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, 2012Oro
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.)99 Wenchang Road, Chenming Industrial Park, Shouguang City,

Shandong, China

262714(Address of principal executive offices)

(Zip Code)
 
 Registrant’s telephone number, including area code: +86 (536) 567 0008
 
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 Yes x No o
 
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 Yes x No o
 
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large accelerated filer o
Accelerated filer xNon-accelerated filer (Do not check if a smaller reporting company) o
Smaller reporting company o
 
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 Yes o No x
  As of August 6, 2012, the registrant had outstanding 34,745,342 shares of common stock.
 
 
 Table of Contents
 
 Part I – Financial InformationItem 1. Financial Statements
1Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
20Item 3. Quantitative and Qualitative Disclosures about Market Risk
39Item 4. Controls and Procedures
40Part II – Other InformationItem 1. Legal Proceedings
40Item 1A. Risk Factors
41Item 2. Unregistered Shares of Equity Securities and Use of Proceeds
41Item 3. Defaults Upon Senior Securities
41Item 4. Mine Safety Disclosures
41Item 5. Other Information
41Item 6. Exhibits
41Signatures
42
 
 Table of Contents
 
 PART I—FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 GULF RESOURCES, INC.AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Expressed in U.S. dollars)(UNAUDITED)
 
 June 30, 2012


December 31, 2011Current AssetsCash

$
72,044,771


$
78,576,060Accounts receivable


41,297,358



21,919,828Inventories


3,955,232



4,437,972Prepayments and deposits


346,210



307,600Prepaid land leases


371,894



46,582Deferred tax assets


105,583



228,702Total Current Assets


118,121,048



105,516,744Non-Current AssetsProperty, plant and equipment, net


142,496,477



147,200,740Property, plant and equipment under capital leases, net


2,156,071



2,336,920Prepaid land leases, net of current portion


752,385



763,814Deferred tax assets


2,461,863



2,509,481Total non-current assets


147,866,796



152,810,955Total Assets

$
265,987,844


$
258,327,699Liabilities and Stockholders’ EquityCurrent LiabilitiesAccounts payable and accrued expenses

$
7,556,148


$
7,373,643Retention payable


97,804



556,450Capital lease obligation, current portion


90,551



189,742Taxes payable


4,232,081



4,058,550Total Current Liabilities


11,976,584



12,178,385Non-Current LiabilitiesCapital lease obligation, net of current portion


2,934,527



3,036,558Total Liabilities

$
14,911,111


$
15,214,943Stockholders’ EquityPREFERRED STOCK; $0.001 par value; 1,000,000 shares authorized; none outstanding

$



$COMMON STOCK; $0.0005 par value; 100,000,000 shares authorized; 34,745,342 and 34,745,342 shares issued; and 34,560,743 and 34,560,743 shares outstanding as of June 30, 2012 and December 31, 2011, respectively


17,373



17,373Treasury stock; 184,599 shares as of June 30, 2012 and December 31, 2011 at cost


(500,000
)


(500,000
)Additional paid-in capital


74,134,279



74,107,979Retained earnings unappropriated


141,051,006



133,314,581Retained earnings appropriated


15,648,913



14,409,557Cumulative translation adjustment


20,725,162



21,763,266Total Stockholders’ Equity


251,076,733



243,112,756Total Liabilities and Stockholders’ Equity

$
265,987,844


$
258,327,699
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 1
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
 (Expressed in U.S. dollars)
 (UNAUDITED)
  Three-Month Period Ended June 30,


Six-Month Period Ended June 30,2012


2011


2012


2011NET REVENUENet revenue

$
31,314,846


$
51,300,812


$
55,123,520


$
96,679,344OPERATING INCOME (EXPENSES)Cost of net revenue


(21,389,651
)


(24,994,703
)


(38,505,533
)


(45,586,087
)Sales, marketing and other operating expenses


(22,709
)


(23,733
)


(40,473
)


(47,745
)Research and development cost


(62,526
)


(133,519
)


(105,324
)


(313,856
)Exploration cost


-



(3,867,286
)


-



(3,867,286
)Write-off/Impairment on property, plant and equipment


(911,995
)


(7,570,566
)


(911,995
)


(7,570,566
)General and administrative expenses


(1,370,866
)


(1,714,694
)


(3,483,071
)


(6,055,985
)Other operating income


76,104



392,298



133,178



415,083(23,681,643
)


(37,912,203
)


(42,913,218
)


(63,026,442
)INCOME FROM OPERATIONS


7,633,203



13,388,609



12,210,302



33,652,902OTHER INCOME (EXPENSE)Interest expense


(54,255
)


(65,740
)


(108,667
)


(107,956
)Interest income


84,915



52,731



183,805



128,775INCOME BEFORE TAXES


7,663,863



13,375,600



12,285,440



33,673,721INCOME TAXES


(1,975,189
)


(3,352,345
)


(3,309,659
)


(9,285,467
)NET INCOME

$
5,688,674


$
10,023,255


$
8,975,781


$
24,388,254COMPREHENSIVE INCOME:NET INCOME

$
5,688,674


$
10,023,255


$
8,975,781


$
24,388,254OTHER COMPREHENSIVE INCOME- Foreign currency translation adjustments


(1,316,002
)


2,816,166



(1,038,104
)


4,837,801COMPREHENSIVE INCOME

$
4,372,672


$
12,839,421


$
7,937,677


$
29,226,055EARNINGS PER SHARE:BASIC

$
0.16


$
0.29


$
0.26


$
0.70DILUTED

$
0.16


$
0.29


$
0.26


$
0.69WEIGHTED AVERAGE NUMBER OF SHARES:BASIC


34,560,743



34,729,179



34,560,743



34,732,527DILUTED


34,560,743



34,733,188



34,561,394



35,128,273
  The accompanying notes are an integral part of these consolidated financial statements.
 
 2
 Table of Contents
 
 GULF RESOURCES, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYSIX-MONTH PERIOD ENDED JUNE 30, 2012(Expressed in U.S. dollars)(UNAUDITED)
 
 Common stockNumber


Number


Number








Additional


Statutory





Cumulativeof shares


of shares


of treasury





Treasury


paid-in


common


Retained


translationissued


outstanding


stock


Amount


stock


capital


reserve


earnings


adjustment


Total$


$


$


$


$


$


$BALANCE AT DECEMBER 31, 2011


34,745,342



34,560,743



184,599



17,373



(500,000
)


74,107,979



14,409,557



133,314,581



21,763,266



243,112,756Translation adjustment

-



-



-


-






-


-


-



(1,038,104
)


(1,038,104
)Issuance of stock options to employees


-



-



-



-



-



26,300



-



-



-



26,300Net income for six-month period ended June 30, 2012

-



-



-


-



-


-


-



8,975,781


-



8,975,781Transfer to statutory common reserve fund


-



-



-



-



-



-



1,239,356



(1,239,356
)


-



-BALANCE AT JUNE 30, 2012


34,745,342



34,560,743



184,599



17,373



(500,000
)


74,134,279



15,648,913



141,051,006



20,725,162



251,076,733
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 3
 Table of Contents
 
 GULF RESOURCES, INC.AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Expressed in U.S. dollars)(UNAUDITED)
 
 Six-Month Period Ended June 30,2012


2011CASH FLOWS FROM OPERATING ACTIVITIESNet income

$
8,975,781


$
24,388,254Adjustments to reconcile net income to net cash provided by operating activities:Interest on capital lease obligation


108,044



106,835Amortization of prepaid land leases


105,051



102,831Depreciation and amortization


11,290,588



7,468,616Write-off/Impairment loss on property, plant and equipment


911,995



7,570,566Exchange gain on inter-company balances


(92,057
)


-Stock-based compensation expense


26,300



3,169,000Deferred tax asset


160,826


(1,913,608
)Changes in assets and liabilities:Accounts receivable


(19,514,217
)


(14,033,743
)Inventories


467,279



(405,227
)Prepayments and deposits


(38,610
)


905,669Other receivables


-



(151,853
)Accounts payable and accrued expenses


206,207



1,468,892Retention payable


(457,813
)


-Taxes payable


189,434



697,706Net cash provided by operating activities


2,338,808



29,373,938CASH FLOWS USED IN INVESTING ACTIVITIESAdditions of prepaid land leases


(422,877
)


(348,196
)Purchase of property, plant and equipment


-



(34,075,105
)Increase in construction in progress


(7,871,130
)


(4,609,456
)Net cash used in investing activities


(8,294,007
)


(39,032,757
)CASH FLOWS USED IN FINANCING ACTIVITIESRepurchase of common stock


-



(348,147
)Repayment of capital lease obligation


(297,598
)


(288,739
)Net cash used in financing activities


(297,598
)


(636,886
)EFFECTS OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS


(278,492
)


1,539,350NET DECREASE IN CASH AND CASH EQUIVALENTS


(6,531,289
)


(8,756,355
)CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD


78,576,060



68,494,480CASH AND CASH EQUIVALENTS - END OF PERIOD

$
72,044,771


$
59,738,125SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATIONCash paid during the period for:Income taxes

$
2,945,542


$
10,341,857Interest paid

$
-


$
1,121SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ANDFINANCING ACTIVITIESInception of capital lease obligation for acquiring property, plant and equipment

$
-


$
3,127,913
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 4
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 (a)           Basis of Presentation
 
 The accompanying condensed financial statements have been prepared by Gulf Resources, Inc. a Delaware corporation and its subsidiaries (collectively, the “Company”), without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of its financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States (“US GAAP”). The balance sheet at December 31, 2011 is derived from the audited balance sheet but does not include all disclosures required by US GAAP. In connection with the consolidated financial statements and notes included in this report, reference is made to the consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the “2011 Form 10-K”).
 
 In the opinion of management, the unaudited financial information for the quarter and six-month period ended June 30, 2012 presented reflects all adjustments, which are only normal and recurring, necessary for a fair statement of results of operations, financial position and cash flows. These condensed financial statements should be read in conjunction with the financial statements included in the Company’s  2011 Form 10-K. Operating results for the interim periods are not necessarily indicative of operating results for an entire fiscal year.
 
 The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts that are reported in the financial statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. The Company also exercises judgments in the preparation of these condensed financial statements in the areas including classification of leases and related party transactions.
 
 Certain comparative amounts in the accompanying condensed financial statements have been reclassified to conform to the current period’s presentation. These reclassifications had no effect on previously reported condensed net income or stockholders’ equity.
 
 (b)           Nature of the Business
 
 The Company manufactures and trades bromine and crude salt through its wholly-owned subsidiary, Shouguang City Haoyuan Chemical Company Limited ("SCHC"), and manufactures chemical products for use in the oil industry and paper manufacturing industry through its wholly-owned subsidiary, Shouguang Yuxin Chemical Industry Co., Limited ("SYCI") in The People’s Republic of China (“PRC”).
 
 (c)           Allowance for Doubtful Accounts
 
 As of June 30, 2012 and December 31, 2011, allowance for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the three-month and six-month periods ended June 30, 2012 and 2011.
 
 (d)           Concentration of Credit Risk
 
 The Company is exposed to credit risk in the normal course of business, primarily related to accounts receivable and cash and cash equivalents. Substantially all of the Company’s cash and cash equivalents are maintained with financial institutions in the PRC, namely, Industrial and Commercial Bank of China Limited and China Merchants Bank Company Limited, which are not insured or otherwise protected. The Company placed $71,994,771 and $78,526,060 with these institutions as of June 30, 2012 and December 31, 2011, respectively.  The Company has not experienced any losses in such accounts in the PRC.
 
 Concentrations of credit risk with respect to accounts receivable exists as the Company sells a substantial portion of its products to a limited number of customers. However, such concentrations of credit risks are limited since the Company performs ongoing credit evaluations of its customers’ financial condition and due to the generally short payment terms.  About 84% and 100% of the balances of accounts receivable as of June 30, 2012 and December 31, 2011, respectively, were outstanding for less than 91 days. For the balances of accounts receivable aged more than 90 days as of June 30, 2012, approximately 76% was settled in July 2012 and the remaining 24% is within the credit term granted to the customers.
 
 5
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 (e)           Property, Plant and Equipment
 
 Property, plant and equipment are stated at cost less accumulated depreciation and any impairment losses. Expenditures for new facilities or equipment, and major expenditures for betterment of existing facilities or equipment are capitalized and depreciated using the straight-line method at rates sufficient to depreciate such costs over the estimated productive lives. All other ordinary repair and maintenance costs are expensed as incurred.
 
 Mineral rights are recorded at cost less accumulated depreciation and any impairment losses. Mineral rights are amortized ratably over the term of the lease, or the equivalent term under the units of production method, whichever is shorter.
 
 Construction in progress primarily represents direct costs of construction of plant, machinery and equipment. Costs incurred are capitalized and transferred to property and equipment upon completion, at which time depreciation commences.
 
 The Company’s depreciation and amortization policies on property, plant and equipment, other than mineral rights and construction in progress, are as follows:
 
 Useful life

(in years)Buildings (including salt pans)

8 - 20Plant and machinery (including protective shells, transmission channels and ducts)

5 - 8Motor vehicles

5Furniture, fixtures and equipment

8
 
 Property, plant and equipment under capital leases are depreciated over their expected useful lives on the same basis as owned assets, or where shorter, the term of the lease, which is 20 years.
 
 (f)           Retirement Benefits
 
 Pursuant to the relevant laws and regulations in the PRC, the Company participates in a defined contribution retirement plan for its employees arranged by a governmental organization. The Company makes contributions to the retirement scheme at the applicable rate based on the employees’ salaries.  The required contributions under the retirement plans are charged to the consolidated income statement on an accrual basis when they are due.  The Company’s contributions totaled $112,275 and $105,537 for the three-month periods ended June 30, 2012 and 2011, respectively, and totaled $242,393 and $226,912 for the six-month periods ended June 30, 2012 and 2011, respectively.
 
 (g)           Revenue Recognition
 
 The Company recognizes revenue, net of value-added tax, when persuasive evidence of an arrangement exists, delivery of the goods has occurred, customer acceptance has been obtained, which means the significant risks and ownership have been transferred to the customer, the price is fixed or determinable and collectability is reasonably assured.
 
 (h)           Shipping and Handling Fees and Costs
 
 The Company does not charge its customers for shipping and handling as all customers arrange their own transportation of finished goods.  The Company classifies shipping and handling costs for purchase of raw materials as part of the cost of net revenue, which amounted to $0 and $167,657 for the three-month periods ended June 30, 2012 and 2011, respectively, and $80,607 and $281,228 for the six-month periods ended June 30, 2012 and 2011, respectively. There is no such shipping and handling costs for the three-month period ended June 30, 2012 as they are borne by the suppliers since April 2012.
  6
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 (i)           Exploration Costs
 
 Exploration costs, which included the cost of researching appropriate places to drill wells and the cost of actual drilling of potential natural brine resources, were charged to the income statement as incurred. For the three-month and six-month periods ended June 30, 2011, the Company incurred exploration costs in the amount of $3,867,286, in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. The Company completed the drilling of exploratory wells in December 2011 and received a testing report in mid-January 2012 which confirmed the underground brine water resources.
 
 (j)           Recoverability of Long-lived Assets
 
 In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-35“Impairment or Disposal of Long-lived Assets”, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable or that the useful lives of those assets are no longer appropriate. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment.
 
 The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the carrying amount of the assets. An impairment loss, if one exists, is then measured as the amount by which the carrying amount of the asset exceeds the discounted estimated future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value of such assets less costs to sell. Asset impairment charges are recorded to reduce the carrying amount of the long-lived asset that will be sold or disposed of to their estimated fair values. Charges for the asset impairment reduce the carrying amount of the long-lived assets to their estimated salvage value in connection with the decision to dispose of such assets.
 
 For the three-month and six-month periods ended June 30, 2012, the Company determined that no further impairment charges were required after going through the impairment testing of the operating long-lived assets (property, plant and equipment, both owned and under capital leases, net). Certain eroded protective shells for transmission channels and ducts, with net book values of $911,995, were replaced during the second phase enhancement project, write-offs of the same amounts, were made in this quarter and included in write-off/impairment on property, plant and equipment for the three-month period ended June 30, 2012. For the three-month and six-month periods ended June 30, 2011, the Company recorded impairment charges of long-lived assets for the relocation of Factory No. 4 and idle plant and machinery in the amount of $3,873,087, and write-off of long-lived assets for certain eroded protective shells for crude salt fields and transmission channels and ducts, at their net book values, in the amount of $3,697,479.
 
 (k)           Basic and Diluted Net Income per Share of Common Stock
 
 Basic earnings per common share are based on the weighted average number of shares outstanding during the periods presented.  Diluted earnings per share are computed using weighted average number of common shares plus dilutive common share equivalents outstanding during the period. Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive, i.e. the exercise prices of the outstanding stock options were greater than the market price of the common stock. Anti-dilutive common stock equivalents which were excluded from the calculation of number of dilutive common stock equivalents amounted to 2,906,971 and 1,378,847 shares for the three-month periods ended June 30, 2012 and 2011, respectively, and amounted to 2,175,548 and 241,002 shares for the six-month periods ended June 30, 2012 and 2011, respectively. These awards could be dilutive in the future if the market price of the common stock increases and is greater than the exercise price of these awards.
  7
 Table of Contents
  GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 (k)           Basic and Diluted Net Income per Share of Common Stock – Continued
 
 The following table sets forth the computation of basic and diluted earnings per share:
  Three-Month Period Ended June 30,


Six-Month Period Ended June 30,2012


2011



2012



2011NumeratorNet income

$
5,688,674


$
10,023,255


$
8,975,781


$
24,388,254DenominatorBasic: Weighted-average common shares outstanding during the period


34,560,743



34,729,179



34,560,743



34,732,527Add: Dilutive effect of stock options


-



4,009



651



395,746Diluted


34,560,743



34,733,188



34,561,394



35,128,273Net income per shareBasic

$
0.16


$
0.29


$
0.26


$
0.70Diluted

$
0.16


$
0.29


$
0.26


$
0.69
 
 (l)           New Accounting Pronouncements
 
 No accounting standards and guidance with an effective date during the three-month and six-month periods ended June 30, 2012 or issued during 2012 had or are expected to have a significant impact on the Company’s condensed consolidated financial statements.
 
 NOTE 2 – ASSET ACQUISITIONS
 
 Pursuant to the lease contract signed by SCHC on November 5, 2010 with State-Operated Shouguang Qingshuibo Farm (the “Lessor”), the Company recognized in January 2011: (1) a 20-year capital lease of real property adjacent to Factory No. 1, with the related production facility, channels and ducts, other production equipment and the buildings located on the property, with an annual payment of Renminbi (“RMB”) 1,877,000 (approximately $295,365) up to December 31, 2030 to the Lessor, aggregating $3,127,913 (the present value of the minimum lease payments); and (2) a 20-year land lease and rights to new extraction wells on which the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings are situated, with an annual payment of RMB3,123,000 (approximately $495,651) up to December 31, 2030 to the Lessor. The lease was accounted for under FASB ASC 840-10-25“Leases - Recognition” and the cost of $3,127,913 was included in property, plant equipment under capital lease in the first quarter of 2011.
 
 The Company also enhanced the new plant and machinery leased in the first quarter of 2011 by making capital improvements in reconstruction and renovation work at a cost of approximately $3,050,400, which was recorded as buildings and plant and machinery, for the operation of the aforesaid real property, production facilities, channels and ducts, other production equipment and the buildings located on the property.
 
 In the second quarter of 2011, the Company carried out enhancement projects to its existing bromine extraction and crude salt production facilities. In particular, the Company incurred reconstruction and renovation works at a cost of approximately $12,379,153 for its crude salt fields in Factory No. 1, 5 to 9, and at a cost of approximately $20,087,600 for its extraction wells and transmission channels and ducts in Factory No. 1 to 9. The above enhancement projects have estimated useful lives of 5 to 8 years and are capitalized as buildings and plant and machinery.
 
 8
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 3 – INVENTORIES
 
 Inventories consist of:
  June 30,

2012


December 31,

2011Raw materials

$
780,747


$
848,596Finished goods


3,189,299



3,604,247Allowance for obsolete and slow-moving inventory


(14,814
)


(14,871
)$
3,955,232


$
4,437,972
 
 NOTE 4 – PREPAID LAND LEASES
 
 The Company prepaid for land leases with lease terms for periods ranging from one to fifty years to use the land on which the office premises, production facilities and warehouses of the Company are situated. The prepaid land lease is amortized on a straight line basis.
 
 During the three-month periods ended June 30, 2012 and 2011, amortization of prepaid land lease totaled $50,180 and $72,989, respectively, which were recorded as cost of net revenue. During the six-month periods ended June 30, 2012 and 2011, amortization of prepaid land lease totaled $105,051 and $102,831, respectively, which were recorded as cost of net revenue.
 
 The Company has the rights to use certain parcels of land located in Shouguang, the PRC, through lease agreements signed with local townships. Such parcels of land are collectively owned by local townships and accordingly, the Company could not obtain land use rights certificates on these parcels of land. The parcels of land that the Company could not obtain land use rights certificates cover a total of approximately 52.39 square kilometers with an aggregate carrying value of $1,081,310 and approximately 43.19 square kilometers with an aggregate carrying value of $766,748 as at June 30, 2012 and December 31, 2011, respectively.
 
 NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET
 
 Property, plant and equipment, net consist of the following:
 
 June 30,

2012


December 31,

2011At cost:Mineral rights

$
6,294,862


$
6,318,750Buildings


40,819,625



40,974,528Plant and machinery


134,002,545



136,862,383Motor vehicles


6,998



7,024Furniture, fixtures and office equipment


4,042,017



4,057,356Construction in progress


7,849,287



-Total


193,015,334



188,220,041Less: Accumulated depreciation and amortization


(50,518,857
)


(41,019,301
)Net book value

$
142,496,477


$
147,200,740
 
 The Company has certain buildings and salt pans erected on parcels of land located in Shouguang, PRC, and such parcels of land are collectively owned by local townships. The Company has not been able to obtain property ownership certificates over these buildings and salt pans as the Company could not obtain land use rights certificates on the underlying parcels of land. The aggregate carrying values of these parcels of land are $30,316,834 and $33,108,012 as at June 30, 2012 and December 31, 2011, respectively.
  9
 Table of Contents
  GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET – Continued
 
 During the three-month period ended June 30, 2012, depreciation and amortization expense totaled $5,521,178, of which $5,403,370 and $117,808 were recorded as cost of net revenue and administrative expenses, respectively. During the three-month period ended June 30, 2011, depreciation and amortization expense totaled $4,027,143, of which $3,830,437 and $196,707 were recorded as cost of net revenue and administrative expenses respectively. During the six-month period ended June 30, 2012, depreciation and amortization expense totaled $11,118,099, of which $10,645,703 and $472,396 were recorded as cost of sales and administrative expenses respectively. During the six-month period ended June 30, 2011, depreciation and amortization expense totaled $7,375,662, of which $6,805,179 and $570,483 were recorded as cost of net revenue and administrative expenses respectively.
 
 Construction in progress as at June 30, 2012 of $7,849,287 represented the second phase enhancement projects to the Company’s existing bromine extraction and crude salt production facilities, which are currently under construction since mid-May 2012. The total contract costs of the enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 are approximately $12,806,910 and $8,139,503, respectively, and the work is expected to be completed by late August 2012. As of June 30, 2012, the percentage of work done is approximately 37%. The above enhancement projects are estimated to have useful lives of 5 to 8 years and will be capitalized as plant and machinery upon completion.
 
 For the three-month periods ended June30, 2012 and 2011, ordinary repair and maintenance expenses were $0 and $38,457, respectively. For the six-month periods ended June 30, 2012 and 2011, ordinary repair and maintenance expenses were $127 and $89,090, respectively.
 
 NOTE 6 – PROPERTY, PLANT AND EQUIPMENT UNDER CAPITAL LEASES, NET
 
 Property, plant and equipment under capital leases, net consist of the following:
 
 June 30,

2012


December 31,

2011At cost:Buildings

$
130,111


$
130,605Plant and machinery


2,467,099



2,476,460Total


2,597,210



2,607,065Less: Accumulated depreciation and amortization


(441,139
)


(270,145
)Net book value

$
2,156,071


$
2,336,920
 
 The above buildings erected on parcels of land located in Shouguang, PRC, are collectively owned by local townships.  The Company has not been able to obtain property ownership certificates over these buildings as the Company could not obtain land use rights certificates on the underlying parcels of land.
 
 During the three-month periods ended June 30, 2012 and 2011, depreciation and amortization expense totaled $86,247 and $92,954, respectively, which was recorded as cost of net revenue. During the six-month periods ended June 30, 2012 and 2011, depreciation and amortization expense totaled $172,489 and $92,954, respectively, which was recorded as cost of net revenue.
 
 10
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 7 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES
 
 Accounts payable and accrued expenses consist of the following:
 
 June 30,


December 31,2012


2011Accounts payable

$
3,833,602


$
3,645,804Salary payable


139,024



132,454Social security insurance contribution payable


50,834



39,129Amount due to a contractor


762,227



1,422,042Price adjustment funds


1,396,366



1,031,685Other payables


1,374,095



1,102,529Total

$
7,556,148


$
7,373,643
 
 NOTE 8 – RELATED PARTY TRANSACTIONS
 
 During the three-month and six-month periods ended June 30, 2012, the Company borrowed $60,000 and $235,000, respectively, and fully repaid later during the same period, from Jiaxing Lighting Appliance Company Limited (Jiaxing Lighting”), in which Mr. Ming Yang, a shareholder and the Chairman of the Company, had a 100% equity interest in Jiaxing Lighting. The amounts due to Jiaxing Lighting were unsecured, interest free and repayable on demand.
 
 NOTE 9 – TAXES PAYABLE
 
 Taxes payable consists of the following:
 
 June 30,


December 31,2012


2011Income tax payable

$
1,957,493


$
1,761,452Mineral resource compensation fee payable


365,942



410,719Value added tax payable


793,338



540,463Land use tax payable


882,821



1,081,117Other tax payables


232,487



264,799Total

$
4,232,081


$
4,058,550
 
 NOTE 10 – CAPITAL LEASE OBLIGATIONS
 
 The components of capital lease obligations are as follows:
 
 Imputed

June 30,

December 31,Interest rate

2012

2011Total capital lease obligations
6.7%

$
3,025,078


$
3,226,300Less: Current portion



(90,551
)


(189,742
)Capital lease obligations, net of current portion


$
2,934,527


$
3,036,558
 
 Interest expenses from capital lease obligations amounted to $54,024 and $65,740 for the three-month periods ended June 30, 2012 and 2011, respectively, which were charged to the income statements. Interest expenses from capital lease obligations amounted to $108,044 and $107,956 for the six-month periods ended June 30, 2012 and 2011, respectively, which were charged to the income statements.
 
 11
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 11 – RETAINED EARNINGS - APPROPRIATED
 
 In accordance with the relevant PRC regulations and the PRC subsidiaries’ Articles of Association, the Company’s PRC subsidiaries are required to allocate its profit after tax to the following reserve:
 
 Statutory Common Reserve Funds
 
 SCHC and SYCI are required each year to transfer 10% of the profit after tax as reported under the PRC statutory financial statements to the Statutory Common Reserve Funds until the balance reaches 50% of the registered share capital.  This reserve can be used to make up any loss incurred or to increase share capital.  Except for the reduction of losses incurred, any other application should not result in this reserve balance falling below 25% of the registered capital. The Statutory Common Reserve Fund as of June 30, 2012 for SCHC and SYCI is 33% and 50% of its registered capital respectively.
 
 NOTE 12 – STOCK-BASED COMPENSATION
 
 Pursuant to the Company’s Amended and Restated 2007 Equity Incentive Plan, the aggregate number shares of the Company’s common stock available for grant of stock options and issuance is 4,341,989 shares.
 
 The fair value of each option award below is estimated on the date of grant using the Black-Scholes option-pricing model. The risk free rate is based on the yield-to-maturity in continuous compounding of the US Government Bonds with the time-to-maturity similar to the expected tenor of the option granted, volatility is based on the annualized historical stock price volatility of the Company, and the expected life is based on the estimated average of the life of options using the “simplified” method, as prescribed in FASB ASC 718, due to insufficient historical exercise activity during recent years as a basis from which to estimate future exercise patterns.
 
 In early March 2012, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.77 per share and the options vested immediately. The options were valued at $15,300 fair value, with assumed 95.89% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.21% and no dividend yield. For the three-month and six-month periods ended June 30, 2012, $0 and $15,300 was recognized as general and administrative expenses.
 
 On May 7, 2012, the Company entered into a service agreement with an independent director in which he would be entitled to receive stock option grants of 12,500 shares of common stock on the date of the agreement and on each anniversary date from that date through May 7, 2014. The exercise price of the options which will equal or exceed the fair market value of a share of the Company’s common stock on the day before the grant date, shall be determined by the Board of Directors and the options shall vest immediately upon the grant date. This agreement remains effective as long as the director continues to serve as a non-employee director of the Company. Pursuant to this agreement, on May 7, 2012, the Company granted to this independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $2.06 per share and the options vested immediately. The options were valued at $11,000 fair value, with assumed 95.21% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.21% and no dividend yield. For the three-month and six-month periods ended June 30, 2012, $11,000 was recognized as general and administrative expenses.
 
 The following table summarizes all Company stock option transactions between January 1, 2012 and June 30, 2012.
 
 Number of Option

and Warrants

Outstanding


Number of Option

and Warrants

Vested


Range of

Exercise Price per Common ShareBalance, January 1, 2012


1,144,471



1,144,471



$2.41 - $12.60Granted and vested during thesix-month period ended June 30, 2012


25,000



25,000



$2.06 - $2.77Balance, June 30, 2012


1,169,471



1,169,471



$2.06 - $12.60
  12
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 12 – STOCK-BASED COMPENSATION – Continued
 
 Stock and Warrants Options OutstandingWeighted Average

Weighted AverageRemaining

Exercise Price ofOutstanding at June 30, 2012

Range of

Exercise Prices

Contractual Life

(Years)

Options Currently

OutstandingExercisable and outstanding

1,169,471

$2.06 - $12.60

2.42

$   6.21
 
 The weighted average grant-date fair values as at June 30, 2012 and December 31, 2011 were $7.18 and $7.29, respectively.
 
 NOTE 13 – INCOME TAXES
 
 The Company utilizes the asset and liability method of accounting for income taxes in accordance with FASB ASC 740-10.
 
 (a)           United States
 
 Gulf Resources, Inc. is subject to the United States of America Tax law at a tax rate of 34%. No provision for the US federal income taxes has been made as the Company had no US taxable income for the three-month and six-month periods ended June 30, 2012 and 2011, and management believes that its earnings are permanently invested in the PRC.
 
 (b)           BVI
 
 Upper Class Group Limited, a subsidiary of Gulf Resources, Inc., was incorporated in the BVI and, under the current laws of the BVI, it is not subject to tax on income or capital gain in the BVI. Upper Class Group Limited did not generate assessable profit for the three-month and six-month periods ended June 30, 2012 and 2011.
 
 (c)           Hong Kong
 
 Hong Kong Jiaxing Industrial Limited, a subsidiary of Upper Class Group Limited, was incorporated in Hong Kong and is subject to Hong Kong profits tax. The Company is subject to Hong Kong taxation on its activities conducted in Hong Kong and income arising in or derived from Hong Kong.  No provision for profits tax has been made as the Company has no assessable income for the three-month and six-month periods ended June 30, 2012 and 2011.  The applicable statutory tax rates for the three-month and six-month periods ended June 30, 2012 and 2011 are 16.5%.
 
 (d)           PRC
 
 Enterprise income tax (“EIT”) for SCHC and SYCI in the PRC is charged at 25% of the assessable profits.
 
 The operating subsidiaries SCHC and SYCI are wholly foreign-owned enterprises (“FIE”) incorporated in the PRC and are subject to PRC Foreign Enterprise Income Tax Law.
 
 On February 22, 2008, the Ministry of Finance (“MOF”) and the State Administration of Taxation (“SAT”) jointly issued Cai Shui [2008] Circular 1 (“Circular 1”). According to Article 4 of Circular 1, distributions of accumulated profits earned by a FIE prior to January 1, 2008 to foreign investor(s) in 2008 will be exempted from withholding tax (“WHT”) while distribution of the profit earned by an FIE after January 1, 2008 to its foreign investor(s) shall be subject to WHT at 5% effective tax rate.
  13
 Table of Contents
  GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 13 – INCOME TAXES – Continued
 
 As of June 30, 2012 and December 31, 2011, the accumulated distributable earnings under the Generally Accepted Accounting Principles (GAAP”) of PRC are $189,972,832 and $180,939,187, respectively. Since the Company intends to reinvest its earnings to further expand its businesses in mainland China, its foreign invested enterprises do not intend to declare dividends to their immediate foreign holding companies in the foreseeable future. Accordingly, as of June 30, 2012 and December 31, 2011, the Company has not recorded any WHT on the cumulative amount of distributable retained earnings of its foreign invested enterprises in China. As of June 30, 2012 and December 31, 2011, the unrecognized WHT are $8,421,768 and $7,965,999, respectively.
 
 The components of the provision for income taxes from continuing operations are:
 
 Three-Month Period Ended June 30,

Six-Month Period Ended June 30,2012

2011

2012

2011Current taxes – PRC

$
1,892,567


$
5,285,957


$
3,148,833


$
11,211,191Deferred taxes – PRC


82,622



(1,933,612
)


160,826



(1,925,724
)$
1,975,189


$
3,352,345


$
3,309,659


$
9,285,467
 
 The effective income tax expenses differ from the PRC statutory income tax rate of 25% from continuing operations in the PRC as follows:
 
 Three-Month Period Ended June 30,

Six-Month Period Ended June 30,Reconciliations
2012

2011

2012

2011Statutory income tax rate

25
%


25
%


25
%


25
%US federal net operating loss

1
%


0
%


2
%


3
%Effective tax rate

26
%


25
%


27
%


28
%
 
 Significant components of the Company’s deferred tax assets and liabilities at June 30, 2012 and December 30, 2011 are as follows:
 
 June 30,


December 31,2012


2011Deferred tax liabilities

$
-


$
-Deferred tax assets:Allowance for obsolete and slow-moving inventories

$
3,704


$
3,718Impairment on property, plant and equipment


636,615



639,031Exploration costs


1,780,714



1,797,391Repair and maintenance costs


101,879



224,984Property, plant and equipment


44,534



73,059US federal net operating loss


10,442,134



10,111,821Total deferred tax assets


13,009,580



12,850,004Valuation allowance


(10,442,134
)


(10,111,821
)Net deferred tax asset

$
2,567,446


$
2,738,183Current deferred tax asset

$
105,583


$
228,702Long-term deferred tax asset

$
2,461,863


$
2,509,481
 
 The increase in valuation allowance for each of the three-month periods ended June 30, 2012 and 2011 is $106,382 and $36,752, respectively, and six-month periods ended June 30, 2012 and 2011 is $330,313 and $1,196,983, respectively.
 
 There was no unrecognized tax benefits and accrual for uncertain tax positions as of June 30, 2012 and December 31, 2011.
 
 14
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 14 – BUSINESS SEGMENTS
 
 The Company has three reportable segments:  bromine, crude salt and chemical products. The reportable segments are consistent with how management views the markets served by the Company and the financial information that is reviewed by its chief operating decision maker. The Company manages its sensors and controls businesses as components of an enterprise for which separate information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance.
 
 An operating segment’s performance is primarily evaluated based on segment operating income, which excludes share-based compensation expense, certain corporate costs and other income not associated with the operations of the segment. These corporate costs (income) are separately stated below and also include costs that are related to functional areas such as accounting, treasury, information technology, legal, human resources, and internal audit. The Company believes that segment operating income, as defined above, is an appropriate measure for evaluating the operating performance of its segments.
 
 Three-Month Period Ended June 30, 2012

Bromine*


Crude

Salt*


Chemical

Products


Segment

Total


Corporate


TotalNet revenue

(external customers)

$
17,539,429


$
3,779,658


$
9,995,759


$
31,314,846


$
-


$
31,314,846Net revenue

(intersegment)


808,596



-



-



808,596



-



808,596Income (loss) from operations before taxes


3,933,561



888,555



3,007,381



7,829,497



(196,294
)


7,633,203Income taxes


1,018,311



198,783



758,095



1,975,189



-



1,975,189Income (loss) from operations after taxes


2,915,250



689,772



2,249,286



5,854,308



(196,294
)


5,658,014Total assets


158,305,734



56,621,811



50,634,822



265,562,367



425,477



265,987,844Depreciation and amortization


3,509,790



1,442,179



655,456



5,607,425



-



5,607,425Capital expenditures


6,567,296



1,281,991



-



7,849,287



-



7,849,287Write-off / Impairment


763,043



148,952



-



911,995



-



911,995
 
 Three-Month Period Ended June 30, 2011

Bromine*


Crude

Salt*


Chemical

Products


Segment

Total


Corporate


TotalNet revenue

(external customers)

$
33,230,646


$
5,994,384


$
12,075,782


$
51,300,812


$
-


$
51,300,812Net revenue

(intersegment)


883,150



-



-



883,150



-



883,150Income (loss) from operations before taxes


9,540,474



1,926,628



2,029,160



13,496,262



(107,653
)


13,388,609Income taxes


2,466,262



379,478



506,605



3,352,345



-



3,352,345Income (loss) from operations after taxes


7,074,212



1,547,150



1,522,555



10,143,917



(107,653
)


10,036,264Total assets


146,989,573



52,795,615



42,676,361



242,461,549



3,013,131



245,474,680Depreciation and amortization


2,859,567



578,359



682,171



4,120,097



-



4,120,097Capital expenditures


21,371,074



15,667,471



37,664



37,076,209



-



37,076,209Write-off / Impairment


3,749,435



2,015,533



1,805,598



7,570,566



-



7,570,566
 
 15
 Table of Contents
 
 GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 14 – BUSINESS SEGMENTS – Continued
 
 Six-Month Period Ended June 30, 2012

Bromine*


Crude

Salt*


Chemical

Products


Segment

Total


Corporate


TotalNet revenue

(external customers)

$
30,993,311


$
6,054,582


$
18,075,627


$
55,123,520


$
-


$
55,123,520Net revenue

(intersegment)


1,563,153



-



-



1,563,153



-



1,563,153Income (loss) from operations before taxes


6,401,865



1,437,005



5,250,276



13,089,146



(878,844
)


12,210,302Income taxes


1,681,209



302,649



1,325,801



3,309,659



-



3,309,659Income (loss) from operations after taxes


4,720,656



1,134,356



3,924,475



9,779,487



(878,844
)


8,900,643Total assets


158,305,734



56,621,811



50,634,822



265,562,367



425,477



265,987,844Depreciation and amortization


7,174,033



2,805,685



1,310,870



11,290,588



-



11,290,588Capital expenditures


6,567,296



1,281,991



-



7,849,287



-



7,849,287Write-off / Impairment


763,043



148,952



-



911,995



-



911,995
 
 Six-Month Period Ended June 30, 2011

Bromine*


Crude

Salt*


Chemical

Products


Segment

Total


Corporate


TotalNet revenue

(external customers)

$
63,379,962


$
11,028,718


$
22,270,664


$
96,679,344


$
-


$
96,679,344Net revenue

(intersegment)


1,503,866



-



-



1,503,866



-



1,503,866Income (loss) from operations before taxes


25,913,373



5,873,546



5,385,697



37,172,616



(3,519,714
)


33,652,902Income taxes


6,742,153



1,192,917



1,350,397



9,285,467



-



9,285,467Income (loss) from operations after taxes


19,171,220



4,680,629



4,035,300



27,887,149



(3,519,714
)


24,367,435Total assets


146,989,573



52,795,615



42,676,361



242,461,549



3,013,131



245,474,680Depreciation and amortization


5,014,155



1,098,678



1,355,783



7,468,616



-



7,468,616Capital expenditures


23,933,922



19,334,613



37,664



43,306,199



-



43,306,199Write-off / Impairment


3,749,435



2,015,533



1,805,598



7,570,566



-



7,570,566
 
 * Certain common production overheads, operating and administrative expenses and asset items (mainly cash and certain office equipment) of bromine and crude salt segments in SCHC were split by reference to the average selling price and production volume of respective segment.
 
 Three-Month Period Ended June 30,


Six-Month Period Ended June 30,Reconciliations

2012


2011


2012


2011Total segment operating income

$
7,829,497


$
13,496,262


$
13,089,146


$
37,172,616Corporate costs


(196,294
)


(107,653
)


(878,844
)


(3,519,714
)Income from operations


7,633,203



13,388,609



12,210,302



33,652,902Other income (expense)


30,660



(13,009
)


75,138



20,819Income before taxes

$
7,663,863


$
13,375,600


$
12,285,440


$
33,673,721
  16
 Table of Contents
  GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 14 – BUSINESS SEGMENTS – Continued
 
 The following table shows the major customer(s) (10% or more) for the three-month period ended June 30, 2012.
 
 Number

Customer

Bromine

(000’s)


Crude Salt

(000’s)


Chemical Products

(000’s)


Total

Revenue

(000’s)


Percentage of

Total Revenue (%)1

Shandong Morui Chemical Company Limited

$
1,904


$
727


$
1,109


$
3,740



11.9%2

Shouguang City Rongyuan Chemical Company Limited

$
2,257


$
898


$
-


$
3,155



10.1%TOTAL



$
4,161


$
1,625


$
1,109


$
6,895



22.0%
 
 The following table shows the major customer(s) (10% or more) for the six-month period ended June 30, 2012.
 
 Number

Customer

Bromine

(000’s)


Crude Salt

(000’s)


Chemical Products

(000’s)


Total

Revenue

(000’s)


Percentage of

Total Revenue (%)1

Shandong Morui Chemical Company Limited

$
3,634


$
1,113


$
2,107


$
6,854



12.4%2

Shouguang City Rongyuan Chemical Company Limited

$
4,278


$
1,346


$
-


$
5,624



10.2%TOTAL



$
7,912


$
2,459


$
2,107


$
12,478



22.6%
 
 The following table shows the major customer(s) (10% or more) for the three-month period ended June 30, 2011.
 
 Number

Customer

Bromine

(000’s)


Crude Salt

(000’s)


Chemical Products

(000’s)


Total

Revenue

(000’s)


Percentage of

Total Revenue (%)1

Shandong Morui Chemical Company Limited

$
3,507


$
1,121


$
760


$
5,388



10.5%TOTAL



$
3,507


$
1,121


$
760


$
5,388



10.5%
 
 The following table shows the major customer(s) (10% or more) for the six-month period ended June 30, 2011.
 
 Number

Customer

Bromine

(000’s)


Crude Salt

(000’s)


Chemical Products

(000’s)


Total

Revenue

(000’s)


Percentage of

Total Revenue (%)1

Shandong Morui Chemical Company Limited

$
9,238


$
1,963


$
1,329


$
12,530



13.0%2

Shouguang City Rongyuan Chemical Company Limited

$
7,285


$
2,622


$
-


$
9,907



10.3%TOTAL



$
16,523


$
4,585


$
1,329


$
22,437



23.3%
 
 NOTE 15 – MAJOR SUPPLIERS
 
 During the three-month and six-month periods ended June 30, 2012, the Company purchased 85.7% and 83.5% of its raw materials from its top five suppliers, respectively.  As of June 30, 2012, amounts due to those suppliers included in accounts payable were $3,305,237. During the three-month and six-month periods ended June 30, 2011, the Company purchased 81.1% and 81.6% of its raw materials from its top five suppliers, respectively.  As of June 30, 2011, amounts due to those suppliers included in accounts payable were $5,094,255. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.
  17
 Table of Contents
  GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 16 – CUSTOMER CONCENTRATION
 
 The Company sells a substantial portion of its products to a limited number of customers.  During the three-month and six-month periods ended June 30, 2012, the Company sold 42.8% and 43.4% of its products to its top five customers, respectively. As of June 30, 2012, amounts due from these customers were $19,888,840. During the three-month and six-month periods ended June 30, 2011, the Company sold 40.8% and 43.9% of its products to its top five customers, respectively. At June 30, 2011, amounts due from these customers were $16,417,668. This concentration makes the Company vulnerable to a near-term severe impact, should the relationships be terminated.
 
 NOTE 17 – FAIR VALUE OF FINANCIAL INSTRUMENTS
 
 The carrying values of financial instruments, which consist of cash, accounts receivable and accounts payable and other payables, approximate their fair values due to the short-term nature of these instruments.  There were no material unrecognized financial assets and liabilities as of June 30, 2012 and December 31, 2011.
 
 NOTE 18 – RESEARCH AND DEVELOPMENT EXPENSES
 
 The total research and development expenses recognized in the income statements during the three-month and six-month periods ended June 30, 2012 were $62,526 and $105,324, respectively, of which the consumption of bromine produced by the Company amounted to $13,268 and $24,008, respectively. The total research and development expenses recognized in the income statements during the three-month and six-month periods ended June 30, 2011 were $133,519 and 313,856, respectively, of which the consumption of bromine produced by the Company amounted to $13,158 and $43,226, respectively.
 
 NOTE 19 – CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS
 
 As of June 30, 2012, the Company has leased a real property adjacent to Factory No. 1, with the related production facility, channels and ducts, other production equipment and the buildings located on the property, under capital lease. The future minimum lease payments required under capital lease, together with the present value of such payments, are included in the table show below.
 
 The Company has leased seven pieces of land under non-cancelable operating leases, which are fixed in rentals and expire through December 2021, December 2030, December 2031, December 2040, February 2059, August 2059 and June 2060, respectively. The Company accounts for the leases as operating leases.
 
 The Company has committed approximately $13,097,126 for the second phase enhancement projects to the Company’s existing bromine extraction and crude salt production facilities as of June 30, 2012.
 
 The following table sets forth the Company’s contractual obligations as of June 30, 2012:
 
 Capital Lease Obligations


Operating Lease Obligations


Construction Project ObligationsPayable within:the next 12 months
$
296,772


$
768,548


$
13,097,126the next 13 to 24 months


296,772



780,865



-the next 25 to 36 months


296,772



790,731



-the next 37 to 48 months


296,772



804,086



-the next 49 to 60 months


296,772



814,891



-thereafter


3,858,044



18,327,069



-Total

$
5,341,904


$
22,286,190


$
13,097,126Less: Amount representing interest


(2,316,826
)Present value of net minimum lease payments

$
3,025,078
  18
 Table of Contents
  GULF RESOURCES, INC.
 AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2012
 (Expressed in U.S. dollars)
 (UNAUDITED)
 
 NOTE 19 – CAPITAL COMMITMENT AND OPERATING LEASE COMMITMENTS – Continued
 
 Rental expenses related to operating leases of the Company amounted to $194,450 and $157,480, which were charged to the income statements for the three-month ended June 30, 2012 and 2011, respectively. Rental expenses related to operating leases of the Company amounted to $388,766 and $261,488, which were charged to the income statements for the six-month ended June 30, 2012 and 2011, respectively.
 
 NOTE 20 – CONTINGENCY
 
 Class Action
 
 The Company and certain of its officers and directors (Ming Yang, Xiaobin Liu, and Min Li, collectively, the Individual Defendants”) have been named as defendants in a putative securities class action lawsuit alleging violations of the federal securities laws.  That action, which is now captionedLewy, et al. v. Gulf Resources, Inc., et al., No. 11-cv-3722 ODW (MRWx), was filed on April 29, 2011 in the United States District Court for the Central District of California.  The lead plaintiffs, who seek to represent a class of all purchasers and acquirers of the Company’s common stock between March 16, 2009 and April 26, 2011 inclusive, filed an amended complaint on September 12, 2011.  Lead plaintiffs assert claims for violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder.  The amended complaint alleges the defendants made false or misleading statements in the Company’s Annual Reports on Form 10-K for the years ended December 31, 2008, 2009, and 2010, and in interim quarterly reports by, among other things, overstating revenue and net income and failing to disclose material related party transactions and certain facts about the CEO’s prior employment at another company.  The amended complaint also asserts claims against the Individual Defendants for violations of Section 20(a) of the Securities Exchange Act of 1934. The amended complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. On May 15, 2012, the Court denied the Company’s motion to dismiss the amended complaint. The parties are required to submit a joint report concerning scheduling and other issues on July 30, 2012, in accordance with Federal Rules of Civil Procedure 16 and 26(f). The Company has submitted the required report on July 30, 2012. The Court has also set a scheduling conference for August 12, 2012.  The Company intends to defend vigorously against the lawsuit.  The Company currently cannot estimate the amount or range of possible losses from this litigation.
 
 The legal costs incurred for the three-month and six-month periods ended June 30, 2012 in connection with the above legal case amounted to $100,000 and $511,289, which was included in the income statements as general and administrative expenses. No legal costs were incurred for the three-month and six-month periods ended June 30, 2011 in connection with the above legal case.
 
 NOTE 21 – SUBSEQUENT EVENTS
 
 On July 2, 2012, the Company granted to an independent director an option to purchase 12,500 shares of the Company’s common stock at an exercise price of $1.22 per share and the options vested immediately. The options were valued at $7,000 fair value, with assumed 94.92% volatility, a three-year expiration term with expected tenor of 1.49 years, a risk free rate of 0.24% and no dividend yield, which will be recognized as general and administrative expense in third quarter of 2012.
 
 On July 17, 2012, the Company granted to 3 executive officers and 18 management staff options to purchase 600,000 shares and 218,000 shares of the Company’s common stock, respectively, at an exercise price of $0.952 per share and the options vested immediately. The options to executive officers and management staff were valued at $344,743 and $125,257 fair value, respectively, both with assumed 88.03% volatility, a four-year expiration term with expected tenor of 2 years, a risk free rate of 0.24% and no dividend yield, which will be recognized as general and administrative expense in third quarter of 2012.
 
 In mid-July 2012, the Company commenced two enhancement projects to its existing bromine and chemical products production facilities. The contract cost of the repair and maintenance and enhancement work to the bromine production facilities in Factory No. 2 is approximately $1,280,691. The contract cost of the enhancement work to the chemical products production facilities is approximately $1,502,045. The enhancement works of both contracts are expected to be completed by mid-September 2012. The enhancement portion to the above projects of approximately $2,761,818 is estimated to have useful lives of 5 to 20 years and will be capitalized as plant and machinery upon completion, and the portion of repair and maintenance expenses of approximately $20,918 will be recognized as cost of net revenue in the third quarter of 2012.
 
 19
 Table of Contents
 
 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 Cautionary Note Regarding Forward-Looking Statements
 
 The discussion below contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act.  We have used words such as “believes,” “intends,” “anticipates,” “expects” and similar expressions to identify forward-looking statements. These statements are based on information currently available to us and are subject to a number of risks and uncertainties that may cause our actual results of operations, financial condition, cash flows, performance, business prospects and opportunities and the timing of certain events to differ materially from those expressed in, or implied by, these statements. These risks, uncertainties and other factors include, without limitation, those matters discussed in Item 1A of Part I of our 2011 Form 10-K.  Except as expressly required by the federal securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances, or for any other reason.  The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing in our 2011 Form 10-K and Item 1A, “Risk Factors” for the year ended December 31, 2011.
 
 Overview
 
 Gulf Resources conducts operations through its two wholly-owned China subsidiaries, SCHC and SYCI. Our business is also reported in these three segments, Bromine, Crude Salt, and Chemical Products.
 
 Through SCHC, we produce and sell bromine and crude salt. We are one of the largest producers of bromine in China, as measured by production output. Elemental bromine is used to manufacture a wide variety of brominated compounds used in industry and agriculture. Bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines, and disinfectants.
 
 Through SYCI, we manufacture and sell chemical products that are used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals.
 
 Our Corporate History
 
 We were incorporated in Delaware on February 28, 1989. From November 1993 through August 2006, we were engaged in the business of owning, leasing and operating coin and debit card pay-per copy photocopy machines, fax machines, microfilm reader-printers and accessory equipment under the name “Diversifax, Inc.”. Due to the increased use of internet services, demand for our services declined sharply, and in August 2006, our Board of Directors decided to discontinue our operations.
 
 Upper Class Group Limited, incorporated in the British Virgin Islands in July 2006, acquired all the outstanding stock of SCHC, a company incorporated in Shouguang City, Shandong Province, PRC, in May 2005. At the time of the acquisition, members of the family of Mr. Ming Yang, our president and former chief executive officer, owned approximately 63.20% of the outstanding shares of Upper Class Group Limited. Since the ownership of Upper Class Group Limited and SCHC was then substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Upper Class Group Limited recognized the assets and liabilities transferred at their carrying amounts.
 
 On December 12, 2006, we, then known as Diversifax, Inc., a public “shell” company, acquired Upper Class Group Limited and SCHC. Under the terms of the agreement, the stockholders of Upper Class Group Limited received 13,250,000 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of voting common stock of Gulf Resources, Inc. in exchange for all outstanding shares of Upper Class Group Limited. Members of the Yang family received approximately 62% of our common stock as a result of the acquisition.  Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class Group Limited for the net assets of Gulf Resources, Inc., accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange is identical to that resulting from a reverse acquisition, except no goodwill is recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, Gulf Resources, Inc., are those of the legal acquiree, Upper Class Group Limited. Share and per share amounts stated have been retroactively adjusted to reflect the share exchange. On February 20, 2007, we changed our corporate name to Gulf Resources, Inc.
 
 20
 Table of Contents
 
 On February 5, 2007, we acquired SYCI, a company incorporated in PRC, in October 2000. Under the terms of the acquisition agreement, the stockholders of SYCI received a total of 8,094,059 (restated for the 2-for-1 stock split in 2007 and the 1-for-4 stock split in 2009) shares of common stock of Gulf Resources, Inc. in exchange for all outstanding shares of SYCI's common stock. Simultaneously with the completion of the acquisition, a dividend of $2,550,000 was paid to the former stockholders of SYCI. At the time of the acquisition, approximately 49.1% of the outstanding shares of SYCI were owned by Ms. Yu, Mr. Yang’s wife, and the remaining 50.9% of the outstanding shares of SYCI were owned by SCHC, all of whose outstanding shares were owned by Mr. Yang and his wife. Since the ownership of Gulf Resources, Inc. and SYCI are substantially the same, the acquisition was accounted for as a transaction between entities under common control, whereby Gulf Resources, Inc. recognized the assets and liabilities of SYCI at their carrying amounts. Share and per share amounts have been retroactively adjusted to reflect the acquisition.
 
 To satisfy certain ministerial requirements necessary to confirm certain government approvals required in connection with the acquisition of SCHC by Upper Class Group Limited, all of the equity interest of SCHC were transferred to a newly formed Hong Kong corporation named Hong Kong Jiaxing Industrial Limited (“Hong Kong Jiaxing”) all of the outstanding shares of which are owned by Upper Class Group Limited. The transfer of all of the equity interest of SCHC to Hong Kong Jiaxing received approval from the local State Administration of Industry and Commerce on December 10, 2007.
 
 As a result of the transactions described above, our corporate structure is linear. That is Gulf Resources owns 100% of the outstanding shares of Upper Class Group Limited, which owns 100% of the outstanding shares of Hong Kong Jiaxing, which owns 100% of the outstanding shares of SCHC, which owns 100% of the outstanding shares of SYCI.
 
 On October 12, 2009 we completed a 1-for-4 reverse stock split of our common stock, such that for each four shares outstanding prior to the stock split there was one share outstanding after the reverse stock split. All shares of common stock referenced in this report have been adjusted to reflect the stock split figures. On October 27, 2009 our shares began trading on the NASDAQ Global Select Market under the ticker symbol “GFRE” and on June 30, 2011 we changed our ticker symbol to “GURE” to better reflection of our corporate name.
 
 Our current corporate structure chart is set forth in the following diagram:
  
 
 As a result of our acquisitions of SCHC and SYCI, our historical financial statements and the information presented below reflects the accounts of SCHC and SYCI. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.
 
 21
 Table of Contents
  RESULTS OF OPERATIONS
 
 The following table presents certain information derived from the consolidated statements of operations, cash flows and stockholders equity for the three-month and six-month periods ended June 30, 2012 and 2011.
 
 Comparison of the Three-Month Periods Ended June 30, 2012 and 2011
 
 Three-Month Period

Ended June 30, 2012

Three-Month Period

Ended June 30, 2011

% ChangeNet revenue
$
31,314,846


$
51,300,812



(39
%)Cost of net revenue
$
(21,389,651
)

$
(24,994,703
)


(14
%)Gross profit
$
9,925,195


$
26,306,109



(62
%)Sales, marketing and other operating expenses
$
(22,709
)

$
(23,733
)


(4
%)Research and development costs
$
(62,526
)

$
(133,519
)


(53
%)Exploration cost
$
-


$
(3,867,286
)


(100
%)Write-off/Impairment on property, plant and equipment
$
(911,995
)

$
(7,570,566
)


(88
%)General and administrative expenses
$
(1,370,866
)

$
(1,714,694
)


(20
%)Other operating income
$
76,104


$
392,298



(81
%)Income from operations
$
7,633,203


$
13,388,609



(43
%)Other income (expense), net
$
30,660


$
(13,009
)


(336
%)Income before taxes
$
7,663,863


$
13,375,600



(43
%)Income taxes
$
(1,975,189
)

$
(3,352,345
)


(41
%)Net income
$
5,688,674


$
10,023,255



(43
%)
 
 Net revenue.  Net revenue was $31,314,846 for three-month period ended June 30, 2012, a decrease of approximately $20.0 million (or 39%) as compared to the same period in 2011. This decrease was primarily attributable to the reduction of overall demand for all of our segment products, specifically, (i) revenue from the bromine segment decreased from $33,230,646 for the three-month period ended June 30, 2011 to $17,539,429 for the same period in 2012, a decrease of approximately 47%; (ii) revenue from the crude salt segment decreased from $5,994,384 for the three-month period ended June 30, 2011 to $3,779,658 for the same period in 2012, a decrease of approximately 37%; and (iii) revenue from the chemical products segment decreased from $12,075,782 for the three-month period ended June 30, 2011 to $9,995,759 for the same period in 2012, a decrease of approximately 17%.
 
 Net Revenue by SegmentThree-Month Period Ended

Three-Month Period Ended

Percent DecreaseJune 30, 2012

June 30, 2011

of Net RevenueSegment




% of total




% of totalBromine

$
17,539,429



56
%

$
33,230,646



65
%


(47
%)Crude Salt

$
3,779,658



12
%

$
5,994,384



12
%


(37
%)Chemical Products

$
9,995,759



32
%

$
12,075,782



23
%


(17
%)Total sales

$
31,314,846



100
%

$
51,300,812



100
%


(39
%)
 
 Bromine and crude salt segments

Three-Month Period Ended


Percentage Changeproduct sold in tonnes

June 30, 2012


June 30, 2011


Increase/(Decrease)Bromine (excluded volume sold to SYCI)


5,031



7,670



(34
%)Crude Salt


100,745



124,809



(19
%)
 
 Three-Month Period Ended


Percentage ChangeChemical products segment sold in tonnes

June 30, 2012


June 30, 2011


Increase/(Decrease)Oil and gas exploration additives


3,057



4,474



(32
%)Paper manufacturing additives


771



917



(16
%)Pesticides manufacturing additives


830



761



9
%Wastewater treatment chemical additives


-



116



(100
%)Overall


4,658



6,268



(26
%)
 
 22
 Table of Contents
 
 Bromine segment
 The decrease in net revenue from our bromine segment was mainly due to the decrease in both the sales volume and selling price of bromine. The sales volume of bromine decreased from 7,670 tonnes for the three-month period ended June 30, 2011 to 5,031 tonnes for the same period in 2012, a decrease of 34%. Despite an increase in the number of our bromine production plants in recent years which maintained our production capacity, sales volume of bromine decreased. The major reason for the decrease in the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy, which has affected our customers’ industries.
 
 Due to the drop in demand of bromine, since the second half of 2011, we needed to offer competitive selling prices to our customers to compete with other bromine manufacturers. The average selling price of bromine decreased from $4,333 per tonne for the three-month period ended June 30, 2011 to $3,486 per tonne for the same period in 2012, a decrease of 20%. The average selling price for this quarter remained relatively stable as compared with the three-month period ended March 31, 2012 ($3,569 per tonne). We expect the average selling price of bromine will remain at current levels through the end of 2012 should the PRC government’s macro-economic tightening policy remain in place. The table below shows the changes in the average selling price and changes in the sales volume of bromine for three-month period ended June 30, 2012 from the same period in 2011.
 
 Three-Month Period

Ended June 30,Increase / (Decrease) in net revenue of bromine as a result of:

2012 vs. 2011Decrease in average selling price

$
(5,373,368
)Decrease in sales volume

$
(10,317,849
)Total effect on net revenue of bromine

$
(15,691,217
)
 
 Crude salt segment
 The decrease in net revenue from our crude salt segment was mainly due to the decrease in both the average selling price and sales volume of crude salt. The average selling price of crude salt decreased from $48.03 per tonne for the three-month period ended June 30, 2011 to $37.52 per tonne for the same period in 2012, a decrease of 22%, and the sales volume of crude salt also decreased by 19% from 124,809 tonnes for the three-month period ended June 30, 2011 to 100,745 tonnes for the same period in 2012. Similar to the bromine segment, the decrease in both the average selling price and sales volume was a result of the macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy. This policy resulted in, among other things, the decrease in the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. The table below shows the changes in the average selling price and changes in the sales volume of crude salt for three-month period ended June 30, 2012 from the same period in 2011.
 
 Three-Month Period

Ended June 30,Increase / (Decrease) in net revenue of crude salt as a result of:

2012 vs. 2011Decrease in average selling price

$
(1,185,440
)Decrease in sales volume

$
(1,029,286
)Total effect on net revenue of crude salt

$
(2,214,726
)
 
 We noted a downward trend in the average selling price of crude salt since the first quarter of 2011 as we offered competitive selling prices to our customers in order to compete with other crude salt manufacturers. The average selling price decreased from $50.09 per tonne in the first quarter of 2011 to $37.52 per tonne in the second quarter of 2012. We expect the average selling price of crude salt will remain at current levels through the end of 2012 should the PRC government’s macro-economic tightening policy remain in place.
 
 23
 Table of Contents
 
 Chemical products segment
  Product Mix of Chemical Products Segment

PercentThree-Month Period Ended

Three-Month Period Ended

Change ofJune 30, 2012

June 30, 2011

Net RevenueChemical Products




% of total




% of totalOil and gas exploration additives

$
5,569,089



56
%

$
7,994,967



66
%


(30
%)Paper manufacturing additives

$
985,068



10
%

$
1,261,663



11
%


(22
%)Pesticides manufacturing additives

$
3,441,602



34
%

$
2,299,138



19
%


50
%Wastewater treatment chemical additives


-



-



520,014



4
%


(100
%)Total sales

$
9,995,759



100
%

$
12,075,782



100
%


(17
%)
 
 Net revenue from our chemical products segment decreased from $12,075,782 for the three-month period ended June 30, 2011 to $9,995,759 for the same period in 2012, a decrease of approximately 17%. The decrease was mainly attributable to the drop in demand for our oil and gas exploration additives and paper manufacturing additives. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $5,569,089 (or 56%) and $7,994,967 (or 66%) of our chemical segment revenue for the three-month periods ended June 30, 2012 and 2011, respectively, with a decrease of $2,425,878, or 30%. Net revenue from our paper manufacturing additives decreased from $1,261,663 for the three-month period ended June 30, 2011 to $985,068 for the same period in 2012, a decrease of approximately 22%. We believe that as result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, the overall demand for chemical products was reduced, which resulted in a decrease in our volume of both oil and gas exploration additives and paper manufacturing additives sold, which decreased by 32% and 16%, respectively, for the three-month period ended June 30, 2012 as compared with the same period in 2011. Also, in June 2011 we stopped production of our wastewater treatment chemical additives and in July 2011 we successfully converted the production equipment to pharmaceutical and agricultural chemical additives which have higher profit margins.
 
 However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price of our pesticides manufacturing additives products due to the strong demand in the PRC market. The average selling price per tonne for our pesticides manufacturing additives increased by 37% for the three-month period ended June 30, 2012 as compared with the same period in 2011. The PRC government continued to support expansion of agricultural related products, which supported the growth in sales of our pesticides manufacturing additives. Also, we successfully converted the production equipment from wastewater treatment chemical additive to pharmaceutical and agricultural chemical additives, which contributed higher profit margins than other chemical products. The table below shows the changes in the average selling price and changes in the sales volume of major chemical products (excluded wastewater treatment chemical additives of $520,014 for three-month period ended June 30, 2011 as the production of such product line was stopped since July 2011) for three-month period ended June 30, 2012 from the same period in 2011.
 
 Increase / (Decrease) in net revenue,

for the three-month period ended June 30,

2012 vs. 2011, as a result of:

Oil and gas exploration additives

Paper manufacturing additives

Pesticides manufacturing additives

TotalIncrease / (Decrease) in average selling price

$
130,910


$
(82,889
)

$
895,178


$
943,199Increase / (Decrease) in sales volume

$
(2,556,788
)

$
(193,706
)

$
247,286


$
(2,503,208
)Total effect on net revenue of chemical products

$
(2,425,878
)

$
(276,595
)

$
1,142,464


$
(1,560,009
)
 
 Cost of Net Revenue.
 
 Cost of Net Revenue by Segment

% ChangeThree-Month Period Ended

Three-Month Period Ended

of Cost ofJune 30, 2012

June 30, 2011

Net RevenueSegment




% of total




% of totalBromine

$
11,969,325



56
%

$
15,518,035



62
%


(23
%)Crude Salt

$
2,556,779



12
%

$
1,410,903



6
%


81
%Chemical Products

$
6,863,547



32
%

$
8,065,765



32
%


(15
%)Total

$
21,389,651



100
%

$
24,994,703



100
%


(14
%)
 
 24
 Table of Contents
 
 Costof net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $21,389,651 for three-month period ended June 30, 2012, a decrease of $3,605,052 (or 14%) as compared to the same period in 2011. The decrease in overall cost of net revenue was mainly attributable to the decrease in volume of products sold and the decrease in purchase price of raw materials, as compared to the last comparable period, which was partially offset by the increase in depreciation and amortization of manufacturing plant and machinery and price adjustment fund, a levy imposed by the local PRC government to our bromine and crude segments since January 2011 for the purpose of enhancing the local PRC government’s ability to adjust the price and stabilize the market price of daily necessities and other important commodities.
 
 Bromine production capacity and utilization of our factories
 
 The table below represents the annual capacity and utilization ratios for all of our bromine producing properties:
 
 Annual Production Capacity (in tonnes)

Utilization

Ratio (ii)Three-month period ended June 30, 2011


41,547
(i)


81%Three-month period ended June 30, 2012


44,547



47%Variance of the three-month periods ended June 30, 2012 and 2011


3,000
(iii)


(34%
)
 
 (i) Annual production capacity for the three-month period ended June 30, 2011 was adjusted with the appraisal report carried out by an international appraisal firm, Grant Sherman Appraisal Limited, in October 2011.
 
 (ii) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the periods divided by the annual production capacity in tonnes.
 
 (iii) The increase in 3,000 tonnes production capacity represents the management’s estimated capacity of Factory No. 10 acquired in late December 2011.
 
 Our utilization ratio decreased by 34% for the three-month period ended June 30, 2012 as compared with the same period in 2011. The decrease in utilization and hence the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which reduced our production volume since mid-2011.
 
 In view of the trend of a decrease in the bromine concentration of the brine water being extracted at our production facilities as explained in 2011 Form 10-K, and in order to reduce the leakage rate and attempt to recover the annual production capacity of bromine and crude salt to a higher level in the future, we decided to carry out large scale enhancement work to replace all the eroded protective shells within a four year timeframe, which work commenced in the second quarter of 2011. In May 2012, we resumed the second phase enhancement works to our existing bromine extraction and crude salt production facilities, which are still under construction as of June 30, 2012. The total construction costs of the enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 are approximately $12,806,910 and $8,139,503, respectively, which are expected to be completed by late August 2012.
 
 Bromine segment
 For the three-month period ended June 30, 2012, the cost of net revenue for the bromine segment was $11,969,325, a decrease of $3,548,710 or 23% over the same period in 2011. The most significant components of the costs of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $6,616,505 (or 55%), depreciation and amortization of manufacturing plant and machinery of $3,423,638 (or 29%) and electricity of $799,502 (or 7%) for the three-month period ended June 30, 2012. For the three-month period ended June 30, 2011, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $10,235,449 (or 66%), depreciation and amortization of manufacturing plant and machinery of $2,590,493 (or 17%) and electricity of $1,257,231 (or 8%), the cost structure changed as compared with the same period in 2012 where the contribution from cost of raw materials and finished goods consumed decreased by 11% and depreciation and amortization of manufacturing plant and machinery increased by 12%. The decrease in net cost of net revenue was attributable mainly to the decrease in raw material prices, which is largely offset by the increase in depreciation and amortization of manufacturing plant and machinery.
  25
 Table of Contents
  The table below represents the major production cost component of bromine per tonne for respective periods:
 
 Per tonne production cost

Three-Month Period Ended

Three-Month Period Endedcomponent of bromine segment

June 30, 2012

June 30, 2011

% Change% of total



% of totalRaw materials

$
1,315



55
%

$
1,334



66
%


(1
%)Depreciation and amortization

$
681



29
%

$
338



17
%


101
%Electricity

$
159



7
%

$
164



8
%


(3
%)Others

$
224



9
%

$
187



9
%


20
%Production cost of bromine per tonne

$
2,379



100
%

$
2,023



100
%


18
%
 
 Our production cost of bromine per tonne was $2,379 for the three-month period ended June 30, 2012, an increase of 18% (or $356) as compared to the same period in 2011, which was attributable mainly to the component of depreciation and amortization of manufacturing plant and machinery. The significant percentage increase in depreciation and amortization per tonne by 101% was due to the enhancement projects in late June 2011 to our extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery. The cost of raw materials consumed per tonne slighted decreased by 1% as compared to the last comparison period, which was mainly attributable to the decrease in the purchase price of raw materials due to the macro-economic tightening policy imposed by the PRC government. Since January 2011, included in our other production cost was a price adjustment fund, a levy charged by the PRC government, of RMB200 (approximately $32) per tonne.
 
 Crude salt segment
 The cost of net revenue for our crude salt segment for the three-month period ended June 30, 2012 was $2,556,779, representing an increase of $1,145,876, or 81%, compared to $1,410,903 for the same period in 2011. The increase in cost was mainly due to the increase in the number of crude salt fields and enhancement projects performed in late June 2011, which in turn resulted in an increase in the depreciation and amortization of manufacturing plant and machinery. The significant cost components for the three-month period ended June 30, 2012 were depreciation and amortization of $1,771,016 (or 69%), resource taxes calculated based on crude salt sold of $319,462 (or 12%) and electricity of $193,917 (or 8%). The significant cost components for the three-month period ended June 30, 2011 were depreciation and amortization of $604,343 (or 43%), resource tax of $410,403 (or 29%) and electricity of $206,755 (or 15%). The table below represents the major production cost component of crude salt per ton for respective periods:
 
 Per tonne production cost

Three-Month Period Ended

Three-Month Period Endedcomponent of crude salt segment

June 30, 2012

June 30, 2011

% Change% of total



% of totalDepreciation and amortization

$
17.6



69
%

$
4.8



43
%


267
%Resource tax

$
3.2



13
%

$
3.3



29
%


(3
%)Electricity

$
2.0



8
%

$
1.7



15
%


18
%Others

$
2.6



10
%

$
1.5



13
%


73
%Production cost of crude salt per tonne

$
25.4



100
%

$
11.3



100
%


125
%
 
 Our production cost of crude salt per tonne was $25.4 for the three-month period ended June 30, 2012, an increase of 125% (or $14.1) as compared to the same period in 2011, which was attributable mainly to the components of depreciation and amortization of manufacturing plant and machinery and the accrual of the price adjustment fund since 2011. The significant percentage increase in depreciation and amortization per tonne by 267% was due to the enhancement projects performed in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery. Since the second quarter of 2011, included in our other production cost was a price adjustment fund, a levy charged by PRC government since January 2011, of RMB3 (approximately $0.48) per tonne. Other production costs represented mainly salaries and welfare of labor worked in the crude salt fields.
 
 Chemical products segment
 Cost of net revenue for our chemical products segment for the three-month period ended June 30, 2012, was $6,863,547, representing a decrease of $1,202,218 or 15% over the same period in 2011. The significant costs were cost of raw material and finished goods consumed of $5,989,603 (or 87%) and $6,961,495 (or 86%) and depreciation and amortization of manufacturing plant and machinery of $640,617 (or 9%) and $674,499 (or 8%) for each of the three-month periods ended June 30, 2012 and 2011, respectively. As the components of our cost of net revenue are fixed levels of depreciation and amortization of our manufacturing plant and machinery, the rate of decrease for the cost of net revenue for our chemical products segment was less than that of net revenue.
 
 26
 Table of Contents
  Gross Profit. Gross profit was $9,925,195, or 32%, of net revenue for three-month period ended June 30, 2012 compared to $26,306,109, or 51%, of net revenue for the same period in 2011. The decrease in gross profit percentage was primarily attributable to a drop in the margin percentage in all of our three segments.
 
 Gross Profit by Segment

% Point ChangeThree-Month Period Ended

Three-Month Period Ended

of GrossJune 30, 2012

June 30, 2011

Profit MarginSegment




Gross Profit Margin




Gross Profit MarginBromine

$
5,570,105



32
%

$
17,712,611



53
%


(21
%)Crude Salt

$
1,222,878



32
%

$
4,583,481



76
%


(44
%)Chemical Products

$
3,132,212



31
%

$
4,010,017



33
%


(2
%)Total Gross Profit

$
9,925,195



32
%

$
26,306,109



51
%


(19
%)
 
 Bromine segment
 For the three-month period ended June 30, 2012, the gross profit margin for our bromine segment was 32% compared to 53% for the same period in 2011. As mentioned in the net revenue discussion above, due to the PRC government’s macro-economic tightening policy to slow down the economy, our selling price and sales volume in the three-month ended June 30, 2012 was adversely affected. We cut the average selling price of bromine from $4,333 per tonne for the three-month period ended June 30, 2011 to $3,486 per tonne for the same period in 2012, a decrease of 20%, in order to compete with other bromine manufacturers. Nevertheless, the sales volume decreased from 7,670 tonnes for the three-month period ended June 30, 2011 to 5,031 tonnes for the same period in 2012, a decrease of 34%. Also, as mentioned in our 2011 Form 10-K, we completed certain enhancements of our facilities during the second quarter of 2011 to pump brine water from deeper underground in order to improve the quality of brine water being extracted from our wells, which in turn increased the depreciation and amortization of the plant and equipment and hence the cost of net revenue of bromine. We expect that the average selling price and gross profit margin of bromine will remain at current level towards the end of 2012 should the PRC government’s macro-economic tightening policy remain in place.
 
 Crude salt segment
 For the three-month period ended June 30, 2012 the gross profit margin for our crude salt segment was 32% compared to 76% for the same period in 2011. This significant 44% decrease in our gross profit margin is attributable to (i) the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects performed in late June 2011 to our crude fields, extraction wells and transmission channels and ducts as mentioned in our 2011 Form 10-K and (ii) the change in the estimated useful life of certain protective shells and transmission channels and ducts from 8 years to 5 years which accelerated the depreciation and amortization of the plant and machinery. For the three-month period ended June 30, 2012, the average selling price of crude salt amounted to $37.52 per tonne, as compared to $48.03 per tonne for the same period in 2011, a decrease of 22%. As previously mentioned, the decrease in gross profit was a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which decreased the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries.
 
 Chemical products segment
 The gross profit margin for our chemical products segment for the three-month period ended June 30, 2012 was 31% compared to 33% for the same period in 2011, a decrease of 2%. As previously mentioned, the decrease in gross profit margin was a result of the decrease in demand for our oil and gas exploration additives and paper manufacturing additives which in turn reduced the sales volume of these chemical products. As sales of oil and gas exploration additives contributed more than 56% of our total chemical products segment’s net revenue, the decrease in demand largely reduced the gross profit margin of our chemical products segment. However, the selling price fluctuation of individual chemical products is not expected to have a significant impact on our gross profit margin for overall chemical products as our factory is capable of producing diversified chemical products, such as pesticides manufacturing additives with higher profit margin.
 
 Research and Development Costs. The total research and development costs incurred for the three-month periods ended June 30, 2012 and 2011 were $62,526 and $133,519, respectively, a decrease of 53%.
 
 Research and development costs for the three-month period ended June 30, 2012 represented raw materials used by SYCI for testing the manufacturing routine and samples of the new chemical products production line. Research and development costs for the three-month period ended June 30, 2011 were mostly related to the Co-Op Research and Development Center set up jointly with East China University of Science and Technology in June 2007 to develop new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry, which amounted to $108,100. On June 7, 2011, SYCI and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for us.
 
 27
 Table of Contents
 
 Exploration cost. Exploration cost of $3,867,286 for the three-month period ended June 30, 2011 represented the drilling of exploratory wells and associated facilities by SCHC in Sichuan Province in order to confirm and measure the brine water resources in the province. We completed the drilling of the first exploratory well in December 2011 and announced in mid-January 2012 that we have discovered underground brine water resources in Daying County, and provided preliminary concentration results after the testing by a third-party independent testing expert. No further exploration cost was incurred for the three-month period ended June 30, 2012 as we are still discussing with the local government of Daying County of the form of cooperation to further explore the brine water resources.
 
 Write-off/Impairment on property, plant and equipment. Write-off on property, plant and equipment of $911,995 for the three-month period ended June 30, 2012 represented the write-off of certain protective shells to transmission pipelines and ducts replaced during the second phase enhancement project that started in May 2012. The write-off and impairment on property, plant and equipment for the three-month period ended June 30, 2011 represented (i) the write-off on property, plant and equipment that could not be relocated to the new Factory No. 4 in the amount of $1,384,443; (ii) the impairment loss on property, plant and equipment related to the conversion of our production line from wastewater treatment chemical additives to the production of pharmaceutical and agricultural chemical intermediates in the amount of $1,805,598; (iii) the impairment loss on property, plant and equipment under capital leases for idle plant and machinery in the amount of $683,046; and (iv) the write-off of certain crude salt field protective shells and transmission pipelines replaced during enhancement projects in the amounts of $1,632,004 and $2,065,475, respectively.
 
 General and Administrative Expenses. General and administrative expenses were $1,370,866 for the three-month period ended June 30, 2012, a decrease of $343,828 (or 20%) as compared to $1,714,694 for the same period in 2011. The decrease of $343,828 was primarily due to the inclusion of demolition and re-installation expense for the three-month period ended June 30, 2011 for relocating Factory No. 4 due to the Chinese government taking the leased land, where our original Factory No. 4 was situated, for civil redevelopment in the amount of $467,327.
 
 Other Operating Income. Other operating income, which represented the sales of wastewater to some of our customers, was $76,104 for the three-month period ended June 30, 2012. Wastewater is generated from the production of bromine and eventually becomes crude salt when it evaporates. Not all of our bromine production plants have sufficient area on the property to allow for evaporation of wastewater to produce crude salt. Certain of our customers who have facilities located adjacent to our bromine production plants have agreed to channel our wastewater into brine pans on their properties for evaporation. These customers then are able to sell the resulting crude salt themselves. We have signed agreements with three of our customers to sell them our wastewater at market prices. The other operating income for the three-month period ended June 30, 2011 represented (i) a sum of $92,298 for sales of wastewater and (ii) a sum of $300,000 for compensation received from a legal case.
 
 Income from Operations. Income from operations was $7,633,203 for the three-month period ended June 30, 2012 (or 24.4% of net revenue), a decrease of $5,755,406, or approximately 43%, over income from operations for the same period in 2011. The decrease resulted primarily from the decrease in net revenue as a result of (i) the macro-economic tightening policy imposed by the PRC government to slow down the economy, which in turn decreased the demand and selling price of our products; and (ii) the increase in depreciation and amortization of the plant and machinery due to the enhancement projects in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery.
 
 Income from Operations by SegmentThree-Month Period Ended

June 30, 2012

Three-Month Period Ended

June 30, 2011Segment:




% of total



% of totalBromine

$
3,933,561


50%

$
9,540,474


71%Crude Salt


888,555


11%


1,926,628


14%Chemical Products


3,007,381


39%


2,029,160


15%Income from operations before corporate costs


7,829,497


100%


13,496,262


100%Corporate costs


(196,294
)




(107,653
)Income from operations

$
7,633,203




$
13,388,609
 
 28
 Table of Contents
 
 Bromine segment
 Income from operations from our bromine segment was $3,933,561 for the three-month period ended June 30, 2012, a decrease of $5,606,913 (or approximately 59%) compared to the same period in 2011. This significant decrease resulted primarily from the decrease in sales volume (contributed a decrease of approximately $10 million) and in average selling price (contributed a decrease of approximately $5 million) as a result of the PRC government’s macro-economic tightening policy which decreased the demand for bromine, which was partially offset by the decrease in (i) the cost of net revenue of bromine of approximately $3.5 million; (ii) exploration cost of approximately $3.4 million and (iii) write-off/impairment of property, plant and equipment of approximately $3.0 million.
 
 Crude salt segment
 Income from operations from our crude salt segment was $888,555 for the three-month period ended June 30, 2012, a decrease of $1,038,072 (or approximately 54%) compared to the same period in 2011. This decrease was mainly due to (i) the decrease in both the average selling price and sales volume (contributed an aggregate decrease of approximately $2.2 million); and (ii) the decrease in the gross profit margin due to the enhancement projects which increased the depreciation of manufacturing facilities of approximately $1.1 million, which was partially offset by the decrease in (i) exploration cost of approximately $0.5 million and (ii) write-off/impairment of property, plant and equipment of approximately $1.9 million.
 
 Chemical products segment
 Income from operations from our chemical products segment was $3,007,381 for the three-month period ended June 30, 2012, an increase of $978,221 (or approximately 48%) compared to the same period in 2011. This increase resulted primarily from (i) the increase in net revenue of our pesticides manufacturing additives of approximately $1.1 million, (ii) the decrease in cost of net revenue of approximately $1.2 million as explained hereinbefore and (iii) the decrease in write-off/impairment of property, plant and equipment of approximately $1.8 million, which was partially offset by the decrease in net revenue of our wastewater treatment chemical additives, oil and gas exploration additives and paper manufacturing additives of approximately $3.2 million due to decreased demand.
 
 Other Income, Net. Other income, net represented bank interest income, net of capital lease interest expense.
 
 Net Income. Net income was $5,688,674 for the three-month period ended June 30, 2012, a decrease of $4,334,581 (or approximately 43%) compared to the same period in 2011. This decrease was primarily attributable to the overall decrease in demand for our products due to the macro-economic tightening policy imposed by the PRC government to slow down the economy.
 
 Effective Tax Rate. Our effective tax rate for the three-month periods ended June 30, 2012 and 2011 was 26% and 25%, respectively. The effective tax rate for the three-month period ended June 30, 2012 of 1% differs from the PRC statutory income tax rate of 25%, which was due to the US federal net operating loss incurred by Gulf.
 
 Comparison of the Six-Month Periods Ended June 30, 2012 and 2011
 
 Six-Month Period

Ended June 30, 2012

Six-Month Period

Ended June 30, 2011

% ChangeNet revenue
$
55,123,520


$
96,679,344



(43
%)Cost of net revenue
$
(38,505,533
)

$
(45,586,087
)


(16
%)Gross profit
$
16,617,987


$
51,093,257



(67
%)Sales, marketing and other operating expenses
$
(40,473
)

$
(47,745
)


(15
%)Research and development costs
$
(105,324
)

$
(313,856
)


(66
%)Exploration cost
$
-


$
(3,867,286
)


(100
%)Write-off/Impairment on property, plant and equipment
$
(911,995
)

$
(7,570,566
)


(88
%)General and administrative expenses
$
(3,483,071
)

$
(6,055,985
)


(42
%)Other operating income
$
133,178


$
415,083



(68
%)Income from operations
$
12,210,302


$
33,652,902



(64
%)Other income, net
$
75,138


$
20,819



261
%Income before taxes
$
12,285,440


$
33,673,721



(64
%)Income taxes
$
(3,309,659
)

$
(9,285,467
)


(64
%)Net income
$
8,975,781


$
24,388,254



(63
%)
 
 29
 Table of Contents
 
 Net revenue.  Net revenue for six-month period ended June 30, 2012 was $55,123,520, representing a decrease of approximately $41.6 million (or 43%) over the same period in 2011. This decrease was primarily attributable to the reduction of overall demand for all of our segment products, specifically, (i) revenue from the bromine segment decreased from $63,379,962 for the six-month period ended June 30, 2012 to $30,993,311 for the same period in 2012, a decrease of approximately 51%; (ii) revenue from the crude salt segment decreased from $11,028,718 for the six-month period ended June 30, 2011 to $6,054,582 for the same period in 2012, a decrease of approximately 45%; and (iii) revenue from the chemical products segment decreased from $22,270,664 for the six-month period ended June 30, 2011 to $18,075,627 for the same period in 2012, a decrease of approximately 19%.
 
 Net Revenue by SegmentSix-Month Period Ended

Six-Month Period Ended

Percent DecreaseJune 30, 2012

June 30, 2011

of Net RevenueSegment




% of total




% of totalBromine

$
30,993,311



56
%

$
63,379,962



66
%


(51
%)Crude Salt

$
6,054,582



11
%

$
11,028,718



11
%


(45
%)Chemical Products

$
18,075,627



33
%

$
22,270,664



23
%


(19
%)Total sales

$
55,123,520



100
%

$
96,679,344



100
%


(43
%)
 
 Bromine and crude salt segments

Six-Month Period Ended


Percentage Changeproduct sold in tonnes

June 30, 2012


June 30, 2011


Increase/(Decrease)Bromine (excluded volume sold to SYCI)


8,800



14,230



(38
%)Crude Salt


160,581



225,320



(29
%)
 
 Six-Month Period Ended


Percentage ChangeChemical products segment sold in tonnes

June 30, 2012


June 30, 2011


Increase/(Decrease)Oil and gas exploration additives


5,401



8,660



(38
%)Paper manufacturing additives


1,253



1,897



(34
%)Pesticides manufacturing additives


1,628



1,443



13
%Wastewater treatment chemical additives


-



116



(100
%)Overall


8,282



12,116



(32
%)
 
 Bromine segment
 The decrease in net revenue from our bromine segment was mainly due to the decrease in both the sales volume and selling price of bromine. The sales volume of bromine decreased from 14,230 tonnes for the six-month period ended June 30, 2011 to 8,800 tonnes for the same period in 2012, a decrease of 38%. Despite an increase in the number of our bromine production plants in recent years which maintained our production capacity, sales volume of bromine decreased. As mentioned hereinbefore, the major reason for the decrease in the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy, which has affected our customers’ industries.
 
 Due to the drop in demand of bromine, since the second half of 2011, we needed to offer competitive selling prices to our customers to compete with other bromine manufacturers. The average selling price of bromine decreased from $4,454 per tonne for the six-month period ended June 30, 2011 to $3,522 per tonne for the same period in 2012, a decrease of 21%. The average selling price for the first half of 2012 remained relatively stable at around $3,500 per tonne. We expect the average selling price of bromine will remain at current levels through the end of 2012 should the PRC government’s macro-economic tightening policy remain in place. The table below shows the changes in the average selling price and changes in the sales volume of bromine for six-month period ended June 30, 2012 from the same period in 2011.
 
 Six-Month Period

Ended June 30,Increase / (Decrease) in net revenue of bromine as a result of:

2012 vs. 2011Decrease in average selling price

$
(10,734,170
)Decrease in sales volume

$
(21,652,481
)Total effect on net revenue of bromine

$
(32,386,651
)
 
 30
 Table of Contents
 
 Crude salt segment
 The decrease in net revenue from our crude salt segment was mainly due to the decrease in both the average selling price and sales volume of crude salt. The average selling price of crude salt decreased from $48.95 per tonne for the six-month period ended June 30, 2011 to $37.70 per tonne for the same period in 2012, a decrease of 23%, and the sales volume of crude salt also decreased by 29% from 225,320 tonnes for the six-month period ended June 30, 2011 to 160,581 tonnes for the same period in 2012. The decrease in both the average selling price and sales volume was a result of the macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy. This policy resulted in, among other things, the decrease in the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. The table below shows the changes in the average selling price and changes in the sales volume of crude salt for six-month period ended June 30, 2012 from the same period in 2011.
 
 Six-Month Period

Ended June 30,Increase / (Decrease) in net revenue of crude salt as a result of:

2012 vs. 2011Decrease in average selling price

$
(2,169,295
)Decrease in sales volume

$
(2,804,841
)Total effect on net revenue of crude salt

$
(4,974,136
)
 
 We noted a downward trend in the average selling price of crude salt since the first quarter of 2011 as we offered competitive selling prices to our customers in order to compete with other crude salt manufacturers. The average selling price decreased from $50.09 per tonne in the first quarter of 2011 to $37.52 per tonne in the second quarter of 2012. We expect the average selling price of crude salt will remain at current levels through the end of 2012 should the PRC government’s macro-economic tightening policy remain in place.
 
 Chemical products segment
 Product Mix of Chemical Products Segment

PercentSix-Month Period Ended

Six-Month Period Ended

Change ofJune 30, 2012

June 30, 2011

Net RevenueChemical Products




% of total




% of totalOil and gas exploration additives

$
9,730,648



54
%

$
15,194,568



68
%


(36
%)Paper manufacturing additives

$
1,665,601



9
%

$
2,507,693



12
%


(34
%)Pesticides manufacturing additives

$
6,679,378



37
%

$
4,048,390



18
%


65
%Wastewater treatment chemical additives


-



-



520,013



2
%


(100
%)Total sales

$
18,075,627



100
%

$
22,270,664



100
%


(19
%)
 
 Net revenue from our chemical products segment decreased from $22,270,664 for the six-month period ended June 30, 2011 to $18,075,627 for the same period in 2012, a decrease of approximately 19%. The decrease was mainly attributable to the drop in demand for our oil and gas exploration additives and paper manufacturing additives. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $9,730,648 (or 54%) and $15,194,568 (or 68%) of our chemical segment revenue for the six-month periods ended June 30, 2012 and 2011, respectively, with a decrease of $5,463,920, or 36%. Net revenue from our paper manufacturing additives decreased from $2,507,693 for the six-month period ended June 30, 2011 to $1,665,601 for the same period in 2012, a decrease of approximately 34%. We believe that as result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, the overall demand for chemical products was reduced, which resulted in a decrease in our volume of both oil and gas exploration additives and paper manufacturing additives sold, which decreased by 38% and 34%, respectively, for the six-month period ended June 30, 2012 as compared with the same period in 2011. Also, in June 2011 we stopped production of our wastewater treatment chemical additives due to the lower profit margin than estimated by the management.
 
 However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price of our pesticides manufacturing additives products due to the strong demand in the PRC market. The average selling price per tonne for our pesticides manufacturing additives increased by 46% for the six-month period ended June 30, 2012 as compared with the same period in 2011. The PRC government continued to support expansion of agricultural related products, which supported the growth in sales of our pesticides manufacturing additives. Also, we successfully converted the production equipment from wastewater treatment chemical additive to pharmaceutical and agricultural chemical additives, which contributed higher profit margins than other chemical products.
 
 31
 Table of Contents
 
 The table below shows the changes in the average selling price and changes in the sales volume of major chemical products (excluded wastewater treatment chemical additives) for six-month period ended June 30, 2012 from the same period in 2011.
 
 Increase / (Decrease) in net revenue,

for the six-month period ended June 30,

2012 vs. 2011, as a result of:

Oil and gas exploration additives

Paper manufacturing additives

Pesticides manufacturing additives

TotalIncrease / (Decrease) in average selling price

$
330,920


$
11,600


$
1,991,966


$
2,334,486Increase / (Decrease) in sales volume

$
(5,794,840
)

$
(853,692
)

$
639,022


$
(6,009,510
)Total effect on net revenue of chemical products

$
(5,463,920
)

$
(842,092
)

$
2,630,988


$
(3,675,024
)
 
 Cost of Net Revenue.
 
 Cost of Net Revenue by Segment

% ChangeSix-Month Period Ended

Six-Month Period Ended

of Cost ofJune 30, 2012

June 30, 2011

Net RevenueSegment




% of total




% of totalBromine

$
21,813,821



57
%

$
28,767,486



63
%


(24
%)Crude Salt

$
4,095,520



10
%

$
2,416,297



5
%


69
%Chemical Products

$
12,596,192



33
%

$
14,402,304



32
%


(13
%)Total

$
38,505,533



100
%

$
45,586,087



100
%


(16
%)
 
 Costof net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $38,505,533 for six-month period ended June 30, 2012, a decrease of $7,080,554 (or 16%) over the same period in 2011. The decrease in overall cost of net revenue was mainly attributable to the decrease in volume of products sold and the decrease in purchase price of raw materials, as compared to the last comparable period, which was partially offset by the increase in depreciation and amortization of manufacturing plant and machinery and price adjustment fund, a levy imposed by the local PRC government to our bromine and crude segments since January 2011 for the purpose of enhancing the local PRC government’s ability to adjust the price and stabilize the market price of daily necessities and other important commodities.
 
 Bromine production capacity and utilization of our factories
 
 The table below represents the annual capacity and utilization ratios for all of our bromine producing properties:
 
 Annual Production Capacity (in tonnes)

Utilization

Ratio (ii)Six-month period ended June 30, 2011


41,547
(i)


70%Six-month period ended June 30, 2012


44,547



42%Variance of the six-month periods ended June 30, 2012 and 2011


3,000
(iii)


(28%
)
 
 (i) Annual production capacity for the six-month period ended June 30, 2011 was adjusted with the appraisal report carried out by an international appraisal firm, Grant Sherman Appraisal Limited, in October 2011.
 
 (ii) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the periods divided by the annual production capacity in tonnes.
 
 (iii) The increase in 3,000 tonnes production capacity represents the management’s estimated capacity of Factory No. 10 acquired in late December 2011.
 
 Our utilization ratio decreased by 28% for the six-month period ended June 30, 2012 as compared with the same period in 2011. The decrease in utilization and hence the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which reduced our production volume since mid-2011.
  32
 Table of Contents
  In view of the trend of a decrease in the bromine concentration of the brine water being extracted at our production facilities as explained in 2011 Form 10-K, and in order to reduce the leakage rate and attempt to recover the annual production capacity of bromine and crude salt to a higher level in the future, we decided to carry out large scale enhancement work to replace all the eroded protective shells within a four year timeframe, which work commenced in the second quarter of 2011. In May 2012, we resumed the second phase enhancement works to our existing bromine extraction and crude salt production facilities, which are still under construction as of June 30, 2012. The total construction costs of the enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 are approximately $12,806,910 and $8,139,503, respectively, which are expected to be completed by late August 2012.
 
 Bromine segment
 For the six-month period ended June 30, 2012, the cost of net revenue for the bromine segment was $21,813,821, a decrease of $6,953,665 or 24% over the same period in 2011. The most significant components of the costs of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $11,466,046 (or 53%), depreciation and amortization of manufacturing plant and machinery of $6,794,153 (or 31%) and electricity of $1,439,750 (or 7%) for the six-month period ended June 30, 2012. For the six-month period ended June 30, 2011, the major components of the cost of net revenue were the cost of raw materials and finished goods consumed of $19,205,474 (or 67%), depreciation and amortization of manufacturing plant and machinery of $4,664,737 (or 16%) and electricity of $2,152,256 (or 7%), the cost structure changed as compared with the same period in 2012 where the contribution from cost of raw materials and finished goods consumed decreased by 14% and depreciation and amortization of manufacturing plant and machinery increased by 15%. The decrease in net cost of net revenue was attributable mainly to the decrease in raw material prices, which is largely offset by the increase in depreciation and amortization of manufacturing plant and machinery. The table below represents the major production cost component of bromine per tonne for respective periods:
 
 Per tonne production cost

Six-Month Period Ended

Six-Month Period Endedcomponent of bromine segment

June 30, 2012

June 30, 2011

% Change% of total



% of totalRaw materials

$
1,303



53
%

$
1,350



67
%


(3
%)Depreciation and amortization

$
772



31
%

$
328



16
%


135
%Electricity

$
164



7
%

$
151



7
%


9
%Others

$
240



9
%

$
193



10
%


24
%Production cost of bromine per tonne

$
2,479



100
%

$
2,022



100
%


23
%
 
 Our production cost of bromine per tonne was $2,479 for the six-month period ended June 30, 2012, an increase of 23% (or $457) over the same period in 2011, which was attributable mainly to the component of depreciation and amortization of manufacturing plant and machinery. The significant percentage increase in depreciation and amortization per tonne by 135% was due to the enhancement projects in late June 2011 to our extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery. The cost of raw materials consumed per tonne slightly decreased by 3% as compared to the last comparison period, which was mainly attributable to the decrease in the purchase price of raw materials due to the macro-economic tightening policy imposed by the PRC government. Since January 2011, included in our other production cost was a price adjustment fund, a levy charged by the PRC government, of RMB200 (approximately $32) per tonne.
 
 Crude salt segment
 For the six-month period ended June 30, 2012, the cost of net revenue for our crude salt segment was $4,095,520, representing an increase of $1,679,223, or 69%, compared to $2,416,297 for the same period in 2011. The increase in cost was mainly due to the increase in the number of crude salt fields and enhancement projects performed in late June 2011, which in turn resulted in an increase in the depreciation and amortization of manufacturing plant and machinery. The significant cost components for the six-month period ended June 30, 2012 were depreciation and amortization of $2,874,870 (or 70%), resource taxes calculated based on crude salt sold of $509,191 (or 12%) and electricity of $277,967 (or 7%). The significant cost components for the six-month period ended June 30, 2011 were depreciation and amortization of $1,037,857 (or 43%), resource tax of $672,514 (or 28%) and electricity of $352,910 (or 15%). The table below represents the major production cost component of crude salt per ton for respective periods:
 
 Per tonne production cost

Six-Month Period Ended

Six-Month Period Endedcomponent of crude salt segment

June 30, 2012

June 30, 2011

% Change% of total



% of totalDepreciation and amortization

$
17.9



70
%

$
4.6



43
%


289
%Resource tax

$
3.2



12
%

$
3.0



28
%


7
%Electricity

$
1.8



7
%

$
1.6



15
%


13
%Others

$
2.6



11
%

$
1.5



14
%


73
%Production cost of crude salt per tonne

$
25.5



100
%

$
10.7



100
%


138
%
  33
 Table of Contents
  Our production cost of crude salt per tonne was $25.5 for the six-month period ended June 30, 2012, an increase of 138% (or $14.8) as compared to the same period in 2011, which was attributable mainly to the components of depreciation and amortization of manufacturing plant and machinery and the accrual of the price adjustment fund since 2011. The significant percentage increase in depreciation and amortization per tonne by 289% was due to the enhancement projects performed in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery. Since the second quarter of 2011, included in our other production cost was a price adjustment fund, a levy charged by PRC government since January 2011, of RMB3 (approximately $0.48) per tonne. Other production costs represented mainly salaries and welfare of labor worked in the crude salt fields.
 
 Chemical products segment
 For the six-month period ended June 30, 2012, cost of net revenue for our chemical products segment was $12,596,192, representing a decrease of $1,806,112 or 13% over the same period in 2011. The significant costs were cost of raw material and finished goods consumed of $10,796,469 (or 86%) and $12,635,144 (or 88%) and depreciation and amortization of manufacturing plant and machinery of $1,281,194 (or 10%) and $1,069,963 (or 7%) for each of the six-month periods ended June 30, 2012 and 2011, respectively. As the components of our cost of net revenue are fixed levels of depreciation and amortization of our manufacturing plant and machinery and the inflated purchase price of raw materials, the rate of decrease for the cost of net revenue for our chemical products segment was less than that of net revenue.
 
 Gross Profit. Gross profit was $16,617,987, or 30%, of net revenue for six-month period ended June 30, 2012 compared to $51,093,257, or 53%, of net revenue for the same period in 2011. The decrease in gross profit percentage was primarily attributable to a drop in the margin percentage in all of our three segments.
 
 Gross Profit by Segment

% Point ChangeSix-Month Period Ended

Six-Month Period Ended

of GrossJune 30, 2012

June 30, 2011

Profit MarginSegment




Gross Profit Margin




Gross Profit MarginBromine

$
9,179,491



30
%

$
34,612,476



55
%


(25
%)Crude Salt

$
1,959,061



32
%

$
8,612,421



78
%


(46
%)Chemical Products

$
5,479,435



30
%

$
7,868,360



35
%


(5
%)Total Gross Profit

$
16,617,987



30
%

$
51,093,257



53
%


(23
%)
 
 Bromine segment
 The gross profit margin for our bromine segment for the six-month period ended June 30, 2012 was 30% compared to 55% for the same period in 2011. As mentioned in the net revenue discussion above, due to the PRC government’s macro-economic tightening policy to slow down the economy, our selling price and sales volume in the six-month ended June 30, 2012 was adversely affected. We cut the average selling price of bromine from $4,454 per tonne for the six-month period ended June 30, 2011 to $3,522 per tonne for the same period in 2012, a decrease of 21%, in order to compete with other bromine manufacturers. Nevertheless, the sales volume decreased from 14,230 tonnes for the six-month period ended June 30, 2011 to 8,800 tonnes for the same period in 2012, a decrease of 38%. Also, as mentioned in our 2011 Form 10-K, we completed certain enhancements of our facilities during the second quarter of 2011 to pump brine water from deeper underground in order to improve the quality of brine water being extracted from our wells, which in turn increased the depreciation and amortization of the plant and equipment and hence the cost of net revenue of bromine. We expect that the average selling price and gross profit margin of bromine will remain at current level towards the end of 2012 should the PRC government’s macro-economic tightening policy remain in place.
 
 Crude salt segment
 For the six-month period ended June 30, 2012, the gross profit margin for our crude salt segment was 32% compared to 78% for the same period in 2011. This significant 46% decrease in our gross profit margin is attributable to (i) the increase in depreciation and amortization of manufacturing facilities as a result of the enhancement projects performed in late June 2011 to our crude fields, extraction wells and transmission channels and ducts as mentioned in our 2011 Form 10-K and (ii) the change in the estimated useful life of certain protective shells and transmission channels and ducts from 8 years to 5 years which accelerated the depreciation and amortization of the plant and machinery. For the six-month period ended June 30, 2012, the average selling price of crude salt amounted to $37.70 per tonne, as compared to $48.95 per tonne for the same period in 2011, a decrease of 23%. As previously mentioned, the decrease in gross profit was a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which decreased the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries.
 
 34
 Table of Contents
 
 Chemical products segment
 The gross profit margin for our chemical products segment for the six-month period ended June 30, 2012 was 30% compared to 35% for the same period in 2011, a decrease of 5%. As previously mentioned, the decrease in gross profit margin was a result of the decrease in demand for our oil and gas exploration additives and paper manufacturing additives which in turn reduced the sales volume of these chemical products. As sales of oil and gas exploration additives contributed more than 54% of our total chemical products segment’s net revenue, the decrease in demand largely reduced the gross profit margin of our chemical products segment. However, the selling price fluctuation of individual chemical products is not expected to have a significant impact on our gross profit margin for overall chemical products as our factory is capable of producing diversified chemical products, such as pesticides manufacturing additives with higher profit margin.
 
 Research and Development Costs. For the six-month periods ended June 30, 2012 and 2011, the total research and development costs incurred were $105,324 and $313,856, respectively, a decrease of 66%.
 
 Research and development costs for the six-month period ended June 30, 2012 represented raw materials used by SYCI for testing the manufacturing routine and samples of the new chemical products production line. Research and development costs for the six-month period ended June 30, 2011 were mostly related to the Co-Op Research and Development Center set up jointly with East China University of Science and Technology in June 2007 to develop new bromine-based chemical compounds and products to be utilized in the pharmaceutical industry, which amounted to $236,816. On June 7, 2011, SYCI and East China University of Science and Technology mutually agreed to terminate the Co-op Research Agreement due to the successful completion of the cooperative research and development tasks related to the development of bromine-related chemical products for us.
 
 Exploration cost. Exploration cost of $3,867,286 for the six-month period ended June 30, 2011 represented the drilling of exploratory wells and associated facilities by SCHC in Sichuan Province in order to confirm and measure the brine water resources in the province. We completed the drilling of the first exploratory well in December 2011 and announced in mid-January 2012 that we have discovered underground brine water resources in Daying County, and provided preliminary concentration results after the testing by a third-party independent testing expert. No further exploration cost was incurred for the six-month period ended June 30, 2012 as we are still discussing with the local government of Daying County of the form of cooperation to further explore the brine water resources.
 
 Write-off/Impairment on property, plant and equipment. Write-off on property, plant and equipment of $911,995 for the six-month period ended June 30, 2012 represented the write-off of certain protective shells to transmission pipelines and ducts replaced during the second phase enhancement project that started in May 2012. The write-off and impairment on property, plant and equipment for the six-month period ended June 30, 2011 represented (i) the write-off on property, plant and equipment that could not be relocated to the new Factory No. 4 in the amount of $1,384,443; (ii) the impairment loss on property, plant and equipment related to the conversion of our production line from wastewater treatment chemical additives to the production of pharmaceutical and agricultural chemical intermediates in the amount of $1,805,598; (iii) the impairment loss on property, plant and equipment under capital leases for idle plant and machinery in the amount of $683,046; and (iv) the write-off of certain crude salt field protective shells and transmission pipelines replaced during enhancement projects in the amounts of $1,632,004 and $2,065,475, respectively.
 
 General and Administrative Expenses. General and administrative expenses were $3,483,071 for the six-month period ended June 30, 2012, a decrease of $2,572,914 (or 42%) as compared to $6,055,985 for the same period in 2011. The significant decrease was primarily due to the inclusion of non-cash expenses of $3,169,000 for the six-month period ended June 30, 2011 related to options granted to our employees in the amount of $2,717,000, and a warrant issued to our investor relations firm in the amount of $452,000 resulting from the service agreement signed in February 2011. The non-cash expenses related to options granted for the six-month period ended June 30, 2012 amounted to $26,300.
 
 Other Operating Income. Other operating income, which represented the sales of wastewater to some of our customers, was $133,178 for the six-month period ended June 30, 2012. Wastewater is generated from the production of bromine and eventually becomes crude salt when it evaporates. Not all of our bromine production plants have sufficient area on the property to allow for evaporation of wastewater to produce crude salt. Certain of our customers who have facilities located adjacent to our bromine production plants have agreed to channel our wastewater into brine pans on their properties for evaporation. These customers then are able to sell the resulting crude salt themselves. We have signed agreements with three of our customers to sell them our wastewater at market prices. The other operating income for the six-month period ended June 30, 2011 represented (i) a sum of $115,083 for sales of wastewater and (ii) a sum of $300,000 for compensation received from a legal case.
  35
 Table of Contents
  Income from Operations. Income from operations was $12,210,302 for the six-month period ended June 30, 2012 (or 22.2% of net revenue), a decrease of $21,442,600, or approximately 64%, over income from operations for the same period in 2011. As mentioned hereinbefore, the decrease resulted primarily from the decrease in net revenue as a result of (i) the macro-economic tightening policy imposed by the PRC government to slow down the economy, which in turn decreased the demand and selling price of our products; and (ii) the increase in depreciation and amortization of the plant and machinery due to the enhancement projects in late June 2011 to our crude salt fields, extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years, which accelerated the depreciation and amortization of the plant and machinery.
 
 Income from Operations by SegmentSix-Month Period Ended

June 30, 2012

Six-Month Period Ended

June 30, 2011Segment:




% of total



% of totalBromine

$
6,401,865


49%

$
25,913,373


70%Crude Salt


1,437,005


11%


5,873,546


16%Chemical Products


5,250,276


40%


5,385,697


14%Income from operations before corporate costs


13,089,146


100%


37,172,616


100%Corporate costs


(878,844
)




(3,519,714
)Income from operations

$
12,210,302




$
33,652,902
 
 Bromine segment
 Income from operations from our bromine segment was $6,401,865 for the six-month period ended June 30, 2012, a decrease of $19,511,508 (or approximately 75%) compared to the same period in 2011. This significant decrease resulted primarily from the decrease in sales volume (contributed a decrease of approximately $21.7 million) and in average selling price (contributed a decrease of approximately $10.7 million) as a result of the PRC government’s macro-economic tightening policy which decreased the demand for bromine, which was partially offset by the decrease in (i) the cost of net revenue of bromine of approximately $6.9 million; (ii) exploration cost of approximately $3.4 million and (iii) write-off/impairment of property, plant and equipment of approximately $3.0 million.
 
 Crude salt segment
 For the six-month period ended June 30, 2012, income from operations from our crude salt segment was $1,437,005, a decrease of $4,436,541 (or approximately 76%) compared to the same period in 2011. This decrease was mainly due to (i) the decrease in both the average selling price and sales volume (contributed an aggregate decrease of approximately $5.0 million); and (ii) the decrease in the gross profit margin due to the enhancement projects which increased the depreciation of manufacturing facilities of approximately $1.7 million, which was partially offset by the decrease in (i) exploration cost of approximately $0.5 million and (ii) write-off/impairment of property, plant and equipment of approximately $1.9 million.
 
 Chemical products segment
 For the six-month period ended June 30, 2012, income from operations from our chemical products segment was $5,250,276, a decrease of $135,421 (or approximately 3%) over same period in 2011. This decrease resulted primarily from the decrease in net revenue of our wastewater treatment chemical additives, oil and gas exploration additives and paper manufacturing additives of approximately $6.8 million due to decreased demand, which was partially offset by (i) the increase in net revenue of our pesticides manufacturing additives of approximately $2.6 million, (ii) the decrease in cost of net revenue of approximately $1.8 million as explained hereinbefore and (iii) the decrease in write-off/impairment of property, plant and equipment of approximately $1.8 million.
 
 Other Income, Net. Other income, net represented bank interest income, net of capital lease interest expense.
 
 Net Income. Net income was $8,975,781 for the six-month period ended June 30, 2012, a decrease of $15,412,473 (or approximately 63%) compared to the same period in 2011. This decrease was primarily attributable to the overall decrease in demand for our products due to the macro-economic tightening policy imposed by the PRC government to slow down the economy.
 
 Effective Tax Rate. Our effective tax rate for the six-month periods ended June 30, 2012 and 2011 was 27% and 28%, respectively. The effective tax rate of 2% and 3%, respectively, differs from the PRC statutory income tax rate of 25%, which was due to the US federal net operating loss incurred by Gulf during both periods.
 
 36
 Table of Contents
 
 LIQUIDITY AND CAPITAL RESOURCES
 
 As of June 30, 2012, cash and cash equivalents were $72,044,771 as compared to $78,576,060 as of December 31, 2011. The components of this decrease of $6,531,289 are reflected below.
 
 Statement of Cash Flows
 
 Six-Month Period Ended June 30,2012


2011Net cash provided by operating activities

$
2,338,808


$
29,373,938Net cash used in investing activities

$
(8,294,007
)

$
(39,032,757
)Net cash used in financing activities

$
(297,598
)

$
(636,886
)Effects of exchange rate changes on cash and cash equivalents

$
(278,492
)

$
1,539,350Net decrease in cash and cash equivalents

$
(6,531,289
)

$
(8,756,355
)
 
 For the six-month period ended June 30, 2012, although our operations were affected by the PRC government’s macro-economic tightening policy, we met our working capital and capital investment requirements mainly by using cash flow from operations and cash on hand. The Company intends to continue to explore opportunities relating to bromine asset purchases and new bromine resource development.
 
 Net Cash Provided by Operating Activities
 
 During the six-month periods ended June 30, 2012 and 2011, we had positive cash flow from operating activities of $2.3 million and $29.4 million, respectively, primarily attributable to net income.
 
 During the six-month period ended June 30, 2012, net income of $9.0 million exceeded our cash flow from operating activities of $2.3 million, which was caused by (i) cash used in working capital of $19.1 million, which mainly consisted of increase in accounts receivable; which was partially offset by (ii) our net income, which included substantial non-cash charges of $12.5 million, mainly in the form of depreciation and amortization of property, plant and equipment, and write-off/impairment loss on property, plant and equipment.
 
 During the six-month period ended June 30, 2011, cash flow from operating activities of $29.4 million exceeded our net income of $24.4 million, which was caused by (i) cash used in working capital of $11.5 million, which mainly consisted of increased accounts receivable, as partially offset by the increase in accounts payable and the decrease in prepayment and deposits for cash provided by working capital; which was partially offset by (ii) our net income, which included substantial non-cash charges of $16.5 million, mainly in the form of stock-based compensation and depreciation and amortization of property, plant and equipment, and write-off/impairment loss on property, plant and equipment.
 
 Accounts receivable
 
 Cash collections on our accounts receivable had a major impact on our overall liquidity. The following table presents the aging analysis of our accounts receivable as of June 30, 2012 and December 31, 2011.
 
 June 30, 2012

December 31, 2011% of total





% of totalAged 1-30 days

$
9,423,014



23
%

$
7,411,018



34
%Aged 31-60 days

$
14,849,885



36
%

$
9,380,766



43
%Aged 61-90 days

$
10,322,620



25
%

$
5,128,044



23
%Aged over 90 days

$
6,701,839



16
%

$
-



-Total

$
41,297,358



100
%

$
21,919,828



100
%
 
 The overall accounts receivable balance as of June 30, 2012 increased by $19,377,530 (or 88%), as compared to those as of December 31, 2011. Such increase is mainly attributable to the extended settlement days by customers due to the macro-economic tightening policy imposed by PRC government to slow down the economy, which in turn lengthened the average turnover days of accounts receivable from customers from 48 days for the fiscal year 2011 to 103 days for the six-month period ended June 30, 2012. Normally, 90 to 120-days credit period is granted to customers with a good repayment history. We are not aware of any allowances for doubtful debts required for the six-month period ended June 30, 2012 as we have policies in place to ensure that sales are made to customers with an appropriate credit history. For the balances of accounts receivable as of June 30, 2012 aged more than 90 days, approximately 76% was settled in July 2012, and the remaining 24% is within the credit term granted to the customers. We perform ongoing credit evaluation on the financial condition of our customers.
 
 37
 Table of Contents
 
 Inventory
 
 Our inventory consists of the following:
  June 30, 2012

December 31, 2011% of total




% of totalRaw materials

$
780,747



19.7
%

$
848,596



19.1
%Finished goods

$
3,189,299



80.7
%

$
3,604,247



81.2
%$
3,970,046



100.4
%

$
4,452,843



100.3
%Allowance for obsolete and slowing-moving inventory

$
(14,814
)


(0.4
%)

$
(14,871
)


(0.3
%)Total

$
3,955,232



100.0
%

$
4,437,972



100.0
%
 
 The gross inventory level as of June 30, 2012 decreased by $482,797 (or 11%), as compared to the gross inventory level as of December 31, 2011.
 
 Raw materials slightly decreased by 8% as of June 30, 2012 as compared to December 31, 2011. All of the raw materials are basic chemical industry materials, few of which have a possibility of loss over time, or major fluctuations in their prices. So, we concluded that all of our raw materials as of June 30, 2012 are fully realizable for production of finished goods without any impairment.
 
 Our finished goods are mainly composed of bromine, crude salt and chemical products. Our chemical products are similar to raw materials, as there is no loss over time and a stable market price with a positive gross profit margin of 30% for the six-month period ended June 30, 2012 (31% for fiscal year 2011). Therefore, we believe that the realization of the chemical products is 100%. Similarly, as there is no depletion of bromine, we believe that the realization of it is also 100%. Although the gross profit margin for the six-month period ended June 30, 2012 decreased to 30%, as compared with 48% in fiscal year 2011, we anticipated that the price in the rest of 2012 will not fluctuate significantly to impair the cost of bromine.
 
 The annual loss of crude salt due to evaporation is around 3%. Although the market price of crude salt decreased from $50.09 per tonne in first quarter of 2011 to $37.52 in the second quarter of 2012, the gross margin is still attractive as the relative cost of production is low, we believe that there will be no realizability problem for crude salt and its selling price should not be lower than its cost.
 
 Net Cash Used in Investing Activities
 
 In the first half of 2012, we used approximately $0.4 million cash for the prepayment of land leases.
 
 In the second quarter of 2012, we used approximately $7.9 million cash to carry out the second phase enhancement project to our existing bromine extraction and crude salt production facilities, which are currently under construction since mid-May 2012. The total construction costs of the enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factory No. 1 to 9 are approximately $12.8 million and $8.1 million, respectively, which are expected to be completed by late August 2012.
 
 The above investing activities were financed by the opening cash balances as of December 31, 2011 and cash generated from operation during the six-month period ended June 30, 2012.
 
 Net Cash Used in Financing Activities
 
 We repaid approximately $0.3 million cash for our capital lease obligation for the six-month period ended June 30, 2012.
 
 We believe that our available funds and cash flows generated from operations will be sufficient to meet our anticipated ongoing operating needs for the next twelve (12) months. However we will likely need to raise additional capital in order to fund the ongoing program of acquiring unlicensed bromine properties, increasing our chemical production capacity and developing new bromine and crude salt production line in Sichuan Province, PRC. We expect to raise those funds through credit facilities obtained with lending institutions. There can be no guarantee that we will be able to obtain such funding, whether through the issuance of debt or equity, on terms satisfactory to management and our board of directors.
 
 Working capital was approximately $106.1 million at June 30, 2012 as compared to approximately $93.3 million at December 31, 2011. The increase was mainly attributable to the cash provided by operating activities and the increase in accounts receivable during the six-month period ended June 30, 2012.
 
 38
 Table of Contents
  We had available cash of approximately $72.0 million at June 30, 2012, most of which is in highly liquid current deposits which earn no or little interest. We intend to retain the cash for future expansion of our bromine and crude salt businesses through acquisition, enhancement works to our existing bromine and crude salt business, and exploration cost of new brine water resources in Sichuan Province, and we do not anticipate paying cash dividends in the foreseeable future.
 
 In the future we intend to focus our efforts on the activities of SCHC and SYCI as these segments continue to expand within the Chinese market. We also intend to explore the possibility of cooperation with overseas large-scale bromine manufacturers for expansion into overseas markets. As a result, we may issue additional shares of our capital stock and incur new debt in order to raise cash for acquisitions and other capital expenditures during the next twelve months.
 
 We may not be able to identify, successfully integrate or profitably manage any businesses or business segment we may acquire, or any expansion of our business. An expansion may involve a number of risks, including possible adverse effects on our operating results, diversion of management attention, inability to retain key personnel, risks associated with unanticipated events and the financial statement effect of potential impairment of acquired intangible assets, any of which could have a materially adverse effect on our condition and results of operations. In addition, if competition for acquisition candidates or operations were to increase, the cost of acquiring businesses could increase materially. We may effect an acquisition with a target business which may be financially unstable, under-managed, or in its early stages of development or growth. In addition, if competition for acquisition candidates or operations were to increase, the cost of acquiring businesses could increase materially. Our inability to implement and manage our expansion strategy successfully may have a material adverse effect on our business and future prospects.
 
 Contractual Obligations and Commitments
 
 We have no significant contractual obligations not fully recorded on our condensed consolidated balance sheets or fully disclosed in the notes to our condensed consolidated financial statements. Additional information regarding our contractual obligations and commitments at June 30, 2012 is provided in the notes to our condensed consolidated financial statements. See “Notes to Condensed Consolidated Financial Statements, Note 19 – Capital Commitment and Operating Lease Commitments”.
 
 Material Off-Balance Sheet Arrangements
 
 We do not currently have any off balance sheet arrangements falling within the definition of Item 303(a) of Regulation S-K.
 
 Critical Accounting Policies and Estimates
 
 Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and this requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ significantly from these estimates under different assumptions or conditions. We have identified the following critical accounting policies and estimates used by us in the preparation of our financial statements: accounts receivable and allowance for doubtful accounts, assets retirement obligation, property, plant and equipment, recoverability of long lived assets, mineral rights, revenue recognition, income taxes, and stock-based compensation. These policies and estimates are described in the Company’s 2011 Form 10-K.
 
 Impact of Inflation
 
 Inflationary factors, such as increases in the cost of our product and overhead costs, may adversely affect our operating results. Based on the Consumer Price Index (“CPI Index”) in the PRC, the average annual rate of inflation over the three-year period from 2008 to 2010 was 2.8%. Inflationary pressures increased in 2011, reflecting the rise in our cost of raw materials and electricity expenses. According to the latest available published CPI Index in May 2012, the rate of inflation was 3.0%. We believe that in the long run the selling prices of its products could be increased at a similar level to compensate the adverse effect. In the foreseeable future, a high rate of inflation may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
 There have been no material changes in market risk from the information provided in “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” of the Company’s 2011 Annual Report on Form 10-K.


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  Item 4. Controls and Procedures
 
 (a) Evaluation of Disclosure Controls and Procedures
 
 We maintain disclosure controls and procedures (as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, regulations and related forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.
 
 Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this Form 10-Q. The material deficiency in our disclosure controls and procedures as of June 30, 2012 was as follows:
 
 ●
We are unable to provide the required Schedule I parent only financial statement audited data for fiscal years 2009 and 2010 to be included in our Annual Report on Form 10-K for the year ended December 31, 2011.
  We anticipate that such material deficiency will be resolved within a two-year period when the Schedule I audited data for three fiscal years are available pursuant to the audit work of our current independent accountant.
 
 (b) Changes in internal controls
 
 There have been no changes in our internal control over financial reporting during the three-month period ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 PART II—OTHER INFORMATION
 
 Item 1. Legal Proceedings
 
 We are not a party to any legal proceedings other than the following.
 
 Class Action
 
 The Company and certain of its officers and directors (Ming Yang, Xiaobin Liu, and Min Li, collectively, the Individual Defendants”) have been named as defendants in a putative securities class action lawsuit alleging violations of the federal securities laws.  That action, which is now captionedLewy, et al. v. Gulf Resources, Inc., et al., No. 11-cv-3722 ODW (MRWx), was filed on April 29, 2011 in the United States District Court for the Central District of California.  The lead plaintiffs, who seek to represent a class of all purchasers and acquirers of the Company’s common stock between March 16, 2009 and April 26, 2011 inclusive, filed an amended complaint on September 12, 2011.  Lead plaintiffs assert claims for violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder.  The amended complaint alleges the defendants made false or misleading statements in the Company’s Annual Reports on Form 10-K for the years ended December 31, 2008, 2009, and 2010, and in interim quarterly reports by, among other things, overstating revenue and net income and failing to disclose material related party transactions and certain facts about the CEO’s prior employment at another company.  The amended complaint also asserts claims against the Individual Defendants for violations of Section 20(a) of the Securities Exchange Act of 1934. The amended complaint seeks damages in an unspecified amount. On November 7, 2011, the Company filed a motion to dismiss the amended complaint. On May 15, 2012, the Court denied the Company’s motion to dismiss the amended complaint. The parties are required to submit a joint report concerning scheduling and other issues on July 30, 2012, in accordance with Federal Rules of Civil Procedure 16 and 26(f). The Court has also set a scheduling conference for August 12, 2012.  The Company intends to defend vigorously against the lawsuit.  The Company currently cannot estimate the amount or range of possible losses from this litigation.


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 Item 1A. Risk Factors
 
 There have been no changes with respect to risk factors as previously disclosed in our 2011 Form 10-K.  Investing in our common stock involves a high degree of risk. Before you invest you should carefully consider the risks and uncertainties described below and in our 2011 Form 10-K, under the caption “Risk Factors”, our Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 2 of Part I of this Quarterly Report on Form 10-Q, our consolidated financial statements and related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and our consolidated financial statements and related notes, as well as our Management’s Discussion and Analysis of Financial Condition and Results of Operations and the other information in our 2011 Form 10-K. Readers should carefully review those risks, as well as additional risks described in other documents we file from time to time with the Securities and Exchange Commission.
 
 Item 2. Unregistered Shares of Equity Securities and Use of Proceeds
 
 None.
 
 Item 3. Defaults Upon Senior Securities
 
 None.
 
 Item 4. Mine Safety Disclosures
 
 No applicable.
 
 Item 5. Other Information
 
 None.
 
 Item 6. Exhibits
 
 Exhibit No.
Description31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 32.1
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 101.1
The following financial statements from Gulf Resources, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations and Other Comprehensive Income (Loss); (iii) the Consolidated Statements of Changes in Equity; (iv) the Consolidated Statement of Cash Flows; and, (v) the Notes to Consolidated Financial Statements, tagged as blocks of text.
 
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  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 9, 2012
By:
/s/ Xiaobin LiuXiaobin LiuChief Executive Officer(principal executive officer)Dated: August 9, 2012
By:
/s/ Min LiMin LiChief Financial Officer(principal financial and accounting officer)
 
 
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