UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q







x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended June
      30, 2008oro
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      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.)Cheming
      Industrial Park, Shouguang City, Shandong, China
            
            262714(Address
      of principal executive offices)
            
            (Zip
      Code)




Registrant’s
telephone number, including area code: (646) 200-6316





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 xNo
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 oNon-accelerated
      filer (Do not check if a smaller reporting company) o
            Smaller
      reporting company x




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes oNo
x


As of
August 13, 2008, the registrant had outstanding  99,668,842 shares of
common stock.







Table
of Contents




Part
      I – Financial InformationItem
      1. Financial
      Statements
            3Item
      2. Management’s Discussion and Analysis of Financial Conditionand
      Results of Operations
            21Item
      3. Quantitative and Qualitative Disclosures about Market
    Risk
            29Item
      4. Controls and Procedures
            29Part
      II – Other InformationItem
      1A
      Risk Factors.Item
      6. Exhibits.




SpecialNote Regarding Forward Looking Information





This
report contains forward-looking statements that reflect management's current
views and expectations with respect to our business, strategies, future results
and events, and financial performance. All statements made in this report other
than statements of historical fact, including statements that address operating
performance, events or developments that management expects or anticipates will
or may occur in the future, including statements related to future reserves,
cash flows, revenues, profitability, adequacy of funds from operations,
statements expressing general optimism about future operating results and
non-historical information, are forward-looking statements. In particular, the
words "believe," "expect," "intend," "anticipate," "estimate," "plan," "may,"
"will," variations of such words and similar expressions identify
forward-looking statements, but are not the exclusive means of identifying such
statements and their absence does not mean that the statement is not
forward-looking. Readers should not place undue reliance on forward-looking
statements which are based on management's current expectations and projections
about future events, are not guarantees of future performance, and are subject
to risks, uncertainties and assumptions. Our actual results, performance or
achievements could differ materially from the results expressed in, or implied
by, these forward-looking statements. Factors that could cause or contribute to
such differences include those discussed in this report, particularly under the
caption "Risk Factors."  Except as required under the federal
securities laws, we do not undertake any obligation to update the
forward-looking statements in this report.


- 2
-




PART
I – FINANCIAL INFORMATION
 Item
1. Financial Statements
 GULF RESOURCES, INC.
 AND
SUBSIDIARIES
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 JUNE 30,
2008 AND DECEMBER 31, 2007
  June
      30,
              
              
              December
      31,2008
              
              
              2007(unaudited)
              
              
              (audited)ASSETSCURRENT
      ASSETSCash
              
              $
              6,384,913
              
              
              $
              10,773,875Restricted
      cash
              
              
              4,199,898
              
              
              
              -Accounts
      receivable
              
              
              12,556,914
              
              
              
              3,945,000Inventories
              
              
              1,884,271
              
              
              
              413,391Prepaid
      expenses
              
              
              -
              
              
              
              145,484Prepayment
      and deposit
              
              
              640,627
              
              
              
              236,269Prepaid
      land lease
              
              
              15,763
              
              
              
              13,521TOTAL
      CURRENT ASSETS
              
              
              25,682,386
              
              
              
              15,527,540PROPERTY,
      PLANT AND EQUIPMENT, Net
              
              
              47,212,217
              
              
              
              30,105,185PREPAID
      LAND LEASE, Net of current portion
              
              
              741,569
              
              
              
              697,107TOTAL
      ASSETS
              
              $
              73,636,172
              
              
              $
              46,329,832LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIESAccounts
      payable and accrued expenses
              
              $
              4,962,303
              
              
              $
              2,928,248Note
      payable – related party
              
              
              3,000,000
              
              
              
              9,939,750Due
      to related parties
              
              
              2,032,230
              
              
              
              32,230Taxes
      payable
              
              
              3,889,032
              
              
              
              1,477,296TOTAL
      CURRENT LIABILITIES
              
              
              13,883,565
              
              
              
              14,377,524NON
      CURRENT LIABILITIESNote
      payable – related party
              
              
              18,237,493
              
              
              
              5,484,000TOTAL
      LIABILITIES
              
              
              32,121,058
              
              
              
              19,861,524STOCKHOLDERS'
      EQUITYPREFERRED
      STOCK ; $0.001 par value; 1,000,000 shares authorized none
      outstanding
              
              
              -
              
              
              
              -COMMON
      STOCK; $0.0005 par value; 400,000,000 shares authorized;
      99,668,842 shares issued and outstanding
              
              
              49,834
              
              
              
              49,834ADDITIONAL
      PAID-IN CAPITAL
              
              
              12,425,530
              
              
              
              11,924,616RETAINED
      EARNINGS - UNAPPROPRIATED
              
              
              23,757,018
              
              
              
              11,323,518RETAINED
      EARNINGS - APPROPRIATED
              
              
              1,321,893
              
              
              
              1,321,893CUMULATIVE
      TRANSLATION ADJUSTMENT
              
              
              3,960,839
              
              
              
              1,848,447TOTAL
      STOCKHOLDERS' EQUITY
              
              
              41,515,114
              
              
              
              26,468,308TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
              
              $
              73,636,172
              
              
              $
              46,329,832
  See
accompanying notes to condensed consolidated financial statements.
  - 3
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 
 Three
      Months Ended
                June
      30,
              
              
              Six
      Months Ended
                June
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007NET
      REVENUENet
      sales
              
              $
              23,766,179
              
              
              $
              12,259,799
              
              
              $
              45,799,736
              
              
              $
              22,194,000Maintenance
      service income
              
              
              -
              
              
              
              130,152
              
              
              
              -
              
              
              
              259,27823,766,179
              
              
              
              12,389,951
              
              
              
              45,799,736
              
              
              
              22,453,278OPERATING
      EXPENSESCost
      of net revenue
              
              
              14,062,903
              
              
              
              7,270,962
              
              
              
              26,662,623
              
              
              
              13,295,664Research
      and development cost
              
              
              135,275
              
              
              
              -
              
              
              
              267,109
              
              
              
              -General
      and administrative expenses
              
              
              1,009,088
              
              
              
              347,017
              
              
              
              1,863,630
              
              
              
              529,19715,207,266
              
              
              
              7,617,979
              
              
              
              28,793,362
              
              
              
              13,824,861INCOME
      FROM OPERATIONS
              
              
              8,558,913
              
              
              
              4,771,972
              
              
              
              17,006,374,
              
              
              
              8,628,417OTHER
      INCOME (EXPENSES)Interest
      expense
              
              
              -
              
              
              
              (24,082
              )
              
              
              (60,111
              )
              
              
              (24,082
              )Interest
      income
              
              
              18,581
              
              
              
              -
              
              
              
              44,257
              
              
              
              -Sundry
      income (expense)
              
              
              14,195
              
              
              
              8,368
              
              
              
              (4,543
              )
              
              
              15,210INCOME
      BEFORE INCOME TAXES
              
              
              8,591,689
              
              
              
              4,756,258
              
              
              
              16,985,977
              
              
              
              8,619,545INCOME
      TAXES - current
              
              
              2,305,780
              
              
              
              1,655,377
              
              
              
              4,552,477
              
              
              
              2,961,851NET
      INCOME
              
              $
              6,285,909
              
              
              $
              3,100,881
              
              
              $
              12,433,500
              
              
              $
              5,657,694EARNINGS
      PER SHARE:BASIC
              
              $
              0.06
              
              
              $
              0.03
              
              
              $
              0.12
              
              
              $
              0.06DILUTED
              
              $
              0.06
              
              
              $
              0.03
              
              
              $
              0.12
              
              
              $
              0.06WEIGHTED
      AVERAGE NUMBER OF SHARES:BASIC
              
              
              99,668,842
              
              
              
              98,953,638
              
              
              
              99,668,842
              
              
              
              93,554,622DILUTED
              
              
              99,668,842
              
              
              
              98,953,638
              
              
              
              99,676,655
              
              
              
              93,554,622
 
 
  - 4
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 (UNAUDITED)
 
 
 
 Three
      Months Ended June 30,
              
              
              Six
      Months Ended June 30,2008
              
              
              2007
              
              
              2008
              
              
              2007NET
      INCOME
              
              $
              6,285,909
              
              
              $
              3,100,881
              
              
              $
              12,433,500
              
              
              $
              5,657,694OTHER
      COMPREHENSIVE INCOMEForeign
      currency translation adjustment
              
              
              852,164
              
              
              
              420,584
              
              
              
              2,112,392
              
              
              
              487,830COMPREHENSIVE
      INCOME
              
              $
              7,138,073
              
              
              $
              3,521,465
              
              
              $
              14,545,892
              
              
              $
              6,145,524
  See
accompanying notes to condensed consolidated financial statements.
  - 5
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
 SIX
MONTHS ENDED JUNE 30, 2008
  Numberof Shares
              
              
              CommonStock
              
              
              AdditionalPaid-in Capital
              
              
              StatutoryCommon Reserve Fund
              
              
              RetainedEarnings
              
              
              CumulativeTranslation
              
              
              TotalBALANCE
      AT DECEMBER 31, 2007 (audited)
              
              
              99,668,842
              
              
              $
              49,834
              
              
              $
              11,924,616
              
              
              $
              1,321,893
              
              
              $
              11,323,518
              
              
              $
              1,848,447
              
              
              $
              26,468,308Cumulative
      translation adjustment
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2,112,392
              
              
              
              2,112,392Waiver
      of accrued interest
              
              
              -
              
              
              
              -
              
              
              
              131,533
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              131,533Issuance
      of warrants for consulting expenses
              
              
              -
              
              
              
              -
              
              
              
              369,381
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              369,381Net
      income for six months ended June 30, 2008
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              12,433,500
              
              
              
              -
              
              
              
              12,433,500BALANCE
      AT JUNE 30, 2008 (unaudited)
              
              
              99,668,842
              
              
              $
              49,834
              
              
              $
              12,425,530
              
              
              $
              1,321,893
              
              
              $
              23,757,018
              
              
              $
              3,960,839
              
              
              $
              41,515,114
 
 See
accompanying notes to condensed consolidated financial statements.
  - 6
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 SIX
MONTHS ENDED JUNE 30, 2008 AND 2007
 (UNAUDITED)
  Six
      Months Ended June 30,2008
              
              
              2007CASH
      FLOWS PROVIDED BY OPERATING ACTIVITIESNet
      income
              
              $
              12,433,500
              
              
              $
              5,657,694Adjustments
      to reconcile net incometo
      net cash provided by operating activitiesAmortization
      of warrants issued for expenses
              
              
              369,381
              
              
              
              -Amortization
      of prepaid expenses by sharesissued
      for consulting fee
              
              
              145,484
              
              
              
              -Depreciation
      and amortization
              
              
              2,136,053
              
              
              
              326,244(Increase)
      decrease in assetsAccounts
      receivable
              
              
              (8,151,159
              )
              
              
              (129,174
              )Inventories
              
              
              (1,424,086
              )
              
              
              3,419Prepaid
      expense
              
              
              -
              
              
              
              268,747Prepayment
      and deposit
              
              
              (365,382
              )
              
              
              -Income
      tax receivable
              
              
              -
              
              
              
              410,453Increase
      (decrease) in liabilitiesAccounts
      payable and accrued expenses
              
              
              1,968,076
              
              
              
              (2,119,944
              )Taxes
      payable
              
              
              2,218,473
              
              
              
              454,460Net
      cash provided by operating activities
              
              
              9,330,340
              
              
              
              4,871,899CASH
      FLOWS USED IN INVESTING ACTIVITIESRestricted
      cash
              
              
              (4,078,833
              )
              
              
              -Property,
      plant and equipment
              
              
              (16,845,218
              )
              
              (5,834,194)Net
      cash used in investing activities
              
              
              (20,924,051
              )
              
              
              (5,834,194
              )CASH
      FLOWS PROVIDED BY FINANCING ACTIVITIESCapital
      contribution
              
              
              -
              
              
              
              50,000Loan
      due to third party
              
              
              -
              
              
              
              5,836,950Advances
      from related party
              
              
              4,998,281
              
              
              
              1,227,222Proceeds
      from notes payable – related party
              
              
              5,590,800
              
              
              
              -Repayment
      on note payable
              
              
              (3,843,675
              )
              
              
              -Dividends
      paid
              
              
              -
              
              
              
              (4,739,600
              )Net
      cash provided by (used in) financing activities
              
              
              6,745,406
              
              
              
              (2,374,572
              )EFFECTS
      OF EXCHANGE RATE CHANGE ON CASH
              
              
              459,343
              
              
              
              98,362NET
      INCREASE (DECREASE) IN CASH
              
              
              (4,388,962
              )
              
              
              1,510,639CASH
      - BEGINNING OF PERIOD
              
              
              10,773,875
              
              
              
              5,692,608CASH
      - END OF PERIOD
              
              $
              6,384,913
              
              
              $
              7,203,247
 
 See
accompanying notes to condensed consolidated financial statements.
  - 7
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
 SIX
MONTHS ENDED JUNE 30, 2008 AND 2007
 (UNAUDITED)
 
 Six
      Months Ended June 30,2008
              
              
              2007SUPPLEMENTAL
      DISCLOSURE OF CASH FLOWINFORMATIONCash
      paid during the period for:Income
      taxes
              
              $
              3,101,479
              
              
              $
              1,657,319Interest
      paid
              
              $
              101,144
              
              
              $
              -
 
 
 SUPPLEMENTAL
      DISCLOSURE OF NON-CASH FINANCINGACTIVITIESWaiver
      of accrued interest to Additional Paid In Capital
              
              $
              131,533
              
              
              $
              -Issuance
      of common stock as payment for accrued expenses
              
              
              -
              
              
              
              5,344,395Issuance
      of common stock for prepaid expenses
              
              
              -
              
              
              
              892,500Issuance
      of common stock for acquiring fixed assets including mineral
      right
              
              
              -
              
              
              
              2,928,479
  See
accompanying notes to condensed consolidated financial statements.
  - 8
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 
 
 NOTE 1 –
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 The
accompanying unaudited consolidated financial statements have been prepared by
Gulf Resources, Inc. and its subsidiaries (collectively, the
“Company”).  These statements include all adjustments (consisting only
of their normal recurring adjustments) which management believes necessary for a
fair presentation of the statements and have been prepared on a consistent basis
using the accounting policies described in the Form 10-K for the year ended
December 31, 2007 (“2007 Form 10-K”).  Certain financial information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission, although the Company believes that the
accompanying disclosures are adequate to make the information presented not
misleading.  The Notes to Financial Statements included in the 2007
Form 10-K should be read in conjunction with the accompanying interim financial
statements.  The interim operating results for the three and six
months ended June 30, 2008 may not be indicative of operating results expected
for the full year.
 
 Basis of
Presentation
 Upper
Class Group Limited was incorporated with limited liability in the British
Virgin Islands on July 28, 2006 and was inactive until October 9, 2006 when
Upper Class Group Limited acquired all the issued and outstanding stock of
Shouguang City Haoyuan Chemical Company Limited (“SCHC”).  SCHC is an
operating company incorporated in Shouguang City, Shangdong Province, the
People’s Republic of China (the “PRC”) on May 18, 2005.  Since the
ownership of Upper Class Group Limited and SCHC were the same, the merger 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, Gulf Resources, Inc. (formerly Diversifax, Inc.), a public
“shell” company, acquired Upper Class Group Limited and its wholly-owned
subsidiary, SCHC (together “Upper Class”).  Under the terms of the
agreement, all stockholders of Upper Class Group Limited received a total amount
of 53,000,000 shares of voting common stock of Gulf Resources, Inc. in exchange
for all shares of Upper Class Group Limited common stock held by all
stockholders.  Under accounting principles generally accepted in the
United States, the share exchange is considered to be a capital transaction in
substance, 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 monetary 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 will be identical to that
resulting from a reverse acquisition, except no goodwill will be
recorded.  Under reverse takeover accounting, the comparative
historical financial statements issued after the acquisition of the legal
acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class
Group Limited, which is considered to be the accounting
acquirer.  Share and per share amounts stated have been retroactively
adjusted to reflect the merger.
 
 On
February 5, 2007, Upper Class Group Limited acquired Shouguang Yuxin Chemical
Industry Co., Limited (“SYCI”), which had been incorporated in PRC on October
30, 2000.  Under the terms of the merger agreement, the stockholders
of SYCI received a total amount of 32,376,236 shares of voting common stock of
Gulf Resources, Inc. in exchange for all of the shares of SYCI’s common
stock.  Also, upon the completion of the merger, Gulf Resources, Inc.
paid a $2,550,000 dividend to the original stockholders of
SYCI.  Since the ownership of Gulf Resources, Inc. and SYCI are
substantially the same, the merger was accounted for as a transaction between
entities under common control, whereby Gulf Resources, Inc. recognized the
assets and liabilities of SYCI transferred at their carrying
amounts.  Since prior to the acquisition the majority of the ownership
of Gulf Resources, Inc. and of SYCI was controlled by the same party, the merger
was accounted for as a transaction between entities under common control,
whereby Gulf Resources, Inc. recognized the assets and liabilities of SYCI
transferred at their carrying amounts.  Share and per share amounts
stated have been retroactively adjusted to reflect the merger.
  - 9
-
 
 GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
  NOTE 1 –
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (Continued)
 On
November 11, 2007, Upper Class Group Limited formed Hong Kong Jiaxing Industrial
Limited (“HKJI”), a wholly-owned subsidiary of Upper Class formerly known as
Jiaxing Technology Limited, in Hong Kong. Upper Class Group Limited then sold
100% of its interests in SCHC to HKJI.
 
 Nature of the
Business
 Gulf
Resources, Inc. and its subsidiaries manufacture and trade bromine and crude
salt through its SCHC subsidiary, and manufacture chemical products for use in
the oil industry and paper manufacturing industry through its SYCI
subsidiary.
 
 Basis of
Consolidation
 The
consolidated financial statements include the accounts of Gulf Resources, Inc.
and its wholly-owned subsidiaries, Upper Class Group Limited, SCHC, SYCI and
HKJI (collectively the “Company”).  All material intercompany
transactions have been eliminated in consolidation.
 
 The
consolidated financial statements have been restated for all periods prior to
the merger to include the financial position, results of operations and cash
flows of the commonly controlled companies.
 
 Use of
Estimates
  The
Company’s 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 and the related disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. The Company bases 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.
 
 Reporting
Currency
 The
Company’s functional currency is Renminbi (“RMB”); however, the reporting
currency is the United States dollar (“USD”).
 
 Foreign Currency
Translation
 Assets
and liabilities of the Company have been translated using the exchange rate at
the balance sheet date. The average exchange rate for the period has been used
to translate revenues and expenses.  Translation adjustments are
reported separately and accumulated in a separate component of equity
(cumulative translation adjustment).
 
 Cash and Cash
Equivalents
  Cash and
cash equivalents consist of all cash balances and highly liquid investments with
maturities of three months or less. Because of the short maturity of these
investments, the carrying amounts approximate their fair value.
 
 Restricted
Cash
 The
Company’s Restricted cash is in the Company’s bank account designated for use in
supporting the Company’s application to increase its registered capital. When
the Company’s application has been approved, the Restricted cash will be
returned to an unrestricted status.  Management believes that this
will occur by end of 2008.
  - 10
-
 
 GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
  NOTE 1 –
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (Continued)
 Restricted
cash consists of $2,000,000 received during the second quarter 2008 from Jiaxing
Lighting Technology (HK) Co. Ltd. (“Jiaxing Lighting”) (Note 5) and $2,199,898
received during first quarter 2008 from Shenzhen Huayin Guaranty and Investment
Company Limited (Note 3).
 
 Accounts
Receivable
 Accounts
receivable is stated at cost, net of allowance for doubtful accounts. As of June
30, 2008 and December 31, 2007 the Company considered all accounts receivable
collectable and therefore did not record an allowance for doubtful
accounts.
 
 Inventories
  Inventories
are stated at the lower of cost, determined on a first-in, first-out cost basis,
or net realizable value. Costs of work-in-progress and finished goods are
composed of direct materials, direct labor and an attributable portion of
manufacturing overhead. Net realizable value is based on estimated selling price
less selling expenses.
  Property, Plant and
Equipment
  Property,
plant and equipment is stated at cost. 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 stated at cost, less accumulated amortization.
  Mineral
rights are amortized ratably over the 50 year term of the lease, or the
equivalent term under the units of production method, whichever is
shorter.
  The
Company’s depreciation and amortization policies on fixed assets are as
follows:
  Useful
      life
                (in
      years)Mineral
      rights
              Lower
      of the period of lease or 50 yearsBuildings
              20Machinery
              8Motor
      vehicles
              5Equipment
              8
  Mineral
Rights
  The
Company follows FASB Staff Position amending SFAS No. 142 and No. 144 which
provide 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.
  Revenue
Recognition
 In
accordance with Securities and Exchange Commission (“SEC”) Staff Accounting
Bulletin (“SAB”) No. 104, Revenue Recognition, the
Company recognizes revenue when persuasive evidence of a customer or distributor
arrangement exists or acceptance occurs, receipt of goods by customer occurs,
the price is fixed or determinable, and the sales revenues are considered
collectible.  Subject to these criteria, the Company generally
recognizes revenue at the time of shipment or delivery to the customer, and when
the customer takes ownership and assumes risk of loss based on shipping
terms.
  - 11
-
 GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 
 
 NOTE 1 –
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (Continued)
  Foreign
Operations
  All of
the Company’s operations and assets are located in China. The Company may be
adversely affected by possible political or economic events in this country. The
effect of these factors cannot be accurately predicted.
 Shipping and Handling Fees
and Costs
 The
Company follows Emerging Issues Task Force (“EITF”) No. 00-10, Accounting for Shipping and Handling
Fees and Costs.  The Company does not charge its customers for
shipping and handling.  The Company classifies shipping and handling
costs as part of the cost of revenue.  For the three months ended June
30, 2008 and 2007, shipping and handling costs were $124,171 and $107,800, and
for the six months ended June 30, 2008 and 2007, shipping and handling costs
were $221,246 and $186,564.
 
 Recently Issued Accounting
Pronouncements
 
 During
September 2006, the Financial Accounting Standards Board (“FASB”)
issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which
is effective for fiscal years beginning after November 15, 2007 with
earlier adoption encouraged. SFAS 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. In February 2008, the
FASB issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No.
157 which delayed the effective date of SFAS 157 for all non-financial assets
and liabilities, except those that are recognized or disclosed at fair value in
the financial statements on a recurring basis, until January 1,
2009.   The Company adopted SFAS 157 on January 1, 2008 for all
financial assets and liabilities, but the implementation did not have a
significant impact on the Company's financial position or results of
operations.  The Company has not yet determined the impact the
implementation of SFAS 157 will have on the Company’s non-financial assets and
liabilities which are not recognized or disclosed on a recurring
basis.  However, the Company does not anticipate that the full
adoption of SFAS 157 will significantly impact their consolidated financial
statements.
 
 During
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities—including an amendment of FASB Statement No.
115 (“SFAS 159”), which permits entities to choose to measure many financial
instruments and certain other items at fair value. The objective of SFAS 159 is
to improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. The Company adopted SFAS 159 on January 1, 2008 and has elected not
to measure any additional financial assets, liabilities or other items at fair
value.
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (“SFAS 141R”). SFAS 141R establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired.
SFAS 141R also establishes disclosure requirements to enable the evaluation
of the nature and financial effects of the business combination. This statement
is effective for the Company beginning January 1, 2009 and will change the
accounting for business combinations on a prospective basis.
  - 12
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 
 
 NOTE 1 –
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (Continued)
 In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51 (“SFAS 160”). SFAS 160 establishes accounting and
reporting standards for ownership interests in subsidiaries held by parties
other than the parent, the amount of consolidated net income attributable to the
parent and to the noncontrolling interest, changes in a parent’s ownership
interest, and the valuation of retained noncontrolling equity investments when a
subsidiary is deconsolidated. SFAS 160 also establishes disclosure
requirements that clearly identify and distinguish between the interests of the
parent and the interests of the noncontrolling owners. This statement is
effective for the Company beginning January 1, 2009. This statement is not
currently applicable since its subsidiaries are wholly-owned.
 
 In March
2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities (“SFAS 161”), which is effective January 1,
2009. SFAS 161 requires enhanced disclosures about derivative instruments and
hedging activities to allow for a better understanding of their effects on an
entity’s financial position, financial performance, and cash flows. Among other
things, SFAS 161 requires disclosures of the fair values of derivative
instruments and associated gains and losses in a tabular format.  SFAS
161 is not currently applicable to the Company since the Company does not have
derivative instruments or hedging activity.
 
 In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchyof Generally Accepted Accounting
Principles(“SFAS 162"). This Standard identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles. FAS 162
directs thehierarchy to the
entity, rather than the independent auditors, as the entity is responsible for
selecting accounting principles for financial statements that are presented in
conformity with generally accepted accounting principles. The Standard is
effective 60 days following SEC approval of the Public Company Accounting
Oversight Board amendments to remove the hierarchy of generally accepted
accounting principles from the auditing standards. SFAS 162 is not expected to
have an impact on the financial statements.
 
 In April
2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of
Intangible Assets, which amends the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible
Assets.This Staff Position is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. Early adoption is prohibited. This FSP is not currently
applicable to the Company.
 
 In June
2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities.
This FSP provides that unvested share-based payment awards that contain
nonforfeitable rights to dividends or dividend equivalents (whether paid or
unpaid) are participating securities and shall be included in the computation of
earnings per share pursuant to the two-class method. The Company does not
currently have any share-based awards that would qualify as participating
securities. Therefore, application of this FSP is not expected to have an effect
on the Company's financial reporting.
 
 In May
2008, the FASB issued FASB Staff Position (FSP) APB 14-1, Accounting for Convertible Debt That
May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)("FSP 14-1"). FSP 14-1 will be effective for financial statements issued
for fiscal years beginning after December 15, 2008. The FSP includes guidance
that convertible debt instruments that may be settled in cash upon conversion
should be separated between the liability and equity components, with each
component being accounted for in a manner that will reflect the entity's
nonconvertible debt borrowing rate when interest costs are recognized in
subsequent periods. FSP 14-1 is not currently applicable to the Company since
the Company does not have convertible debt.
 
 
 - 13
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 
 NOTE 2-
PROPERTY, PLANT AND EQUIPMENT
  June
      30,
              
              
              December
      31,2008
              
              
              2007(unaudited)
              
              
              
              (audited)Building
              
              $
              6,375,853
              
              
              $
              2,379,252Furniture
      & equipment
              
              
              2,340,953
              
              
              
              1,120,059Plant
      and machinery
              
              
              36,766,058
              
              
              
              24,280,822Motor
      vehicle
              
              
              57,631
              
              
              
              54,155Mineral
      rights
              
              
              5,808,743
              
              
              
              4,221,059Construction
      in progress
              
              
              129,559
              
              
              
              -51,478,797
              
              
              
              32,055,347Accumulated
      depreciation
              
              
              (4,266,580
              )
              
              
              (1,950,162
              )$
              47,212,217
              
              
              $
              30,105,185
  On
January 8, 2008, SCHC entered into an Asset Purchase Agreement with Mr. Xiaodong
Yang for the purchase of wells, pipelines and other production equipment of a
bromine production facility located in Wei Fang City Hanting Area, along with
mineral rights and land lease. The consideration for the assets amounted to
$9,722,222. The property has 200,000 to 210,000 metric tons of proven bromine
reserves and its production capacity is estimated to be approximately 4,700
metric tons per year. This acquisition was deemed to be a purchase of assets and
not a purchase of a business.
 
 NOTE
      3 – NOTE PAYABLE
              
              June
      30
              
              
              December
      312008
              
              
              2007(unaudited)
              
              
              (audited)Bank
      borrowing from Citibank (China) Company Limited Shanghai Branch of
      $3,770,250 was due March 30, 2008 at the prevailing interest rate
      regulated by The People’s Bank of China minus 5% from October 31, 2007 to
      March 30, 2008, guaranteed by a shareholder, Shenzhen Huayin Guaranty and
      Investment Company Limited.
              
              $
              -
              
              
              $
              3,770,250Note
      payable to a stockholder, Shenzhen Huayin Guaranty and Investment Company
      Limited, was for $11,653,500. Of this, $6,169,500 of the borrowing was
      with interest at 3.33% per annum from March 20, 2007 to March 19, 2008 and
      was due on March 19, 2008. The remaining borrowing of $5,484,000 was
      interest free and was scheduled to mature on April 1,
2009.
              
              
              -
              
              
              
              11,653,500Note
      payable to a stockholder, Shenzhen Huayin Guaranty and Investment Company
      Limited, of $3,000,000 is unsecured, non-interest bearing and is due May
      2009. The loan is denominated in US dollars.  $2,199,898 of this
      loan is reflected in restricted cash (Note 1).
              
              
              3,000,000
              
              
              
              -Note
      payable to a stockholder, Shenzhen Huayin Guaranty and Investment Company
      Limited, of $18,237,493 (RMB125,000,000) is unsecured, and non-interest
      bearing, pursuant to an agreement which, as is Chinese custom, states that
      the loan need not be paid in the immediate future.  The Company
      believes the earliest the loan would be required to be repaid is December
      2009.
              
              
              18,237,493
              
              
              
              -Total
      loans
              
              
              21,237,493
              
              
              
              15,423,750Less:
      current portion
              
              
              (3,000,000
              )
              
              
              (9,939,750
              )Long-term
      loans, less current portion
              
              $
              18,237,493
              
              
              $
              5,484,000
   - 14
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 (UNAUDITED)
 
 NOTE 3 –
NOTE PAYABLE - Continued
 
 Future
      maturities of long-term loans are as follows as ofJune
      30, 2008:2009
              
              $
              21,237,4932010
              
              
              -2011
              
              
              -Total
              
              $
              21,237,493
 During
the three months ended months ended March 31, 2008, Shenzhen Huayin Guaranty and
Investment Company Limited waived $131,533 of accrued interest, which was
recorded as a credit to additional paid in capital.
 
 
 NOTE 4 –
TAXES PAYABLE
 
 Taxes
      payable consists of the following:June 30,
                2008
              
              
              December 31,2007(unaudited)
              
              
              (audited)Income
      tax payable
              
              $
              2,723,186
              
              
              $
              798,090Mineral
      resource compensation fee payable
              
              
              585,423
              
              
              
              -Value
      added tax payable and others
              
              
              580,422
              
              
              
              679,206Total
              
              $
              3,889,032
              
              
              $
              1,477,296
 
 
 NOTE 5 –
DUE TO RELATED PARTIES
 
 Due
      to related parties consists of the following:June 30,
              
              
              December 31,2008
              
              
              2007(unaudited)
              
              
              (audited)Advance
      from major stockholder
              
              $
              32,230
              
              
              $
              32,230Due
      to related company - Jiaxing Lighting
              
              
              2,000,000
              
              
              
              -$
              2,032,230
              
              
              $
              32,230
 The
$32,230 due to related party represents advance from major
stockholder.  The $2,000,000 due to related company represents funds
received from Jiaxing Lighting for investment purpose in SCHC.  Mr.
Ming Yang, CEO of the Company, is the director and shareholder of Jiaxing
Lighting. The investment arrangement in the Company is still in progress and the
cash is reflected as restricted cash on the balance sheet (Note
1).  Advance from major stockholder and balances due to related
company are unsecured, non-interest bearing and have no fixed repayment
terms.
  - 15
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 (UNAUDITED)
 
 NOTE 6 –
RETAINED EARNINGS – APPROPRIATED
 
 In
accordance with the relevant PRC regulations and the Company’s Articles of
Association, the Company is required to classify 10% of the profit after tax as
reported under the PRC statutory financial statements to the Statutory Common
Reserve Fund until the balance reaches 50% of the registered share
capital.  This reserve can be used to make up any loss incurred or to
increase share capital.  Except for the reduction of losses incurred,
any other application should not result in this reserve balance falling below
25% of the registered capital. As of December 31, 2007 the Statutory Common
Reserve Fund had reached 50% of the Company’s registered capital.
 
 NOTE 7 –
STOCK OPTIONS AND WARRANTS
 
 Common
stock, stock options and common stock warrants issued to other than employees or
directors are recorded on the basis of their fair value, as required by SFAS No.
123(R), which is measured as of the date required by EITF Issue 96-18,
“Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services.”  In
accordance with EITF 96-18, the stock options or common stock warrants are
valued using the Black-Scholes model on the basis of the market price of the
underlying common stock on the “valuation date,” which for options and warrants
related to contracts that have substantial disincentives to non-performance is
the date of the contract, and for all other contracts the measurement date is
the date that the service is complete. Expense related to the options and
warrants is recognized on a straight-line basis over the shorter of the period
over which services are to be received or the vesting period. Where expense must
be recognized prior to a valuation date, the expense is computed under the
Black-Scholes model on the basis of the market price of the underlying common
stock at the end of the period, and any subsequent changes in the market price
of the underlying common stock up through the valuation date is reflected in the
expense recorded in the subsequent period in which that change
occurs.
 
 The
Company has issued 1,000,000 warrants on February 5, 2008 at a price of $2.51
per share as part of a consulting agreement with its investor relations firm.
The warrants were valued using the Black-Scholes option-pricing model with an
assumed 86% volatility, a three year term for the warrants, a risk free rate of
3% and a dividend yield of 0%. These warrants may be exercised through the third
anniversary of the date of the Agreement, and vest in 12 quarterly installments
in equal amounts beginning in the second quarter of 2008. The consulting expense
for these services is recognized on a straight line basis over the one year
period of the related consulting contract. The related expense for the three
months and six months ended June 30, 2008 is $139,151 and $369,381.
 
 
 The
following table summarizes all Company stock option transactions between January
1, 2008 and June 30, 2008
  Option
      & Warrants Outstanding
              
              
              Options
      & Warrants Vested
              
              
              Range
      of Exercise Price per Common ShareBalance,
      December 31, 2007
              
              
              100,000
              
              
              
              100,000
              
              
              $
              2.00
      - $2.05Granted
      or vested during the six months ended June 30, 2008
              
              
              1,000,000
              
              
              
              83,333
              
              
              
              2.51Expired
      during the six months ended June 30, 2008
              
              
              -
              
              
              
              -
              
              
              
              -Balance,
      June 30, 2008
              
              
              1,100,000
              
              
              
              183,333
              
              
              $
              2.00
      - $2.45
  - 16
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 (UNAUDITED)
 
 NOTE 7 –
STOCK OPTIONS – Continued
  Stock
      Options Outstanding
 Number
      Outstanding
              
              Weighted
      Average
              
              Weighted
      AverageRange
      of
              
              Currently
      Exercisable
              
              Remaining
              
              Exercise
      Price of OptionsExercise
      Prices
              
              at
      June 30, 2008
              
              Contractual
      Life (Years)
              
              Currently
      Exercisable$2.00-$2.51
              
              183,333
              
              1.89
              
              $   2.25
 
 
 NOTE 8 –
INCOME TAXES
 
 The
Company utilizes the asset and liability method of accounting for income taxes
in accordance with SFAS No. 109. The Company’s effective tax rates for the three
months and six months ended June 30, 2008 were 26.8%.  Effective tax
rates for the three months and six months ended June 30, 2007 were 34.8% and
34.4%.  These rates in those periods differed from the statutory PRC
rates of 25% and 33%, respectively, due to the non-deductibility of certain
expenses incurred outside of the PRC.
 
 No
provision for deferred taxes has been made as there were no material temporary
differences at June 30, 2008 and December 31, 2007.
 
 There was
no change in unrecognized tax benefits during the period ended June 30, 2008 and
there was no accrual for uncertain tax positions as of June 30,
2008.
 
 Tax years
from 2005 through 2007 remain subject to examination by major tax
jurisdictions.
 
 
 NOTE 9 –
BUSINESS SEGMENTS
 
 The
Company follows SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information,which requires the Company to provide
certain information about their operating segments.  The Company has
two reportable segments:  bromine and crude salt and chemical
products.
 
 Three
      Months EndedJune
      30, 2008
                (unaudited)
              
              Bromine
      and
                Crude
      Salt
              
              
              Chemical
                Products
              
              
              Segment
                Total
              
              
              Corporate
              
              
              Consolidated
                TotalNet
      sales
              
              $
              18,008,559
              
              
              $
              5,757,620
              
              
              $
              23,766,179
              
              
              $
              -
              
              
              $
              23,766,179Income
      (loss) from operations
              
              
              7,156,765
              
              
              
              2,034,415
              
              
              
              9,191,180
              
              
              
              (632,267
              )
              
              
              8,558,913Total
      assets
              
              
              60,450,820
              
              
              
              12,993,781
              
              
              
              73,444,601
              
              
              
              191,571
              
              
              
              73,636,172Depreciation
      and amortization
              
              
              1,037,986
              
              
              
              112,576
              
              
              
              1,150,562
              
              
              
              -
              
              
              
              1,150,562Capital
      expenditures
              
              
              127,792
              
              
              
              6,835,909
              
              
              
              6,963,701
              
              
              
              -
              
              
              
              6,963,701
  - 17
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 (UNAUDITED)
 
 NOTE 9 –
BUSINESS SEGMENTS (CONTINUED)
 
 Three
      Months EndedJune
      30,2007
                (unaudited)
              
              Bromine
      and
                Crude
      Salt
              
              
              Chemical
                Products
              
              
              Segment
                Total
              
              
              Corporate
              
              
              Consolidated
                TotalNet
      sales
              
              $
              7,703,140
              
              
              $
              4,686,811
              
              
              $
              12,389,951
              
              
              $
              -
              
              
              $
              12,389,951Income
      (loss) from operations
              
              
              3,257,477
              
              
              
              1,753,629
              
              
              
              5,011,106
              
              
              
              (239,134
              )
              
              
              4,771,972Total
      assets
              
              
              20,832,156
              
              
              
              5,836,921
              
              
              
              26,669,077
              
              
              
              665,862
              
              
              
              27,334,939Depreciation
      and amortization
              
              
              162,999
              
              
              
              46,571
              
              
              
              209,570
              
              
              
              -
              
              
              
              209,570Capital
      expenditures
              
              
              5,834,194
              
              
              
              -
              
              
              
              5,834,194
              
              
              
              -
              
              
              
              5,834,194
 
 Six
      Months EndedJune
      30, 2008
                (unaudited)
              
              Bromine
      and
                Crude
      Salt
              
              
              Chemical
                Products
              
              
              Segment
                Total
              
              
              Corporate
              
              
              Consolidated
                TotalNet
      sales
              
              $
              34,520,664
              
              
              $
              11,279,072
              
              
              $
              45,799,736
              
              
              $
              -
              
              
              $
              45,799,736Income
      (loss) from operations
              
              
              14,341,085
              
              
              
              3,873,541
              
              
              
              18,214,626
              
              
              
              (1,208,252
              )
              
              
              17,006,374Total
      assets
              
              
              60,450,820
              
              
              
              12,993,781
              
              
              
              73,444,601
              
              
              
              191,571
              
              
              
              73,636,172Depreciation
      and amortization
              
              
              1,975,189
              
              
              
              160,864
              
              
              
              2,136,053
              
              
              
              -
              
              
              
              2,136,053Capital
      expenditures
              
              
              10,009,309
              
              
              
              6,835,909
              
              
              
              16,845,218
              
              
              
              -
              
              
              
              16,845,218
 
 Six
      Months EndedJune
      30,2007
                (unaudited)
              
              Bromine
      and
                Crude
      Salt
              
              
              Chemical
                Products
              
              
              Segment
                Total
              
              
              Corporate
              
              
              Consolidated
                TotalNet
      sales
              
              $
              13,004,867
              
              
              $
              9,448,411
              
              
              $
              22,453,278
              
              
              $
              -
              
              
              $
              22,453,278Income
      (loss) from operations
              
              
              5,498,985
              
              
              
              3,454,905
              
              
              
              8,953,890
              
              
              
              (325,473
              )
              
              
              8,628,417Total
      assets
              
              
              20,832,156
              
              
              
              5,836,921
              
              
              
              26,669,077
              
              
              
              665,862
              
              
              
              27,334,939Depreciation
      and amortization
              
              
              233,084
              
              
              
              93,160
              
              
              
              326,244
              
              
              
              -
              
              
              
              326,244Capital
      expenditures
              
              
              5,834,194
              
              
              
              -
              
              
              
              5,834,194
              
              
              
              -
              
              
              
              5,834,194
 
 Three
      Months Ended
              
              
              Six
      Months EndedJune
      30,
              
              
              June
      30,Reconciliations
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Total
      segment operating income
              
              $
              9,191,180
              
              
              $
              5,011,106
              
              
              $
              18,214,626
              
              
              $
              8,953,890Corporate
      overhead expenses
              
              
              (632,267
              )
              
              
              (239,134
              )
              
              
              (1,208,252
              )
              
              
              (325,473
              )Other
      income (expense)
              
              
              32,776
              
              
              
              (15,714
              )
              
              
              (20,397
              )
              
              
              (8,872
              )Income
      tax expense
              
              
              (2,305,780
              )
              
              
              (1,655,377
              )
              
              
              (4,552,477
              )
              
              
              (2,961,851
              )Total
      consolidated net income
              
              $
              6,285,909
              
              
              $
              3,100,881
              
              
              $
              12,433,500
              
              
              $
              5,657,694
  - 18
-
  GULF
RESOURCES, INC.
 AND
SUBSIDIARIES
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30,
2008
 (UNAUDITED)
 
 NOTE 10 –
MAJOR SUPPLIER
 
 During
the three months and six months ended June 30, 2008, the Company purchased 62%
of its raw material from two suppliers.  At June 30, 2008, amounts due
to those suppliers included in accounts payable were $2,257,452. During the
three months and six months ended June 30, 2007, the Company purchased 50% and
45% of its raw material from two suppliers.  At June 30, 2007, amounts
due to those suppliers included in accounts payable were $1,286,400. This
concentration makes the Company vulnerable to a near-term severe impact, should
the relationships be terminated.
 
 NOTE 11 –
CUSTOMER CONCENTRATION
 
 The
Company sells a substantial portion of its product to a limited number of
customers.  During the three months ended June 30, 2008, sales to the
Company’s two largest customers, based on net revenue made to such customers,
aggregated $5,625,665, or approximately 24% of total net
revenue.  During the six months ended June 30, 2008, the Company's
four largest customers aggregated $16,702,133, or approximately 40% of total net
revenue. At June 30, 2008, amounts due from these customers were
$7,962,106.
 
 During
the three months and six months ended June 30, 2007, sales to three customers
totaled $4,746,682 and $8,080,550, or approximately 40% and 39% of total net
revenue.  At June 30, 2007, amounts due from these customers were
$1,282,509.  This concentration makes the Company vulnerable to a
near-term severe impact, should the relationships be terminated.
  NOTE 12 –
RELATED PARTY TRANSACTIONS
 
 June
      30,2008
              
              
              December
      31,2007(unaudited)
              
              
              (audited)Waiver
      of interest expenses during first quarter 2008 by a related
      party:Shenzhen
      Huayin Guaranty and Investment Company Limited (Note 3)
              
              $
              131,533
              
              
              $
              -Note
      payable - related party:Shenzhen
      Huayin Guaranty and Investment Company Limited (Note 3)
              
              $
              21,237,493
              
              
              $
              11,653,500Due
      to related party:Jiaxing
      Lighting
              
              $
              2,000,000
              
              
              $
              -Advance
      from major stockholder
              
              
              32,230
              
              
              
              32,230$
              2,032,230
              
              
              $
              32,230
  NOTE 13 –
ESTABLISHMENT OF CO-OP RESEARCH AND DEVELOPMENT CENTER
 
 On
September 6, 2007, the Company’s wholly-owned subsidiary, SYCI, and East China
University of Science and Technology signed an agreement to facilitate the
pursuing targeted research and development of refined bromide compounds and end
products. As part of this agreement the Co-Op Research and Development Center
was opened and is now equipped with state of the art chemical engineering
instruments. According to the Co-op Research Agreement, any research achievement
or patents will become assets of the Company. The Company will provide $500,000
annually during the next five years to East China University of Science and
Technology for research. The research and development expense recognized during
the three months and six months ended June 30, 2008 was $135,275 and $267,109.
No research and development expense was recorded during the three months and six
months ended June 30, 2007.
  - 19
-
  Item
2.  Management’s Discussion and Analysis of Financial Condition and Results
of Operations.
 
 This
report contains forward-looking statements that reflect management's current
views and expectations with respect to our business, strategies, future results
and events, and financial performance. All statements made in this report other
than statements of historical fact, including statements that address operating
performance, events or developments that management expects or anticipates will
or may occur in the future, including statements related to future reserves,
cash flows, revenues, profitability, adequacy of funds from operations,
statements expressing general optimism about future operating results and
non-historical information, are forward-looking statements. In particular, the
words "believe," "expect," "intend," "anticipate," "estimate," "plan," "may,"
"will," variations of such words and similar expressions identify
forward-looking statements, but are not the exclusive means of identifying such
statements and their absence does not mean that the statement is not
forward-looking. Readers should not place undue reliance on forward-looking
statements which are based on management's current expectations and projections
about future events, are not guarantees of future performance, and are subject
to risks, uncertainties and assumptions. Our actual results, performance or
achievements could differ materially from the results expressed in, or implied
by, these forward-looking statements. Factors that could cause or contribute to
such differences include those discussed in this report, particularly under the
caption "Risk Factors."  Except as required under the federal
securities laws, we do not undertake any obligation to update the
forward-looking statements in this report.
 
 Overview
  Gulf
Resources conducts operations through its two wholly-owned China subsidiaries,
SCHC and SYCI. Our business is also reported in these two segments, Bromine and
Crude salts (SCHC), and Chemical Products (SYCI).
  Through
SCHC, we believe that 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, papermaking, chemical agents and
inorganic chemicals.
  On December 12, 2006, Gulf Resources,
which was then an inactive “shell” company, acquired, through a share exchange,
Upper Class Group Limited, a British Virgin Islands holding corporation which
then owned all of the outstanding shares of SCHC. Under accounting principles
generally accepted in the United States, this share exchange is considered to be
a capital transaction, rather than a business combination, with the share
exchange equivalent to the issuance of stock by Upper Class for the net assets
of Gulf Resources, accompanied by a recapitalization, and is accounted for as a
change in capital structure. Accordingly, the accounting for the share exchange
was identical to that resulting from a reverse acquisition, except no goodwill
was recorded.Under reverse takeover accounting, the comparative
historical financial statements issued after the acquisition of the legal
acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class
Group Limited, which is considered to be the accounting
acquirer.  Share and per share amounts stated have been retroactively
adjusted to reflect the merger.
  On
February 5, 2007, Gulf Resources, through its subsidiary SCHC, acquired SYCI.
Since prior to the acquisition the majority of the ownership of Gulf Resources
and of SYCI was controlled by the same party, the transaction was accounted for
as a transaction between entities under common control, whereby the assets and
liabilities of SYCI were recognized at their carrying amounts. Share and per
share amounts stated in this report have also been retroactively adjusted to
reflect this transaction.
  The
following discussion should be read in conjunction with our consolidated
financial statements and notes thereto appearing elsewhere in this
report.
  Possible
PRC Government-mandated restrictions affecting the production activities of our
customers, or celebrations prior to and during the Olympics to be held in China
in August 2008 may have an adverse effect on our business and results of
operations.
  - 20
-
  RESULTS
OF OPERATIONS
  The
following table presents certain information derived from the consolidated
statements of operations, cash flows and shareholders’ equity for the three
months and six months ended June 30, 2008 and June 30, 2007.
 
 Three
      months ended
                June 30,
      2008
              
              
              Three
      months ended
                June 30,
      2007
              
              
              Percentage
      ChangeNet
      Revenue
              
              $
              23,766,179
              
              
              $
              12,389,951
              
              
              
              91.8
              %Cost
      of Net Revenue
              
              
              14,062,903
              
              
              
              7,270,962
              
              
              
              93.4
              %Gross
      Profit
              
              
              9,703,276
              
              
              
              5,118,989
              
              
              
              89.6
              %Research
      and Development costs
              
              
              135,275
              
              
              
              -
              
              
              
              n/mGeneral
      and Administrative expenses
              
              
              1,009,088
              
              
              
              347,017
              
              
              
              191
              %Income
      from operations
              
              
              8,558,913
              
              
              
              4,771,972
              
              
              
              78.2
              %Other
      Income (expenses), net
              
              
              32,776
              
              
              
              (15,714)
              
              
              
              n/mIncome
      before taxes
              
              
              8,591,689
              
              
              
              4,756,258
              
              
              
              80.6
              %Income
      Taxes
              
              
              2,305,780
              
              
              
              1,655,377
              
              
              
              39.3
              %Net
      Income
              
              $
              6,285,909
              
              
              $
              3,100,881
              
              
              
              102.7
              %
 
 Six
      months ended
                June 30,
      2008
              
              
              Six
      months ended
                June 30,
      2007
              
              
              Percentage
      ChangeNet
      Revenue
              
              $
              45,799,736
              
              
              $
              22,453,278
              
              
              
              104.0
              %Cost
      of Net Revenue
              
              
              26,662,623
              
              
              
              13,295,664
              
              
              
              100.5
              %Gross
      Profit
              
              
              19,137,113
              
              
              
              9,157,614
              
              
              
              109
              %Research
      and Development costs
              
              
              267,109
              
              
              
              -
              
              
              
              n/mGeneral
      and Administrative expenses
              
              
              1,863,630
              
              
              
              529,197
              
              
              
              252
              %Income
      from operations
              
              
              17,006,374
              
              
              
              8,628,417
              
              
              
              97.1
              %Other
      Income (expenses), net
              
              
              (20,397)
              
              
              
              (8,872
              )
              
              
              130.0
              %Income
      before taxes
              
              
              16,985,977
              
              
              
              8,619,545
              
              
              
              97.1
              %Income
      Taxes
              
              
              4,552,477
              
              
              
              2,961,851
              
              
              
              53.7
              %Net
      Income
              
              $
              12,433,500
              
              
              $
              5,657,694
              
              
              
              119.8
              %
 Net revenueNet revenues were $23,766,179 for three months ended June 30, 2008,
an increase of $11,376,228 (or approximately 92%) as compared to the 2007
comparable period. This increase was primarily attributable to strong growth in
our Bromine and Crude salt segment, with revenues increasing from $7,703,140 for
three months ended June 30, 2007 to $18,008,559 in 2008, an increase of
approximately 134%. This increase was primarily the result of increased
production due to the purchases of four bromine producing properties during 2007
and one in January 2008, which generated approximately $9,500,000 of additional
revenue in the second quarter. The appreciation of the Chinese Yuan increased
the segment’s US dollar revenue by approximately $800,000 as compared to the
three months ended June 30, 2007.
 
 Revenues
in the Chemical Products segment increased from $4,686,811 for three months
ended March 31, 2007 to $5,757,620 during the same period in 2008, an increase
of approximately 23%. This was largely due to the development of new chemical
products with about $515,000 resulting from the Chinese Yuan
appreciation.
  - 21
-
  Among the
total increase of net revenues of $11,376,228 , approximately $9,500,000was due
to the contribution of the five newly acquired bromine properties, and
approximately $1,355,000 was due to the higher rate of the Yuan.
 
 Net
      Revenue by SegmentThree
      months ended
              
              
              Three
      months endedJune 30,
      2008
              
              
              June 30,
      2007Segment
              
              
              
              
              Percent
      of total
              
              
              
              
              
              Percent
      of totalBromine
      and Crude salt
              
              $
              18,008,559
              
              
              
              75.8%
              
              
              $
              7,703,140
              
              
              
              62.2%Chemical
      Products
              
              
              5,757,620
              
              
              
              24.2%
              
              
              
              4,686,811
              
              
              
              37.8%Total
      Revenues
              
              $
              23,766,179
              
              
              
              100.0%
              
              
              $
              12,389,951
              
              
              
              100.0%
 
 
 Three
      months ended June 302008
      vs. 2007Segment
              Percent increase of
      Net revenueBromine
      and Crude salt
              133.8%Chemical
      Products
              22.8%
 
 Net
revenues for the six months ended June 30, 2008, were $45,799,736, representing
an increase of $23,346,458 or 104% over the comparable 2007
period.  The Bromine and Crude salts segment’s revenue grew by
$21,515,797 to $34,520,664  resulting from the acquisition of the five
bromine facilities, which contributed approximately $19,500,000 of additional
revenue, and approximately $1,400,000 of benefit from the appreciation of the
Chinese Yuan.
 
 The
revenues from the Chemical Products segment were $11,279,072, an increase of
$1,830,661 or 19% over the comparable 2007 period.   This
increase was largely due to the Yuan appreciation, which was approximately
$1,000,000, and the remainder due to the development of new chemical
products.
 
 Of the
total revenue increase of $23,346,458 during the first six months of 2008 as
compared to the similar 2007 period, approximately $19,500,000 resulted from
impact of the five bromine properties acquired, and $2,400,000 was due to the
Yuan appreciation.
  Net Revenue by SegmentSix
      months ended
              
              
              Six
      months endedJune 30,
      2008
              
              
              June 30,
      2007Segments
              
              
              
              
              Percent
      of total
              
              
              
              
              
              Percent
      of totalBromine
      and Crude salt
              
              $
              34,520,664
              
              
              
              75.4%
              
              
              $
              13,004,867
              
              
              
              57.9%Chemical
      Products
              
              
              11,279,072
              
              
              
              24.6%
              
              
              
              9,448,411
              
              
              
              42.1%Total
      Revenues
              
              $
              45,799,736
              
              
              
              100.0%
              
              
              $
              22,453,278
              
              
              
              100.0%
 
 
 Six
      Months Ended June 302008
      vs. 2007Segments
              Percent increase of
      Net revenueBromine
      and Crude salt
              165.4%Chemical
      Products
              19.4%
 
 Bromine
      and Crude salt segment product sold in metric tons
              
              Three
      months ended
                June
      30, 2008
              
              
              Three
      months ended
                June
      30, 2007
              
              
              Percentage
      ChangeBromine
              
              
              9,265
              
              
              
              3,956
              
              
              
              134
              %Crude
      Salt
              
              
              22,500
              
              
              
              26,000
              
              
              
              -13.5
              %
  - 22
-
 Bromine
      and Crude salt segment product sold in metric tons
              
              Six
      months ended
                June
      30, 2008
              
              
              Six
      months ended
                June
      30, 2007
              
              
              Percentage
      ChangeBromine
              
              
              17,327
              
              
              
              6,824
              
              
              
              254
              %Crude
      Salt
              
              
              30,500
              
              
              
              28,000
              
              
              
              8.9
              %
 
 Due to
the diverse product mix and varying values, management does not believe that the
tonnage sold by the Chemical Products segment is a meaningful
metric.
  Cost of Net
revenue and Gross profitThe Cost of net revenue reflects the raw
materials consumed, electricity, depreciation, the direct salaries and benefits
of staff engaged in the production process, and other manufacturing costs. Our
Cost of net revenue and the resulting Gross profit for the three and six months
ended June 30, 2008 and 2007 were:
 Three
      months ended June 302008
              
              
              % of Netrevenue
              
              
              2007
              
              
              % of NetrevenueCost
      of net revenue
              
              $
              14,062,903
              
              
              
              59.2
              %
              
              $
              7,270,962
              
              
              
              58.7
              %Gross
      Profit
              
              $
              9,703,276
              
              
              
              40.8
              %
              
              $
              5,118,989
              
              
              
              41.3
              %Six
      months ended June 302008
              
              
              % of Netrevenue
              
              
              2007
              
              
              % of NetrevenueCost
      of net revenue
              
              $
              26,662,623
              
              
              
              58.2
              %
              
              $
              13,295,664
              
              
              
              59.2
              %Gross
      Profit
              
              $
              19,137,113
              
              
              
              41.8
              %
              
              $
              9,157,614
              
              
              
              40.8
              %
 
 The
increases in the Cost of net revenue were largely the result of the
substantially higher sales volumes recorded in both the three and six month
periods ended June 30, 2008 as compared to the corresponding prior year
periods.  The reduction in the Cost of net revenue as a percentage of
Net revenue for the first half was due to a higher percentage of revenue from
the Bromine and Crude salt segment, which has a lower product cost as a
percentage of its net revenue, as well as production efficiencies in consumables
and electricity, in part as a result of economies of scale achieved due to the
acquisitions, and greater utilization of bromine production capacity, partially
offset by the effect of a new tax on revenue derived from the sales of mineral.
This tax is effective as of January 1, 2008 but this announcement was only
received after the first quarter, and thus approximately $700,000 was accrued
for this cost in the second quarter.  It was due to this that the Cost
of net revenue as a percentage of net revenue grew slightly in the second
quarter. The increases in Gross profit for both periods were largely the result
of higher sales volumes as well as the other factors noted
above.
  Research and
Development CostsThe Research and development costs result from the
agreement that the Company and East China University of Science and Technology
entered in September 2007 which established a Co-Op Research and Development
Center to develop new bromine-based chemical compounds and products to be
utilized in the pharmaceutical industry. There were no comparable costs incurred
in the 2007 periods.  All research findings and patents developed by
this Center will belong to Gulf Resources.
  General and
Administrative ExpensesGeneral and administrative expenses were
$1,009,088 and $1,863,630, representing increases of $662,071 and $1,334,433,
for three and six months ended June 30, 2008, respectively.  These
significant increases in general and administrative expenses were primarily due
to expenses related to corporate costs resulting from higher directors’ fees and
insurance, and investor relations expenses, which amounted to approximately
$356,000 and $730,000, respectively, and higher land tax fees and salary expense
due to the expanded operations of $237,000 and $382,000,
respectively.
  - 23
-
  Income
from Operations
  Income
      from Operations by SegmentThree
      months ended
              
              
              Three
      months endedJune
      30, 2008
              
              
              June
      30, 2007Segment
              
              
              
              
              
              Percent
      oftotal
              
              
              
              
              
              
              Percent
      of totalBromine
      and Crude salt
              
              $
              7,156,765
              
              
              
              77.8%
              
              
              $
              3,257,477
              
              
              
              65.0%Chemical
      Products
              
              
              2,034,415
              
              
              
              22.2%
              
              
              
              1,753,629
              
              
              
              35.0%Income
      from operations before corporate costs
              
              
              9,191,180
              
              
              
              100.0%
              
              
              
              5,011,106
              
              
              
              100.0%Corporate
      costs
              
              
              (632,267)
              
              
              
              
              
              
              
              (239,134)Income
      from operations
              
              $
              8,558,913
              
              
              
              
              
              
              $
              4,771,972
  Income
      from Operations by SegmentSix
      months ended
              
              
              Six
      months endedJune
      30, 2008
              
              
              June
      30, 2007Segment
              
              
              
              
              
              Percent
      of total
              
              
              
              
              
              
              Percent
      of totalBromine
      and Crude salt
              
              $
              14,341,085
              
              
              
              78.7%
              
              
              $
              5,498,985
              
              
              
              61.4%Chemical
      Products
              
              
              3,873,541
              
              
              
              21.3%
              
              
              
              3,454,905
              
              
              
              38.6%Income
      from operations before corporate costs
              
              
              18,,214,626
              
              
              
              100.0%
              
              
              
              8,953,890
              
              
              
              100.0%Corporate
      costs
              
              
              (1,208,252)
              
              
              
              
              
              
              
              (325,473)Income
      from operations
              
              $
              17,006,374
              
              
              
              
              
              
              $
              8,628,417
 
 Income
from Operations before corporate costs was $9,191,180 for three months ended
June 30, 2008 (38.7% of net revenue), an increase of $4,180,074 (or
approximately 83.4%) over Income from Operations for three months ended June 30,
2007.  Income from Operations before corporate costs was $18,214,626
for the six months ended June 30, 2008 (39.7% of net revenue), an increase of
$9,260,736 (or approximately 103.4%). These increases resulted primarily from
the increases in revenues and the resulting higher Income from Operations from
the Bromine and Crude salts segment of the Company. For three months ended June
30, 2008, Income from operations for the Bromine and Crude salt segment was
$7,156,765, an increase of 120% from $3,257,477 for three months ended June
30, 2007. For six month period ended June 30, 2008, income from operations for
the Bromine and Crude salt segment was $14,341,085, an increase of 161% from the
six months ended June 30, 2007. These increases in the revenue and Income from
operations of Bromine and Crude salt segment were primarily as a result of the
purchase of five new bromine producing assets and a higher gross margin due to
production cost efficiencies. The smaller increases in revenue and income from
operations of our Chemical Products were largely due to the completion of
equipment upgrades and the development of new chemical products.
  Net IncomeNet Income was $6,285,909 for three months ended June 30, 2008, an
increase of $3,185,028 (102.7%), and Net Income was $12,433,500 for the six
months ended June 30, 2008, an increase of $6,775,806 (120%), as compared to the
comparative prior year periods. These increases were primarily attributable to
the higher operating profit resulting from the increases in revenues, and a
decrease in the effective tax rate to 26.8% in 2008 from approximately 34% in
2007 due to the reduction of the PRC corporate tax rate which was effective as
of January 1, 2008.
 
 LIQUIDITY
AND CAPITAL RESOURCES
  As of
June 30, 2008, Cash, and Cash Equivalents were $6,384,913 as compared to
$10,773,875 as of December 31, 2007. The components of this decrease of
$4,388,962 are reflected below.
  Cash
Flow
  Six
      Months Ended June 302008
              
              
              2007Net
      cash provided by operating activities
              
              $
              9,330,340
              
              
              $
              4,871,899Net
      cash used in investing activities
              
              
              (20,924,051)
              
              
              
              (5,834,194
              )Net
      cash provided by financing activities
              
              
              6,745,406
              
              
              
              2,374,572Net
      cash inflow (outflow)
              
              $
              (4,388,962)
              
              
              $
              1,510,639
  - 24
-
  For six
months ended June 30, 2008 the Company met its working capital and capital
investment requirements mainly by using cash flow from operations and net
additional borrowings of $6,657,348.  Included in the total additional
borrowings were additional loans from related parties of
$10,589,081.  These funds were investing in a bromine production
facility for $9,722,222, spending for an expansion of the Company’s chemical
plant in the amount of approximately $6,835,000, and an application to increase
the Company’s registered capital, which required a deposit of about $4,200,000
and is classified as Restricted cash as of June 30, 2008.  When the
Company’s application is approved, the restricted cash will be returned to an
unrestricted status.
  As
discussed in Note 3 of the Notes to Consolidated Financial Statements in Item 1,
“Consolidated Financial Statements and Supplemental Data”, as of June 30, 2008 ,
the Company has a note payable to a stockholder, Shenzhen Huayin Guaranty and
Investment Company Limited, in the aggregate amount of
$21,237,493.  This note is unsecured and non-interest
bearing.  Of this, $3,000,000 is due in May, 2009 and the Company
believes that the earliest that the remaining amount is due is December
2009.  As discussed in Note 4 to the Consolidated Financial
Statements, the Company also received $2,000,000 of funds from Jiaxing Lighting
Technology (HK) Co. Ltd.  Mr. Ming Yang, Gulf Resource’s CEO and
Chairman, is the director and shareholder of this company.  The terms
of this advance have not been finalized.
  As
previously disclosed, the Company will continue to explore opportunities
relating to bromine asset purchases.
  Net
Cash Provided by Operating Activities
  During
six months ended June 30, 2008, we had positive cash flow from operating
activities of $9,330,340, primarily attributable to net income of $12,433,500,
an increases in taxes payable of $2,218,473 and in accounts payable and accrued
expenses of $1,968,076, partially offset by an increase of accounts receivable
of $8,151,159 and in inventories of $1,424,086. Net Cash Provided by Operating
Activities during six months ended June 30, 2008 increased by $4,458,411 from
that of six months ended June 30, 2007. The primary source of this was a
$6,775,806 increase in Net Income, and the increases in accounts payable and
accrued expenses, and in taxes payable, partially offset by the increase in
accounts receivable.  The increase in accounts receivables was due in
part to extended payment terms provided to new customers.
  Net
Cash Used by Investing Activities
  The
Company used $9,722,222 to acquire property, plant and equipment mineral rights
and land leasepertaining to a bromine
production facility during three months ended June 30, 2008.  The
Company also expanded its Chemical production facility to enable it to provide a
new category of environmentally friendly chemical products.  This
expansion required the use of approximately $6,900,000.  The Company
also utilized $4,199,898 as funds to support the Company’s application to
increase its registered capital.  These funds are classified as
Restricted Cash and will be returned to an unrestricted status one the
application has been approved.
  Net
Cash Provided by Financing Activities
 
 We
believe that our available funds and cash flows generated from operations will
be sufficient to meet our anticipated ongoing operating needs for the next
twelve months. However it is possible that the Company might need to raise
additional capital in order to fund the acquisition of unlicensed bromine
properties and/or increase our chemical production capacity. 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 June 30, 2008 was approximately $11,798,821 as compared to $1,150,016
at December 31, 2007, reflecting the higher account receivable
balance.
  For the
immediate future we intend to focus our efforts to continue to expand within the
Chinese market. Our long-term strategic goal is to extend our market to overseas
countries.
  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. We may affect 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.
  - 25
-
  We are
not currently party to any contracts or other arrangements with respect to
future acquisitions.
  Critical
Accounting Policies and Estimates
  The
accompanying unaudited consolidated financial statements have been prepared by
Gulf Resources, Inc. and its subsidiaries (collectively, the
“Company”).  These statements include all adjustments (consisting only
of their normal recurring adjustments) which management believes necessary for a
fair presentation of the statements and have been prepared on a consistent basis
using the accounting policies described in the Form 10-K for the year ended
December 31, 2007 (“2007 Form 10-K”).  Certain financial information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission, although the Company believes that the
accompanying disclosures are adequate to make the information presented not
misleading.  The Notes to Financial Statements included in the 2007
Form 10-K should be read in conjunction with the accompanying interim financial
statements.  The interim operating results for the three and six
months ended June 30, 2008 may not be indicative of operating results expected
for the full year.
 
 Basis of
Consolidation
 
 The
consolidated financial statements include the accounts of Gulf Resources, Inc.
and its wholly-owned subsidiaries, Upper Class Group Limited, SCHC, SYCI and
HKJI (collectively the “Company”).  All material intercompany
transactions have been eliminated in consolidation.
 
 The
consolidated financial statements have been restated for all periods prior to
the merger to include the financial position, results of operations and cash
flows of the commonly controlled companies.
  Use of
Estimates
  The
Company’s 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 and the related disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. The Company bases 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.
  Cash and Cash
Equivalents
  Cash and
cash equivalents consist of all cash balances and highly liquid investments with
maturities of three months or less. Because of the short maturity of these
investments, the carrying amounts approximate their fair value.
 
 Restricted
Cash
 The
Company’s Restricted cash is in the Company’s bank account designated for use in
supporting the Company’s application to increase its registered capital. When
the Company’s application has been approved, the Restricted cash will be
returned to an unrestricted status.  Management believes that this
will occur by end of 2008.
 
 Accounts
Receivable
 Accounts
receivable is stated at cost, net of allowance for doubtful accounts. As of June
30, 2008 and December 31, 2007 the Company considered all accounts receivable
collectable and therefore did not record an allowance for doubtful
accounts.
  Inventories
  Inventories
are stated at the lower of cost, determined on a first-in, first-out cost basis,
or net realizable value. Costs of work-in-progress and finished goods are
composed of direct materials, direct labor and an attributable portion of
manufacturing overhead. Net realizable value is based on estimated selling price
less selling expenses.
  Property, Plant and
Equipment
  Property,
plant and equipment is stated at cost. 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 stated at cost, less accumulated amortization.
  - 26
-
  Mineral
rights are amortized ratably over the 50 year term of the lease, or the
equivalent term under the units of production method, whichever is
shorter.
  The
Company’s depreciation and amortization policies on fixed assets are as
follows:
  Useful
      life
                (in
      years)Mineral
      rights
              Lower
      of the period of lease or 50 yearsBuildings
              20Machinery
              8Motor
      vehicles
              5Equipment
              8
  Mineral
Rights
  The
Company follows FASB Staff Position amending SFAS No. 142 and No. 144 which
provide 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.
  Reporting Currency and
Translation
  The
Company’s functional currency is Renminbi (“RMB”); however, the reporting
currency is the United States dollar (“USD”). Assets and liabilities of the
Company have been translated into dollars using the exchange rate at the balance
sheet date. The average exchange rate for the period has been used to translate
revenues and expenses. Translation adjustments are reported separately and
accumulated in a separate component of equity (cumulative translation
adjustment).
  Foreign
Operations
  All of
the Company’s operations and assets are located in China. The Company may be
adversely affected by possible political or economic events in this country. The
effect of these factors cannot be accurately predicted.
  Revenue
Recognition
  In
accordance with Securities and Exchange Commission (“SEC”) Staff Accounting
Bulletin (“SAB”) No. 104, “Revenue Recognition”, the Company recognizes revenue,
net of any taxes, when persuasive evidence of a customer or distributor
arrangement exists or acceptance occurs, receipt of goods by customer occurs,
the price is fixed or determinable, and the sales revenues are considered
collectible. Subject to these criteria, the Company generally recognizes revenue
at the time of shipment or delivery to the customer, and when the customer takes
ownership and assumes risk of loss based on shipping terms.
  Shipping and Handling Fees
and Costs
 The
Company follows Emerging Issues Task Force (“EITF”) No. 00-10, Accounting for Shipping and Handling
Fees and Costs.  The Company does not charge its customers for
shipping and handling.  The Company classifies shipping and handling
costs as part of the cost of revenue.  For the three months ended June
30, 2008 and 2007, shipping and handling costs were $124,171 and $107,800, and
for the six months ended June 30, 2008 and 2007, shipping and handling costs
were $221,246 and $186,564.
  Basic and Diluted Net Income
per Share of Common Stock
  In
accordance with Financial Accounting Standards No. 128, “Earnings per Share”,
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.
  - 27
-
  Item
3. Quantitative and Qualitative Disclosures About Market Risk.
 
 Not
applicable to smaller reporting companies.
 
 Item
4. Controls and Procedures.
 
 Based on
an evaluation of our disclosure controls and procedures as of the end of the
quarterly period covered by this report (and the financial statements contained
in the report), our president and chief financial officer have determined that
our current disclosure controls and procedures are effective.
 
 The
following amends the statements in the Company’s Form 10-K for the year ended
December 31, 2007 under Item 9 (b): Management's Annual Report on Internal
Control over Financial Reporting.
 
 The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting, as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act. The Company’s internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. The
Company’s internal control over financial reporting includes those policies and
procedures that are intended to:
 
 1 pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the Company’s assets;
 
 2 provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorizations of our management and directors;
and
 
 3.
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our assets that could have a
material effect on the Company’s financial statements.
 
 Because
of the inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
 
 On
December 12, 2006, the Company, then a public shell company, acquired Upper
Class Group Limited and SCHC, then a privately held business in the PRC. At such
time the management of SCHC assumed management control of the Company. Further,
as the Company had no operations prior to such acquisition, upon the acquisition
of SCHC, SCHC’s system of financial controls and procedures were adopted as
those of the Company.  Following the acquisition of SCHC, the
Company’s management commenced a review of the effectiveness of its disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Securities and
Exchange Act of 1934) as of the end of 2006. Based upon that evaluation, the
Company began the process of upgrading its financial controls and
procedures.
 
 During
2007 the Company made a number of acquisitions.  Since none of the
businesses or properties acquired had financial controls and procedures
appropriate for a public company, the Company began the procedure of
incorporating the assets or operations acquired into its financial
systems.
 
 Based
upon the Company’s assessment of its internal controls over financial reporting
as of December 31, 2007, management concluded that Company’s internal control
over financial reporting were not effective.  Although the Company’s
operational procedures were adequate in the areas of inventory control,
purchasing process and cash and bank account management processes, during the
course of its review management found a number of areas where the procedures
required by Section 404 had not been fully implemented due, in certain
instances, to the operating procedures of SCHC and SCYI.  Management
believes that these discrepancies do not represent material deficiencies in the
Company’s financial reporting systems.  Nevertheless, management has
recommended changes to be adopted in respect of each deficiency uncovered and
intends to implement such changes.  Management will continue to assess
the adequacy of our financial reporting systems in light of the anticipated
continued growth in the Company’s operations.  We anticipate that if
we grow significantly, we will have to continuously upgrade our systems to
ensure the reliability of our financial statements.
  - 28
-
 
 To
address this issue, among other things, we are planning to upgrade the financial
controls and procedures at our operating subsidiaries and to evaluate and
enhance, where necessary, our financial reporting personnel. Such improvements
are intended to ensure that information required to be disclosed in our periodic
filings under the Exchange Act is accumulated and communicated to our
management, to allow timely decisions regarding required disclosure and that all
transactions are recorded, accumulated and processed to permit the preparation
of financial statements in accordance with generally accepted accounting
principles on a timely basis to allow compliance with our reporting obligations
under the Exchange Act. In making this assessment, management used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in Internal Control-Integrated Framework.
 
 There
have not been any changes in our internal control over financial reporting (as
such term is defined in Rules 13a-15(f) under the Exchange Act) during our most
recently completed fiscal quarter which is the subject of this
report  that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
 
 
 PART II—OTHER INFORMATION.
 
 Item
1A. Risk Factors.
 
 The
purchase of our common stock involves a high degree of risk. Before you invest
you should carefully consider the risks and uncertainties described in our
Annual Report on Form 10-K for the fiscal year ended December 31,2007 (the “2007
Form 10-K”) under the caption "Risk Factors" and in Item 1A of Part II of our
Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, our
Management's Discussion and Analysis of Financial Condition and Results of
Operations set forth in Item 2 of Part I of this report, our consolidated
financial statements and related notes included in Item 1 of Part I of this
report and our consolidated financial statements and related notes, our
Management’s Discussion and Analysis of Financial Condition and Results of
Operations and the other information in our 2007 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.
  In the
second quarter of 2008, there were no material changes from the risk factors
previously disclosed in our 2007 Form 10-K and Form 10-Q for the quarter
ended March 31, 2008.
   Item
6. Exhibits.
 
 Exhibit
      No.
              Description31.1
              Rule
      13a-14(a)/15d-14(a) Certification of Chief
      Executive Officer.
 
 31.2
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer.
 
 32.1
              Section
      1350 Certification of Chief Executive
Officer.
 
 32.2
              Section
      1350 Certification of Chief Financial
Officer.
  - 29
-
  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:
      August 13, 2008
              By:
              /s/
      Ming YangMing
      YangChairman
      and Chief Executive Officer(principal
      executive officer)By:
              /s/
      Min LiMin
      LiChief
      Financial Officer(principal
      financial and accounting officer)
   - 30
-