In view of the trend of a decrease in the bromine concentration of the brine water being extracted at our production facilities as explained hereinbefore, in October 2011 we engaged a professional appraisal firm, Grant Sherman Appraisal Limited, to reassess the optimal annual production capacity of all of our factory facilities. The report by Grant Sherman Appraisal Limited determined that our optimal annual production capacity of bromine and crude salt to be 41,547 tons and 861,143 tons, respectively.

Bromine segment
For the three-month period ended September 30, 2011, the cost of net revenue for the bromine segment was $15,003,570, representing an increase of $1,070,767 or 8% over the same period in 2010. The three major components of the cost of net revenue for the bromine segment, namely, cost of raw materials and finished goods consumed, depreciation and amortization of manufacturing plant and machinery and electricity, contributed $8,961,623 (or 60%), $2,993,772 (or 20%) and $1,121,067 (or 8%), respectively to of the cost of net revenue for the three-month period ended September 2011. For the three-month period ended September 30, 2010, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $9,350,451 (or 67%), depreciation and amortization of manufacturing plant and machinery of $1,875,396 (or 14%) and electricity of $1,414,513 (or 10%), a similar cost structure as compared with the same in 2011 except that the contribution from depreciation and amortization of manufacturing plant and machinery increased by 6% point. The increase in depreciation and amortization was due to enhancement projects performed in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts and the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years.

Crude salt segment
The cost of net revenue for our crude salt segment for the three-month period ended September 30, 2011 was $1,094,508, a decrease of $131,748 (or 11%) compared to $1,226,256 for the same period in 2010. The decrease was mainly attributable to a decrease in the production of bromine, which in turn decreased the volume of wastewater available for the evaporation of crude salt in this quarter, which decreased the corresponding variable costs, such as resource taxes paid and electricity. Whereas the depreciation and amortization of manufacturing plant and machinery increased for the three-month period ended September 30, 2011 as compared with the same period in 2010 as a result of the enhancement projects performed in late June 2011 to our crude fields, extraction wells and transmission channels and ducts and the change in the estimated useful life of certain protective coverings and transmission channels and ducts from 8 years to 5 years. The significant cost components for the three-month period ended September 30, 2011 were depreciation and amortization of $645,089 (or 59%), resource taxes calculated based on crude salt sold of $118,103 (or 11%) and electricity of $64,666 (or 6%). The significant cost components for the three-month period ended September 30, 2010 were depreciation and amortization of $387,387 (or 32%), resource tax of $325,173 (or 27%) and electricity of $301,760 (25%).

Chemical products segment
Cost of net revenue for our chemical products segment for the three-month period ended September 30, 2011, was $7,725,866, representing a decrease of $117,778 or 2% over the same period in 2010. The rate of decrease for the cost of net revenue for our chemical products segment was less than that of net revenue due to the drop in selling price of oil and gas exploration additives and paper manufacturing additives as a result of a decrease in demand. The significant costs were cost of raw material and finished goods consumed of $6,763,332 (or 88%) and $6,796,921 (87%) and depreciation and amortization of manufacturing plant and machinery of $618,083 (or 8%) and $685,079 (or 9%) for each of the three-month periods ended September 30, 2011 and 2010, respectively. As the components of our cost of net revenue are fixed levels of depreciation and amortization of our manufacturing plant and machinery and the inflated purchase price of raw materials, the overall cost of net revenue for our chemical products segment remained the same for the three-month period ended September 30, 2011 and 2010.
Gross Profit Gross profit was $13,938,031, or 37%, of net revenue for three-month period ended September 30, 2011 compared to $21,755,591, or 49%, of net revenue for the same period in 2010.
  Gross Profit by Segment % Point
  Three-Month Period Ended Three-Month Period Ended Change
  September 30, 2011 September 30, 2010 of Gross Profit
Segment    Gross Profit Margin    Gross Profit Margin    
Bromine $9,816,624   40% $14,248,081   51%  (11%) 
Crude Salt $1,360,799   55% $3,353,620   73%  (18%) 
Chemical Products $2,760,608   26% $4,153,890   35%  (9%) 
Total Gross Profit $13,938,031   37% $21,755,591   49%  (12%) 

Bromine segment
For the three-month period ended September 30, 2011, the gross profit margin for our bromine segment was 40% compared to 51% for the same period in 2010. Although the average selling price of bromine increased from $2,817 per tonne for the three-month period ended September 30, 2010 to $3,597 per tonne for the same period in 2011, an increase of 28%, the decrease in sales volume of bromine outweighed the favorable effect of the price increase. The sales volume decreased from 10,003 tonnes for the three-month period ended September 30, 2010 to 6,900 tonnes for the same period in 2011, a decrease of 31%. As mentioned in the net revenue discussion above, due to the decrease in the bromine concentration of brine water being extracted and the PRC government’s macro-economic tightening policy to slow down the economy, our actual production in the three-month ended September 30, 2011 was adversely affected. In order to improve the quality of brine water being extracted from our wells, we completed enhancements of our facilities during the second quarter of 2011 to pump brine water from deeper underground. We expect that the production capacity of bromine will improve in the near future as a result of these enhancements and that the average selling price of bromine will remain at current level towards the end of 2011 should the PRC government’s macro-economic tightening policy remain in place.
Crude salt segment
For the three-month period ended September 30, 2011 the gross profit margin for our crude salt segment was 55% compared to 73% for the same period in 2010. This 18% decrease in our gross profit margin is attributable to (i) the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects performed in late June 2011 to our crude fields, extraction wells and transmission channels and ducts; and (ii) the change in the estimated useful life of certain protective shells and transmission channels and ducts from 8 years to 5 years. As mentioned hereinbefore, the decrease in gross profit was a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which decreased the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries.

Chemical products segment
The gross profit margin for our chemical products segment for the three-month period ended September 30, 2011 was 26% compared to 35% for the same period in 2010, a decrease of 9%. As mentioned hereinbefore, the decrease in gross profit margin was a result of the decrease in demand for our oil and gas exploration additives and paper manufacturing additives which in turn reduced the sales volume of these chemical products. As sales of oil and gas exploration additives contributed more than 63% of our total chemical products segment’s net revenue, the decrease in demand largely reduced the gross profit margin of our chemical products segment.

Research and Development Costs The total research and development costs incurred for the three-month period ended September 30, 2011 and 2010 were $33,565 and $891,509, respectively, a decrease of 96%. Research and development costs for the three-month period ended September 30, 2011 represented raw materials used by SYCI for testing the manufacturing routine and samples of the new production line of wastewater treatment additives and production line of pharmaceutical and agricultural chemical intermediates. Research and development costs for the three-month period ended September 30, 2010 were mostly related to the Co-Op Research and Development Center set up jointly with East China University of Science and Technology in June 2007 to develop new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry. On June 7, 2011, SYCI and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for us.
The new production line began operations in April 2011. However, we switched the aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as we experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. The converted new production line began operation and normal production in late July 2011 with positive cash from operations.

Exploration Costs To explore natural brine resources in Sichuan province, SCHC incurred exploration costs in the amount of $1,047,110 for the three-month month period ended September 30, 2011. These costs consisted of the drilling of exploratory wells and associated facilities in order to confirm and measure the brine water resources in the province. We charged the exploration costs to the income statement as incurred. The exploratory wells are still under construction and are expected to be completed by the end of 2011.
General and Administrative Expenses General and administrative expenses were $5,459,069 for the three-month period ended September 30, 2011, an increase of $4,455,940 (or 444%) compared to $1,003,129 for the same period in 2010. The significant increase was primarily due to (i) demolition and re-installation expenses in the amount of $63,116 for relocating Factory No. 4 due to the Chinese government taking the leased land, where our original Factory No. 4 was situated, for civil redevelopment; (ii) inclusion of $229,052 of depreciation of property, plant and equipment for Factory No. 4 which temporarily suspended operations due to the relocation; and (iii) a non-cash expense of $4,298,000 related to cancellation of all non-vested stock options in late September 2011.

Other Operating Income Other operating income was $1,368,074 for the three-month period ended September 30, 2011, a significant increase of $1,301,519 from $66,555 for the same period in 2010. Such increase was primarily due to the sum of $1,340,026 received from the local PRC government as compensation for the demolition of our original Factory No. 4. Other operating income for the three-month period ended September 30, 2010 represented the sales of wastewater to some of our customers. 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 salt pans on their properties for evaporation. These customers then are able to sell the resulting crude salt themselves. We have signed agreements with these customers to sell them our wastewater at market prices. The other operating income from sales of wastewater was $28,048 for the three-month period ended September 30, 2011.

Income from Operations Income from operations was $8,746,245 for the three-month period ended September 30, 2011 (or 23.2% of net revenue), a decrease of $11,162,474 (or approximately 56%) over income from operations for the same period in 2010. The decrease resulted primarily from the decrease in net revenue as a result of (i) the macro-economies tightening policy imposed by the PRC government to slow down the economy, which in turn decrease the demand and selling price of our products; and (ii) a non-cash expense of $4,298,000 related to cancellation of all non-vested stock options in late September 2011.

  Income from Operations by Segment
  
Three-Month Period Ended
September 30, 2011
 
Three-Month Period Ended
September 30, 2010
Segment:    Percent of total   Percent of total 
Bromine $9,408,923    70% $13,901,242    68% 
Crude Salt  1,317,015    10%  3,265,430    16% 
Chemical Products  2,661,362    20%  3,206,300    16% 
Income from operations before corporate costs  13,387,300  100%  20,372,972  100% 
Corporate costs  (4,641,055)    (464,253)   
Income from operations $8,746,245    $19,908,719    

Bromine segment
Income from operations from our bromine segment was $9,408,923 for the three-month period ended September 30, 2011, a decrease of $4,492,319 (or approximately 32%) compared to the same period in 2010. This decrease resulted primarily from (i) the decrease in sales volume (contributed approximately $10 million) as a result of the PRC government’s macro-economies tightening policy which decreased the demand for bromine; and (ii) the increase in exploration costs to explore natural brine resources in Sichuan province (contributed approximately $1 million), which was partially offset by the increase in average selling price of bromine of approximately $6.6 million.

Crude salt segment
Income from operations from our crude salt segment was $1,317,015 for the three-month period ended September 30, 2011, a decrease of $1,948,415 (or approximately 60%) compared to the same period in 2010. This decrease was mainly due to the decrease in both the average selling price and sales volume as mentioned before.

Chemical products segment
Income from operations from our chemical products segment was $2,661,362 for the three-month period ended September 30, 2011, a decrease of $544,938 (or approximately 17%) compared to the same period in 2010. This decrease resulted primarily from (i) the decrease in net revenue of our oil and gas exploration chemicals of approximately $1.9 million due to the decreased demand, which was partially offset by (i) the increase in net revenue of our agricultural intermediates of approximately $0.6 million; and (ii) the decrease in our research and development costs paid to East China University of Science and Technology of approximately $0.8 million as explained hereinbefore. 

Other Income, net Other income, net represented bank interest income, net of capital lease interest expense. The decrease in other income was primarily due to the charge of capital lease interest expense since January 2011 for the acquisition of fixed assets under capital leases.  
Net Income Net income was $5,584,346 for the three-month period ended September 30, 2011, a decrease of $9,280,756 (or approximately 62%) compared to the same period in 2010. This decrease was primarily attributable to the overall decrease in demand for our products due to the macro-economic tightening policy imposed by the PRC government to slow down the economy, which in turn reduced the our average selling price of bromine and sales volume, and a non-cash expense of $4,298,000 related to cancellation of all non-vested stock options in late September 2011.
Comparison of the Nine-Month Periods Ended September 30, 2011 and 2010

 
Nine-Month Period
Ended September 30, 2011
 
Nine-Month Period
Ended September 30, 2010
 % Change
Net revenue$134,441,319  $121,203,521 　 11%
Cost of net revenue$(69,410,031)  $(62,709,174) 　 11%
Gross profit$65,031,288  $58,494,347 　 11%
Sales, marketing and other operating expenses$(67,861)  $(115,174)  (41%)
Research and development costs$(347,421)  $(1,612,862) 　 (78%)
Exploration costs$(4,914,396) $- 　 - 
Write-off / Impairment on property, plant and equipment$(7,570,566)  $-   - 
General and administrative expenses$(11,515,054)  $(3,991,515) 　 188%
Other operating income 1,783,157   88,553   1,914%
Income from operations$42,399,147  $52,863,349 　 (20%)
Other income, net$38,466  $180,047 　 (79%)
Income before taxes$42,437,613  $53,043,396 　 (20%)
Income taxes$(12,465,013)  $(13,759,713) 　 (9%)
Net income$29,972,600  $39,283,683 　 (24%)

Net revenue Net revenue for the nine-month period ended September 30, 2011, was $134,441,319, representing an increase of $13,237,798 or 11% over the same period in 2010. This increase was primarily attributable to (i) the growth in our bromine segment, in which revenue increased from $76,183,791 for the nine-month period ended September 30, 2010 to $88,200,156 for the same period in 2011, an increase of approximately 16%; and (ii) the strong growth in our crude salt segment, in which revenue increased from $11,457,497 for the nine-month period ended September 30, 2010 to $13,484,025 for the same period in 2011, an increase of approximately 18%.

  Net Revenue by Segment  
  Nine-Month Period Ended Nine-Month Period Ended Percent Increase
  September 30, 2011 September 30, 2010 of Net Revenue
Segment    Percent of total    Percent of total   
Bromine $88,200,156   66% $76,183,791   63%  16% 
Crude Salt $13,484,025   10% $11,457,497   9%  18% 
Chemical Products $32,757,138   24% $33,562,233   28%  (2%) 
Total sales $134,441,319   100% $121,203,521   100%  11% 

  Nine-Month Period Ended  Percentage Change
Bromine and crude salt segments product sold in tonnes September 30, 2011  September 30, 2010  Increase/(Decrease) 
Bromine  21,130   27,579   (23%)  
Crude Salt  291,334   288,031   1%  
  Nine-Month Period Ended  Percentage Change
Chemical products segment sold in tonnes September 30, 2011  September 30, 2010  Increase/(Decrease)
Oil and gas exploration additives  12,550   17,724   (29%)
Paper manufacturing additives  2,972   3,942   (25%)
Pesticides manufacturing additives  2,053   2,178   (6%)
Wastewater treatment chemical additives  120   -    -
Overall  17,695   23,844   (26%)
Bromine segment
The increase in net revenue from our bromine segment was mainly due to the increase in the average selling price of bromine. The average selling price of bromine increased from $2,762 per tonne for the nine-month period ended September 30, 2010 to $4,174 per tonne for the same period in 2011, an increase of 51%. The increase in the average selling price was a result of (i) strong demand in the China market following the recovery of business and economic conditions and reforms in the medical industry in China, and (ii) expansion of bromine applications in a variety of industries. However, as mentioned hereinbefore, we noted that the effect of the increase in the average selling price was diminished due to the macro-economic tightening policy imposed by the PRC government which weakened the demand of bromine beginning in the second half of 2011. The average selling of bromine decreased from a high in the first quarter of 2011 ($4,596 per tonne) to $3,597 per tonne in the third quarter of 2011. We expect the average selling price of bromine will remain at current levels (around $3,597 per tonne) through the end of 2011 should the PRC government’s macro-economic tightening policy remain in place.

The favorable effect of the increase in the average selling price of bromine was partly offset by a decrease in the sales volume of bromine from 27,579 tonnes for the nine-month period ended September 30, 2010 to 21,130 tonnes for the same period in 2011, a decrease of approximately 23%. Despite an increase in the number of our bromine production plants in recent years, sales volume of bromine decreased. The reasons for the decrease in the sales volume of bromine are the same as mentioned in aforesaid paragraphs for the three-month period ended September 30, 2011. The table below shows the changes in the average selling price and the changes in the sales volume of bromine for nine-month period ended September 30, 2011 from the same period in 2010.

   
Nine-Month Period
Ended September 30
Increase / (Decrease) in net revenue of bromine as a result of:  2011 vs. 2010
Increase in average selling price  $34,383,552 
Decrease in sales volume  $(22,367,187) 
Total effect on net revenue of bromine  $12,016,365 

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 $39.80 per tonne for the nine-month period ended September 30, 2010 to $46.30 per tonne for the same period in 2011, an increase of 16%, and the sales volume of crude salt also increased from 288,031 tonnes for the nine-month period ended September 30, 2010 to 291,334 tonnes for the same period in 2011, an increase of approximately 1%. The increase in the average selling price was a result of increased demand for crude salt and the increase in our production capacity was a result of the additional crude salt field we acquired in late 2010. 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, 2011 from the same period in 2010.

   
Nine-Month Period
Ended September 30
Increase / (Decrease) in net revenue of crude salt as a result of:  2011 vs. 2010
Increase in average selling price  $1,884,407 
Increase in sales volume  $142,121 
Total effect on net revenue of bromine  $2,026,528 

Despite the above increasing factors, we noted a trend of decrease in both the average selling price and sales volume of crude salt for the first nine months of 2011. The average selling price decreased from $50.10 per tonne in the first quarter of 2011 to $37.20 per tonne in this quarter of 2011, and the sales volume of crude salt also decreased from 100,511 tonnes in the first quarter of 2011 to 66,014 tonnes in this quarter of 2011. We expect this trend will continue through the end of 2011 should the PRC government’s macro-economic tightening policy remain in place.

Chemical products segment

  Product Mix of Chemical Products Segment Percent
  Nine-Month Period Ended Nine-Month Period Ended Change of
  September 30, 2011 September 30, 2010 Net Revenue
Chemical Products    Percent of total    Percent of total    
Oil and gas exploration additives $21,784,468   66% $24,734,754   74%  (12%) 
Paper manufacturing additives $3,909,927   12% $4,296,865   13%  (9%) 
Pesticides manufacturing additives $6,526,735   20% $4,530,614   13%  44% 
Wastewater treatment chemical additives $536,008   2% $-   -   -  
Total sales $32,757,138   100% $33,562,233   100%  (2%) 
Revenues from our chemical products segment decreased from $33,562,233 for the nine-month period ended September 30, 2010 to $32,757,138 for the same period in 2011, a decrease of approximately 2%. The decrease was mainly attributable to the drop 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 our chemical products segment and contributed $21,784,468 (or 66%) and $24,734,754 (or 74%) of our chemical segment revenue for the nine-month period ended September 30, 2011 and 2010, respectively, a decrease of $2,950,286. Net revenue from our agricultural intermediates increased from $4,530,614 for nine-month period ended September 30, 2010 to $6,526,735 for the same period in 2011, an increase of approximately 44%. As mentioned hereinbefore, we believe that as result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, the overall demand for chemical products was reduced, which resulted in a decrease in our volume of chemical products sold. The sales volume of chemical products decreased by 26% from 23,844 tonnes for the nine-month period ended September 30, 2010 to 17,695 tonnes for the same period in 2011.

However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price for all of our chemical products due to the continuing high level of oil prices. The average selling price per tonne increased by a range from 21% to 53% for the nine-month period ended September 30, 2011 as compared with the same period in 2010. In particular, the PRC government continued to support expansion of agricultural related products, which supported the growth in sales of our pesticides manufacturing additives. Also, in June 2011 we stopped production of our wastewater treatment chemical additive and in July we successfully converted the production equipment from this wastewater treatment chemical additive to pharmaceutical and agricultural chemical additives which have higher profit margins. The table below shows the changes in the average selling price and changes in the sales volume of our major chemical products for nine-month period ended September 30, 2011 from the same period in 2010.

Increase / (Decrease) in net revenue, for the nine-month period ended September 30, 2011 vs. 2010, as a result of: 
Oil and gas
exploration additives
 Paper manufacturing additives Agricultural intermediates
Increase in average selling price $5,150,558  $779,782  $2,325,917 
Decrease in sales volume $(8,100,844) $(1,166,720) $(329,796)
Total effect on net revenue of chemical products $(2,950,286) $(386,938) $1,996,121 

Cost of Net Revenue

  Cost of Net Revenue by Segment % Change
  Nine-Month Period Ended Nine-Month Period Ended of Cost of
  September 30, 2011 September 30, 2010 Net Revenue
Segment    
% of Segment
Net Revenue
    
% of Segment
Net Revenue
   
Bromine $43,771,055   50% $37,970,602   50%  15% 
Crude Salt $3,510,806   26% $2,951,183   26%  19% 
Chemical Products $22,128,170   68% $21,787,389   65%  2% 
Total $69,410,031   52% $62,709,174   52%  11% 

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 $69,410,031 for nine-month period ended September 30, 2011, an increase of $6,700,857 (or approximately 11%) compared to the same period in 2010. The increase was primarily due to the increase in the purchase price of raw materials, depreciation and amortization of manufacturing plant and machinery and mineral resource compensation fees paid for extraction of brine water in our bromine segment.

Bromine production capacity and utilization of our factories

The table below represents the annual capacity and utilization ratios for our all of our bromine producing properties:

  Annual Production Capacity (in tons)  
Utilization
Ratio
 
Nine-month period ended September 30, 2010  46,300   88% 
Nine-month period ended September 30, 2011  41,547   74% 
Variance of the nine-month periods ended September 30, 2011 and 2010  (4,753)  (14%)

Utilization ratio is calculated based on the annualized actual production volume in tons for the nine-month period divided by the annual production capacity in tons
Our utilization ratio decreased by 14% for the nine-month period ended September 30, 2011 as compared with the same period in 2010. The decrease in utilization and hence the sales volume of bromine was mainly attributable to (i) the suspension of operations of our original Factory No. 4 in early July 2011 to cooperate with the demolition of the factory and construction of a new factory, which was still under construction as of September 30, 2011; and (ii) intermittent suspension of operations of some of our factories in the first half of 2011 due to the annual scheduled repair and maintenance, the increased number of environmental inspections by the local government and the restriction of the supply of electricity to all industrial factories by the local government.

Bromine segment
The cost of net revenue for our bromine segment for the nine-month period ended September 30, 2011 was $43,771,055, an increase of $5,800,453 (or 15%) compared to $37,970,602 for the same period in 2010. The most significant components of our cost of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $28,167,097 (or 64%), depreciation and amortization of manufacturing plant and machinery of $7,658,509 (or 17%) and electricity of $3,273,323 (or 7%) for the nine-month period ended September 30, 2011. The major components of the cost of revenue for the nine-month period ended September 30, 2010 were cost of raw materials and finished goods consumed of $25,589,405 (or 67%), depreciation and amortization of manufacturing plant and machinery of $5,238,355 (or 14%) and electricity of $3,982,645 (or 10%), a similar cost structure as compared with the same in 2011. The increase in cost of net revenue was attributable to the increase in raw material prices. 

Crude salt segment
For the nine-month period ended September 30, 2011, the cost of net revenue for our crude salt segment was $3,510,806, representing an increase of $559,623, or 19%, over the same period in 2010. As mentioned hereinbefore, the increase in cost was mainly due to the increase in the number of crude salt fields and enhancement projects performed in late June 2011 as mentioned hereinbefore, which in turn increased the depreciation and amortization of manufacturing plant and machinery. The significant costs were depreciation and amortization of $1,682,946 (or 48%), resource tax of $790,617 (or 23%) and electricity of $417,576 (or 12%) for the nine-month period ended September 30, 2011. The major cost components were depreciation and amortization of $892,848 (or 30%), resource tax of $847,703 (or 29%) and electricity of $686,327 (or 23%) for the nine-month period ended September 30, 2010.

Chemical products segment
For the nine-month period ended September 30, 2011, the cost of net revenue for our chemical products segment was $22,128,170, representing an increase of $340,781 or 2% over the same period in 2010. The rate of increase for the cost of net revenue for our chemical products segment was similar to that of net revenue. The significant costs were cost of raw material and finished goods consumed of $19,398,476 (or 88%) and $19,251,843 (or 88%) and depreciation and amortization of manufacturing plant and machinery of $1,688,046 (or 8%) and $1,512,734 (or 7%) for each of the nine-month periods ended September 30, 2011 and 2010, respectively. As the components of our cost of net revenue are fixed levels of depreciation and amortization of manufacturing plant and machinery and the inflated purchase price of raw materials, the overall cost of net revenue for chemical products segment remained at a same level for the nine-month period ended September 30, 2011 compared to the same period in 2010.

Gross Profit Gross profit was $65,031,288, or 48%, of net revenue for nine-month period ended September 30, 2011 compared to $58,494,347, or 48%, of net revenue for the same period in 2010.
  Gross Profit by Segment % Point
  Nine-Month Period Ended Nine-Month Period Ended Change
  September 30, 2011 September 30, 2010 of Gross Profit
Segment    Gross Profit Margin    Gross Profit Margin   
Bromine $44,429,101   50% $38,213,189   50%  0% 
Crude Salt $9,973,219   74% $8,506,314   74%  0% 
Chemical Products $10,628,968   32% $11,774,844   35%  (3%) 
Total Gross Profit $65,031,288   48% $58,494,347   48%  0% 
Bromine segment
The gross profit margin for our bromine segment was 50% for both the nine-month periods ended September 30, 2011 and 2010. The average selling price of bromine increased from $2,762 per tonne to $4,174 per tonne for the same period in 2010, an increase of 51%. We do not expect that the selling price for bromine will continue to increase during the rest of the year.  As mentioned before, due to a decrease in the bromine concentration of brine water being extracted and the PRC government’s macro-economic tightening policy, our production level and sales volume for the three-month period ended September 30, 2011 was adversely affected. In order to improve the quality of brine water being extracted from our wells, we completed enhancements of our facilities during the second quarter of 2011 to pump brine water from deeper underground. We expect that the production capacity of bromine will improve in the near future as a result of these enhancements and that the gross profit margin of bromine will remain at current level through the end of 2011 should the PRC government’s macro-economic tightening policy remains in place.
Crude salt segment
For both the nine-month periods ended September 30, 2011 and 2010, the gross profit margin for our crude salt segment was 74%. The average selling price of crude salt increased from $39.8 per tonne to $46.3 per tonne compared to the same period in 2010, an increase of 16%. As mentioned hereinbefore, the increase in average selling price was a result of increased demand for crude salt which was offset by the increase in cost of net revenue.

Chemical products segment
The gross profit margin for our chemical products segment remained constant for the nine-month period ended September 30, 2011 as compared to the same period in 2010. As our factory is capable of producing diversified chemical products, the selling price fluctuation of individual chemical products is not expected to have significant impact to our gross profit margin for overall chemical products.

Research and Development Costs The total research and development costs incurred for the nine-month periods ended September 30, 2011 and 2010 were $347,421 and $1,612,862, respectively, with a decrease of 79%.

Included in research and development costs are costs paid to East China University of Science and Technology for the establishment of a Co-Op Research and Development Center in June 2007 to develop new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry. On June 7, 2011, SYCI and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for us. The research and development costs paid pursuant to this agreement amounted to $236,817 and $376,123 for the nine-month periods ended September 30, 2011 and 2010, respectively.

Since the second quarter of 2010, SYCI conducted research for the new production line of wastewater treatment additives, the purpose of which is for the testing the manufacturing routine and samples. The research and development expenses incurred for the new production line of wastewater treatment additives during the nine-month periods ended September 30, 2011 and 2010 were $110,604 and $1,236,739, respectively. The new production line began operations in April 2011. However, we switched the aforesaid production line to the production of pharmaceutical and agricultural chemical intermediates in mid-June 2011 as we experienced some technological limitations on extraction purity, which lead to a lower than expected gross margin for wastewater treatment chemical additives. The converted new production line was started operation and normal production in late July 2011 with positive cash from operations.

Exploration Costs To explore natural brine resources in Sichuan province, SCHC incurred exploration costs in the amount of $4,914,396 for the nine-month period ended September 30, 2011. These costs consisted of the drilling of exploratory wells and associated facilities in order to confirm and measure the brine water resources in the province. We charged the exploration costs to the income statement as incurred. The exploratory wells are still under construction and are expected to complete by the end of 2011.

Write-off/Impairment on property, plant and equipment The write-off and impairment on property, plant and equipment represented (i) the write-off on property, plant and equipment that could not be relocated to the new Factory No. 4 in the amount of $1,384,443; (ii) the impairment loss on property, plant and equipment related to the conversion of our production line from wastewater treatment chemical additives to the production of pharmaceutical and agricultural chemical intermediates in the amount of $1,805,598; (iii) the impairment loss on property, plant and equipment under capital leases for idle plant and machinery in the amount of $683,046; and (iv) the write-off of certain crude salt field protective shells and transmission pipelines replaced during renovation work in the amounts of $1,632,004 and $2,065,475, respectively.

General and Administrative Expenses General and administrative expenses were $11,515,054 for the nine-month period ended September 30, 2011, an increase of $7,523,539 (or 188%) compared to $3,991,515 for the same period in 2010. The significant increase was primarily due to non-cash expenses of $7,467,000 for the nine-month period ended September 30, 2011 related to options granted to our employees in the amount of $2,717,000, recognition of non-vested options which were cancelled in late September 2011 in the amount of $4,298,000, and a warrant issued to our investor relations firm in the amount of $452,000 related to a the service agreement signed in February 2011. The non-cash expenses related to options and a warrant granted for the nine-month period ended September 30, 2010 amounted to $1,188,966, which resulted in an increase of $1,980,034, or 167%, as compared with the same period in 2011.  The increase in stock options was primarily for the purpose of incentivizing our employees. Other reasons for the increase in general and administrative expenses were due to (i) demolition and re-installation expense in the amount of $530,443 for relocating Factory No. 4 due to the Chinese government taking the leased land, where our original Factory No. 4 was situated, for civil redevelopment; and (ii) $229,052 of depreciation of property, plant and equipment for Factory No. 4 which were temporarily suspended operations due to the relocation.

Other Operating Income Other operating income was $1,783,157 for the nine-month period ended September 30, 2011, a significant increase of $1,694,604 from $88,553 for the same period in 2010. Such increase was primarily due to a sum of $1,340,026 received from the local PRC government as compensation for the demolition of our original Factory No. 4. Included in other operating income for the nine-month periods ended September 30, 2011 and 2010 were $143,131 and $88,553 income from sales of wastewater to some of our customers.
Income from Operations
  Income from Operations by Segment
  
Nine-Month Period Ended
September 30, 2011
 
Nine-Month Period Ended
September 30, 2010
Segment:    Percent of total   Percent of total 
Bromine $35,322,297    70% $36,751,337    67% 
Crude Salt  7,190,560    14%  8,241,849    15% 
Chemical Products  8,047,059    16%  9,959,587    18% 
Income from operations before corporate costs  50,559,916  100%  54,952,773  100% 
Corporate costs  (8,160,769)    (2,089,424)   
Income from operations $42,399,147    $52,863,349    
Bromine segment
Income from operations from our bromine segment was $35,322,297 for the nine-month period ended September 30, 2011, a decrease of $1,429,040 (or approximately 4%) compared to the same period in 2010. Despite the effect of increase in bromine’s selling price which contributed an increase of approximately $34 million in income from operations, the overall decrease in income from operations bromine segment resulted primarily from (i) the decrease in sales volume (contributed a decrease of approximately $22 million) as a result of the PRC government’s macro-economies tightening policy which decrease the demand of bromine; (ii) the increase in cost of net revenue, in particular, cost of raw material and depreciation and amortization of manufacturing plant and machinery (contributed a decrease of approximately $5 million); (iii) the impairment losses and write-off of certain property, plant and equipment (contributed a decrease of approximately $4 million); and (iv) the increase in exploration costs to explore natural brine resources in Sichuan province (contributed a decrease of approximately $4 million).

Crude salt segment
Income from operations from our crude salt segment was $7,190,560 for the nine-month period ended September 30, 2011, a decrease of $1,051,289 (or approximately 13%) compared to the same period in 2010. This decrease was mainly due to (i) the impairment losses and write-off of certain property, plant and equipment of approximately $2 million; and (ii) the increase in exploration costs to explore natural brine resources in Sichuan province of approximately $0.6 million, which outweighed the increase in net revenue of approximately $2 million.

Chemical products segment
Income from operations from our the chemical products segment was $8,047,059 for the nine-month period ended September 30, 2011, a decrease of $1,912,528 (or approximately 19%) compared to the same period in 2010. This decrease resulted primarily from (i) the decrease in net revenue of our oil and gas exploration chemicals and paper manufacturing additives of approximately $3.3 million due to the decreased demand; and (ii) the impairment losses and write-off of certain property, plant and equipment of approximately $1.8 million, which was partially offset by (i) the increase in net revenue of our agricultural intermediates of approximately $2 million; and (ii) the decrease in our research and development costs paid to East China University of Science and Technology of approximately $1 million as explained hereinbefore. 
Other Income, net Other income represented bank interest income, net of the capital lease interest expense. The decrease in other income was primarily due to the charge of capital lease interest expense since January 2011 for the acquisition of fixed assets under capital lease.  

Net Income Net income was $29,972,600 for the nine-month period ended September 30, 2011, a decrease of $9,311,083 (or approximately 24%) compared to the same period in 2010. This decrease was primarily attributable to the impairment losses recognized for and the write-off of certain property, plant and equipment of approximately $7.6 million, exploration costs related to the drilling of exploratory wells in Sichuan province of approximately $4.9 million and recognition of non-vested options which cancelled in late September 2011 of approximately $4.3 million, which outweighed the increase in gross profit from our bromine and crude salt segments of approximately $6.2 million and $1.5 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2011, cash and cash equivalents were $85,821,856 as compared to $68,494,480 as of December 31, 2010. The components of this increase of $17,327,376 are reflected below.
Statement of Cash Flows
  Nine-Month Period Ended September 30, 
  2011  2010 
Net cash provided by operating activities $53,541,606  $52,444,888 
Net cash used in investing activities $(38,751,815) $(28,196,066)
Net cash (used in)/provided by financing activities $(788,739) $2,209,729 
Effects of exchange rate changes on cash and cash equivalents $3,326,324  $1,403,085 
Net increase in cash and cash equivalents $17,327,376  $27,861,636 
For the nine-month period ended September 30, 2011 the Company met its 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 period ended September 30, 2011, we had positive cash flow from operating activities of $53,541,606 primarily attributable to net income of $29,972,600. Net cash provided by operating activities during the nine-month period ended September 30, 2011 increased by $1,096,718 compared to the same period in 2010. The primary source of this increment was due to the increase in accounts payable and accrued expenses, which attributable to the other payable and amount due to a contractor for relocation of our Factory No. 4 of approximately $1.2 million.
Net Cash Used in Investing Activities
In the first quarter of 2011, we used approximately $3 million cash to reconstruct and renovate a subdivision of Factory No. 1 which included bromine production facilities and brine water channels acquired under a capital lease.
In the second quarter of 2011, we used approximately $31 million cash to carry out enhancement projects to our existing bromine extraction and crude salt production facilities. In particular, we incurred reconstruction and renovation works in the amount of approximately $12 million for our crude salt fields at Factory No. 1, 5 to 9 and in the amount of approximately $19 million for our extraction wells and transmission channels and ducts at Factory No. 1 to 9. We also used approximately $4.6 million cash for the construction of our new Factory No. 4 due to the taking of leased land by the PRC local government for redevelopment.

In the third quarter of 2011, we further used approximately $0.6 million cash for the construction of our new Factory No. 4. The construction of new Factory No. 4 is still under construction and expected to be completed and start operations on a trial basis in November 2011. Further capital expenditure needed to complete the construction of new Factory No. 4 is estimated to be approximately $1 million. We also used approximately $0.2 million cash for the setup and construction of a chemical production line for bromopropane.

These projects were financed by opening cash balances as of December 31, 2010 and cash generated from operations during the nine-month period ended September 30, 2011.
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, 2011 and used another $0.5 million to repurchase 184,599 shares of common stock of the Company under the approval of the Board of Directors.

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 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 at September 30, 2011 was approximately $97.6 million as compared to approximately $79.8 million at December 31, 2010. The increase was mainly attributable to the cash provided by operating activities during the nine-month period ended September 30, 2011.
We had available cash of approximately $85.8 million at September 30, 2011, most of which is in highly liquid current deposits which earn no or little interest. We intend to retain the cash in highly liquid deposit accounts for future expansion of our bromine and crude salt businesses through acquisition, 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 Commitments
The following table sets forth payments due by period for fixed contractual obligations as of September 30, 2011.
  Capital Lease Obligations  Operating Lease Obligations  Purchase Obligations 
          
Less than 1 year $295,366  $434,283  $2,436,720 
1 - 3 years  590,729   1,267,767   - 
3 - 5 years  590,729   1,280,813   - 
More than 5 years  4,135,106   17,637,271   - 
Total $5,611,930  $20,620,134  $2,436,720 
Less: Amount representing interest  (2,464,953)        
Present value of net minimum lease payments $3,146,977         

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 its 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 2010 Form 10-K.
Impact of Inflation

Inflationary factors, such as increases in the cost of our product and overhead costs, may adversely affect our operating results. Based on the Consumer Price Index in the PRC, the average annual rate of inflation over the three-year period from 2008 to 2010 was 2.8%. Inflationary pressures increased in 2011, reflecting the rise in our cost of raw materials and electricity expenses. For the three-month and nine-month periods ended September 30, 2011, the rates of inflation were 6.3% and 5.7%, respectively. The Company believes that in the long run the selling prices of its products could be increased at a similar level to compensate the adverse effect. In the foreseeable future, a high rate of inflation may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.

Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in market risk from the information provided in “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” of the Company’s 2010 Form 10-K.

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 as of September 30, 2011, our disclosure controls and procedures were not effective.effective as of the end of the period covered by this Form 10-Q.  The material weakness ondeficiency in our disclosure controls and procedures as of September 30, 2011 wereMarch 31, 2012 was as follows:

 ●None of
We are unable to provide the required Schedule I parent only financial statement audited data for fiscal years 2009 and 2010 to be included in our accounting department personnel have significant experience or training in U.S. GAAP and we primarily relyAnnual Report on outside consultants to prepare our U.S. GAAP financial statements.Form 10-K for the year ended December 31, 2011.

In responseWe anticipate that such material deficiency will be resolved within a two-year period when the Schedule I audited data for three fiscal years are available pursuant to the above identified material weakness and to continue strengtheningaudit work of our internal control over financial reporting, we are going to undertake the following remediation initiatives:current independent accountant.

●Hire additional personnel with significant knowledge and experience in U.S. GAAP; and

●Providing ongoing training courses in U.S. GAAP to existing personnel, including our CFO.

These new remediation initiatives will be put into place in the fourth quarter of 2011. We will continue to monitor and assess our remediation initiatives to ensure that the aforementioned material weakness is remediated.
 
(b) Changes in internal controls
 
The following changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act of 1934) have been made during the three-month period ended September 30, 2011March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We have implemented the following steps to improve our disclosure controls and procedures to address the material weaknesses as mentioned forin the three-month period ended June 30, 2011:2011 Form 10-K:

 ●In September 2011,March 2012, we developed and put into use an additional checklist for our management to complete priorincrease their oversight to release of our periodic filings for disclosure of subsequent events.timely report any related party transactions and the translation gain or loss on intercompany balances, if any.

 ●In early October 2011,Since January 2012, we updatedprovided ongoing training courses to our fixed assets registermanagement personnel, including our CFO, for the updates of US GAAP and will carry out timely assessment on potential impairment of fixed assets, if any, in our future periodic filings.SEC reporting requirements.
 
PART II—OTHER INFORMATION

Item 1. Legal Proceedings

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

The Company and certain of its officers and directors (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 plaintiff asserts 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 complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. The Company intends to defend vigorously against the lawsuit.  The Company currently cannot estimate the amount or range of possible losses from this litigation. 

Item 1A. Risk Factors

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 2010 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 2010 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.
We may have to reduce our bromine production volumes based on guidelines isssued by the Shouguang Bromine Professional Association.

We are a member of the Shouguang Bromide Professional Association (the “Association”), whose members are bromine producers in the Shouguang region of Shandong province.  Members of the Association are required to follow production guidelines recommended by the Association. If the Association asks its members to reduce production volumes in the future, we may be required to limit our bromine production volume which could adversely affect our business, financial condition and results of operations.

We may have to temporarily halt production at our facilities in order to prepare for environmental inspections made by the local government.

In the past two years we have experienced an increase in the number of environmental inspections of our factories made by the local government in order to renew our mining licenses, which we have successfully passed.  As a result of these inspections, we may be required to temporarily halt production at our factories in order to prepare for and pass the inspections made by the local government.  If we are required to close some or all of our factories in order to prepare for these inspections, our business, financial condition and results of operations could be adversely affected.

Mr. Ming Yang, our Chairman and a substantial shareholder, has potential conflicts of interest with us, which may adversely affect our business

Mr. Ming Yang, our chairman, was a substantial owner of SCHC and SCYI before their acquisition by us, and remains, with the shares held by him, both individually and through Shandong Haoyuan Industry Group Ltd., and by his wife and son, Wenxiang Yu and Zhi Yang, a substantial owner of our securities.  There may have been conflicts of interest between Mr. Yang and our Company as a result of such ownership interests. The terms on which we acquired SCHC and SCYI may have been different from those that would have been obtained if SCHC and SCYI were owned by unrelated parties.  In addition, conflicts of interest between Mr. Yang’s dual roles as our shareholder and our director may arise. We cannot assure you that, when conflicts of interest arise, Mr. Yang will act in the best interests of the Company or that conflicts of interest will be resolved in our favor.

Currently, we do not have existing arrangements to address potential conflicts of interest between Mr. Yang and us. We rely on these Mr. Yang to abide by the laws of the State of Delaware, which provide that directors owe a fiduciary duty to the Company, and which require them to act in good faith and in the best interests of the Company, and not use their positions for personal gain. If we cannot resolve any conflicts of interest or disputes between us and Mr. Yang, we would have to rely on legal proceedings, which could result in disruption of our business and substantial uncertainty as to the outcome of any such legal proceedings.
 
Because we do not have any proven or probable reserves of brine water, we may not be able to continue to produce bromine and crude salt at existing levels in the future which could harm our business, results or operations and financial condition

The SEC’s Industry Guide 7, which relates to businesses with mining operations such as ours defines “reserves” as: “that part of a mineral deposit which could be economically and legally extracted or produced at the time of the reserve determination.” In addition, Industry Guide 7 provides the following definitions with respect to the classification of reserves for mining companies:

●“Proven (Measured) Reserves” - Reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and/or quality are computed from the results of detailed sampling and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth and mineral content of reserves are well-established.

●“Probable (Indicated) Reserves” - Reserves for which quantity and grade and/or quality are computed form information similar to that used for proven (measure) reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven (measured) reserves, is high enough to assume continuity between points of observation.

We do not have any proven or probable reserves of brine water on our mining properties. Therefore, we cannot provide investors with any assurance that there will be adequate volume or concentration of brine water on our mining properties to continue our bromine and crude salt operations at existing levels or to expand our production capacity of bromine and crude salt. If we experience decreases in the volume and/or concentration of brine water we are able to extract from our mining properties, our business, results of operations and financial condition may be adversely affected.

Because of the uncertainties regarding the feasibility of producing bromine from brine water resources in Sichuan province, there may not be a return on our investment in certain related exploration costs.

For the nine-month period ended September 30, 2011, we incurred exploration costs in the amounts of $4,914,396 in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. The exploratory wells are still under construction and are expected to be completed by end of 2011.  To date there has be no bromine produced from the brine water resources in Sichuan province. We cannot be certain that that there will be sufficient bromine concentration in the brine water where we are drilling in Sichuan province to make the production of bromine there feasible.  In addition, we cannot be certain that the local authorities in Sichuan province will issue a mining permit to us. As a result of these uncertainties, we cannot assure you that there will be a return on our investment in such exploration costs.

We are subject to comprehensive regulation by the PRC legal system, which is uncertain. As a result, it may limit the legal protections available to you and us and we may not now be, or remain in the future, in compliance with PRC laws and regulations

SCHC and SYCI, our PRC operating companies, are incorporated under and are governed by the laws of the PRC; all of our operations are conducted in the PRC; and our suppliers and customers are all located in the PRC. The PRC government exercises substantial control over virtually every sector of the PRC economy, including the production, distribution and sale of bromine, brominated chemical products and crude salt. In particular, we are subject to regulation by local and national branches of the Ministry of Land and Resources, as well as the State Administration of Foreign Exchange, and other regulatory bodies. In order to operate under PRC law, we require valid licenses, certificates and permits, which must be renewed from time to time. If we were to fail to obtain the necessary renewals for any reason, including sudden or unexplained changes in local regulatory practice, we could be required to shut down all or part of our operations temporarily or permanently.
SCHC and SYCI are subject to PRC accounting laws, which require that an annual audit be performed in accordance with PRC accounting standards. The PRC foreign-invested enterprise laws require that our subsidiary, SCHC, submit periodic fiscal reports and statements to financial and tax authorities and maintain its books of account in accordance with Chinese accounting laws. If PRC authorities were to determine that we were in violation of these requirements, we could lose our business license and be unable to continue operations temporarily or permanently.
The legal and judicial systems in the PRC are still rudimentary. The laws governing our business operations are sometimes vague and uncertain and enforcement of existing laws is inconsistent. Thus, we can offer no assurance that we are, or will remain, in compliance with PRC laws and regulations.

We will continue to incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance requirements.
As a public company we incur significant legal, accounting and other expenses under the Sarbanes-Oxley Act of 2002, together with rules implemented by the Securities and Exchange Commission and applicable market regulators. These rules impose various requirements on public companies, including requiring certain corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

Currently, none of our employees have significant experience or training in U.S. GAAP and we primarily rely on outside consultants to prepare our U.S. GAAP financial statements. Until such time that our employees gain sufficient experience or we hire additional employees with relevant U.S. GAAP experience, we will continue to incur costs related to these outside consultants.
In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, commencing in 2007, we must perform system and process evaluations and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Compliance with Section 404 may require that we incur substantial accounting expenses and expend significant management efforts. If we are not able to comply with the requirements of Section 404 in a timely manner, or if our accountants later identify deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other applicable regulatory authorities.

Fluctuations in the value of the RMB may reduce the value of your investment

The value of the RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China's political and economic conditions and China's foreign exchange policies. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on exchange rates set by the People's Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB solely to the U.S. dollar. Under this revised policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. Following the removal of the U.S. dollar peg, the RMB appreciated more than 20% against the U.S. dollar over the following three years. However, the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate and achieve policy goals. For almost two years after July 2008, the RMB traded within a narrow range against the U.S. dollar. As a consequence, the RMB fluctuated significantly during that period against other freely traded currencies, in tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase RMB exchange rate flexibility. However, it remains unclear how this flexibility might be implemented. There remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar.
Because substantially all of our revenues and expenditures are denominated in RMB and our cash is denominated in U.S. dollars, fluctuations in the exchange rate between the U.S. dollar and RMB will affect the relative purchasing power of such amounts and our balance sheet and earnings per share in U.S. dollars. In addition, we report financial results in U.S. dollars, and appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollars terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of earnings from and the value of any U.S. dollar-denominated investments we make in the future.

Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedging transactions may be limited and we may not be able to successfully hedge our exposure at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currency.

Failure of our PRC resident shareholders to comply with regulations on foreign exchange registration of overseas investment by PRC residents could cause us to lose our ability to contribute capital to SCHC and remit profits out of the PRC as dividends

The Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents to Engage in Overseas Financing and Round Trip Investment via Overseas Special Purpose Vehicles (“Circular 75”), issued by the SAFE and effective on November 1, 2005, regulates the foreign exchange matters in relation to the use of a “special purpose vehicle” by PRC residents to seek offshore equity financing and conduct a ‘‘round trip investment’’ in China. Under Circular 75, a “special purpose vehicle” refers to an offshore entity directly established or indirectly controlled by PRC resident natural or legal persons (“PRC residents”) for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents in onshore companies, while “round trip investment” refers to the direct investment in China by such PRC residents through the “special purpose vehicles,” including, without limitation, establishing foreign-invested enterprises and using such foreign-invested enterprises to purchase or control onshore assets through contractual arrangements. Circular 75 requires that, before establishing or controlling a “special purpose vehicle”, PRC residents and PRC entities are required to complete a foreign exchange registration with the competent local branches of the SAFE for their overseas investments. After the completion of a round-trip investment or the overseas equity financing, the PRC residents are required to go through foreign exchange registration alteration formalities of overseas investment in respect of net assets of special purpose vehicles that such PRC residents hold and the variation thereof.

In addition, an amendment to the registration is required if there is a material change in the “special purpose vehicle,” such as increase or reduction of share capital and transfer of shares. Failure to comply with the registration procedures set forth in Circular 75 may result in restrictions on the foreign exchange activities of the relevant foreign-invested enterprises, including the payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate and the capital inflow from the offshore parent, and may also subject the relevant PRC residents to penalties under PRC foreign exchange administration regulations.
We have requested our current PRC resident shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the scope of the Circular 75 and urges PRC residents to register with the local SAFE branch as required under the Circular 75. Our affiliates subject to the SAFE registration requirements, including Mr. Ming Yang, our Chairman, Ms. Wenxiang Yu, the wife of Mr. Yang, and Mr. Zhi Yang, Mr. Yang’s son, have informed us that they have not made their initial registrations with SAFE. The failure of our PRC resident shareholders and/or beneficial owners to timely furnish or amend their SAFE registrations pursuant to the Circular 75 or the failure of our future shareholders and/or beneficial owners who are PRC residents to comply with the registration requirement set forth in the Circular 75 may subject such shareholders, beneficial owners and/or SCHC to fines and legal sanctions. Any such failure may also limit our ability to contribute additional capital into SCHC, limit SCHC’s ability to distribute dividends to us or otherwise adversely affect our business.

The PRC government could restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain expenses as they come due or may restrict which limit the payment of dividends from the Company.
We may be treated as a resident enterprise for PRC tax purposes under the currently effective EIT Law, which may subject us to PRC income tax on our taxable global income

On March 16, 2007, the National People’s Congress approved and promulgated a new tax law, the PRC Enterprise Income Tax Law (“EIT Law”). On November 28, 2007, the PRC State Council passed the implementing rules of the EIT Law. Both the EIT Law and the implementing rules of the EIT Law took effect on January 1, 2008. Under the EIT Law, enterprises are classified as “resident enterprises” and “non-resident enterprises.” An enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define “de facto management bodies” as a managing body that in practice exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise; however, it remains unclear whether the PRC tax authorities would deem our managing body as being located within China. Due to the short history of the EIT Law and lack of applicable legal precedents, the PRC tax authorities determine the PRC tax resident treatment of a foreign (non-PRC) company on a case-by-case basis.

If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our global taxable income, as well as PRC enterprise income tax reporting obligations. Second, under the EIT Law and its implementing rules, dividends paid between “qualified resident enterprises” are exempt from enterprise income tax. It is unclear whether the dividends we receive will constitute dividends between “qualified resident enterprises” and would therefore qualify for tax exemption, because the definition of qualified resident enterprises is unclear and the relevant PRC governmental authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes.

In addition to the uncertainty as to the application of the “resident enterprise” classification, there can be no assurance that the PRC governmental authorities will not amend or revise the taxation laws, rules and regulations to impose stricter tax requirements, higher tax rates or retroactively apply the EIT Law, or any subsequent changes in PRC tax laws, rules or regulations. If such changes occur and/or if such changes are applied retroactively, such changes could materially and adversely affect our results of operations and financial condition.

Techniques employed by manipulative short sellers in Chinese small cap stocks may drive down the market price of our common stock

Short selling is the practice of selling securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale.   As it is therefore in the short seller’s best interests for the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short.  While traditionally these disclosed shorts were limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research reports that mimic the type of investment analysis performed by large Wall Street firm and independent research analysts.  These short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base.  Issuers with business operations based in China and who have limited trading volumes and are susceptible to higher volatility levels than U.S. domestic large-cap stocks, can be particularly vulnerable to such short attacks.
These short seller publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not subject to the certification requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst Certification) and, accordingly, the opinions they express may be based on distortions of actual facts or, in some cases, fabrications of facts.  In light of the limited risks involved in publishing such information, and the enormous profit that can be made from running just one successful short attack, unless the short sellers become subject to significant penalties, it is more likely than not that disclosed shorts will continue to issue such reports.

While we intend to strongly defend our public filings against any such short seller attacks, oftentimes we are constrained, either by principles of freedom of speech, applicable state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceed against the relevant short seller.  You should be aware that in light of the relative freedom to operate that such persons enjoy – oftentimes blogging from outside the U.S. with little or no assets or identity requirements – should we be targeted for such an attack, our stock will likely suffer from a temporary, or possibly long term, decline in market price should the rumors created not be dismissed by market participants.
On April 26, 2011, a report created by Glaucus Research Group and distributed on Seeking Alpha website containing allegations concerning the reliability of the Company’s financial statements filed with the SEC was sent to the investment community.  We have issued various press releases to dispute the allegations in the anonymous report.  Our stock price fell 30.1% from April 25, 2011 to April 26, 2011 after the publication of this report.  The trading volume of the Company’s stock was approximately 12 million the day the report was published as compared to its average daily trading volume over the three-month period prior to the report of 677,061.

Although we will continue to educate investors that the April allegations were inaccurate and misleading, the price of our stock remains vulnerable to the continuing attacks by this and any other short seller.

Decreases in the bromine yield from our brine water could have an adverse effect on our business, financial position and results of operations

In recent months, we have been able to extract less bromine from brine water during the production process due to a decrease in the bromine concentration of brine water being extracted. In an effort to address this issue, we carried out enhancement projects to our extraction wells in June 2011 by increasing the depth of our brine water wells to extract brine water from a lower second layer which we believe will have a higher bromine concentration.  However, we can not be certain that this will improve the bromine yield from our production facilities in the long run. If we are not able to improve the bromine yield at our production facilities or if the bromine concentration in the brine water we extract continues to decline, our business, financial condition and results of operations could be adversely affected.

Restricted power supply could disrupt our production and have an adverse effect on our business, financial position and results of operations

All of our products are produced at our manufacturing facilities in Shouguang, Shandong province, China.  A significant disruption at those facilities, such as electricity power control, even on a short-term basis, could impair our ability to timely produce and deliver products, which could have an adverse effect on our business, financial position and results of operations. We have encountered power shortages historically due to restrictions on the power supply provided to industrial users when the usage of electricity is high and the supply is limited or as a result of damage to the electricity supply network. Interruptions of electricity supply could result in lengthy production shutdowns, increased costs associated with restarting production and the loss of production in progress.  Any major suspension or termination of electricity or other unexpected business interruptions could have an adverse impact on our business, financial condition and results of operations.

Taking of leased land by the Chinese government could disrupt our production facilities and capacity, and have a material adverse effect on our business, financial position and results of operations

Most of our bromine and crude salt manufacturing facilities are located on land leased by SCHC.  Any taking of leased land by the Chinese government could impair our carrying value of production facilities and our ability to timely produce and deliver products, which could have an adverse effect on our business, financial position and results of operations. In mid-May 2011, one of our leased parcels of land was taken by the Chinese government for civil redevelopment, which caused suspension of the operations of Factory No. 4 in early July 2011 for relocation, which took four months. Any future taking of our leased lands will adversely affect our existing business and productivity.
Item 2. Unregistered Shares of Equity Securities and Use of Proceeds

Pursuant to our approved Company stock purchase program, we made the following purchases of our equity securities during the third quarter of 2011.

Period 
(a) Total
Number of
Shares
Purchased
  
(b) Average
Price Paid per
Share ($)
  
(c) Total
Number of
Shares
Purchased as
Part of
Publicly
Announced
Plans or
Programs
  
(d) Maximum
Number or
Approximate
Dollar Value of
Shares that May
Yet Be
Purchased
Under the Plans
or Program
 
July 1 through July 31, 2011  0            
August 1 through August 31, 2011  0            
September 1 through September 30, 2011  84,099   1.81        
                
Total  84,099   1.81       0(1)
(1) The authorization for the stock purchase program expired on September 22, 2011. 

Item 3. Defaults Upon Senior Securities

None.

Item 4. (Reserved and Removed)

Item 5. Other Information

None.
Item 6. Exhibits
 
Exhibit No.
Description
31.1                         Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.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                         Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.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, Certificationas adopted pursuant to Section 906 of Chief Executive Officer and Chief Financial Officer
101.1                         The following financial statements from Gulf Resources, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated StatementsSarbanes-Oxley Act 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.2002.
 
SIGNATURES
 
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 14, 2011July 11, 2012
By:/s/ Xiaobin Liu
  Xiaobin Liu
  Chief Executive Officer
  (principal executive officer)
   
Dated: November 14, 2011July 11, 2012
By:/s/ Min Li
  Min Li
  Chief Financial Officer
  (principal financial and accounting officer)
 
 
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