GULF RESOURCES, INC. 10-Q

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. 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. Overview We are a Nevada holding company which conducts operations through our wholly-owned China-based subsidiaries. Our business is conducted and reported in four segments, namely, bromine, crude salt, chemical products and natural gas. Through our wholly-owned subsidiary, SCHC, we produce and trade 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 bromine compounds used in industry and agriculture. Bromine also is used to form intermediary chemical compounds such as Tetramethylbenzidine. Bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines and disinfectants. Crude salt is the principal material in alkali production as well as chlorine alkali production and is widely used in the chemical, food and beverage, and other industries. Through our wholly-owned subsidiary, SYCI, we manufacture and sell chemical products used in oil and gas field exploration, oil and gas distribution, oil field drilling, papermaking chemical agents, inorganic chemicals and materials that are used for human and animal antibiotics. Our wholly-owned subsidiary, DCHC, was established to explore and develop natural gas and brine resources (including bromine and crude salt) in Sichuan Province, China. As disclosed in the Company’s Current Report on Form 8-K filed on September 8, 2017, the Company received, on September 1, 2017, letters from the Yangkou County, Shouguang City government addressed to each of its subsidiaries, SCHC and SYCI, which stated that in an effort to improve the safety and environmental protection management level of chemical enterprises, the plants are requested to immediately stop production and perform rectification and improvements in accordance with the country’s new safety and environmental protection requirements. In the Company’s press release of August 11, 2017 and on its conference call of August 14, 2017, the Company addressed concerns that increased government enforcement of stringent environmental rules that were adopted in early 2017 to insure corporations bring their facilities up to necessary standards so that pollution and other negative environmental issues are limited and remediated, could have an impact on our business in both the short and long-term. The Company also expressed that although it believed its facilities were fully compliant at the time, the Company did not know how its facilities would fare under the new rules. Teams of inspectors from the government were sent to many provinces to inspect all mining and manufacturing facilities. The local government requested that facilities be closed, so that the facilities could undergo the inspection and analysis in the most efficient manner by inspectors’ team. As a result, our facilities were closed on September 1, 2017. The Company believes that this is another step by the government to improve the environment. It further believes the goal of the government is not to close all plants, but rather to codify the regulations related to project approval, land use, planning approval and environmental protection assessment approval so that illegal plants are not able to open in the future and so that plants close to population centers do not cause serious environmental damage. In addition, the Company believes that the Shandong provincial government wants to assure that each of its regional and county governments has applied the Notice in a consistent manner. The Shouguang City Bromine Association, on behalf of all the bromine plants in Shouguang, started discussions with the local government agencies. The local governmental agencies confirmed the facts that their initial requirements for the bromine industry did not include the project approval, the planning approval and the land use rights approval and that those three additional approvals were new requirements of the provincial government. The Company understood from the local government that it has been coordinating with several government agencies to solve these three outstanding approval issues in a timely manner and that all the affected bromine plants willnot be allowed to commence production prior to obtaining those approvals. In February 2019, the Company received a notification from the local government of Yangkou County that its Factory No. 1, No.4, No. 7 and No. 9 had passed inspection and could resume operations. In April 2019, Factory No. 1 and No. 7 resumed operations. On February 28, 2020, the Company announced that it received an approval from the government to resume bromine production after winter temporary closure. Subsequently, it received another approval from the Shouguang Yangkou People’s Government dated on March 5, 2020 to resume production at its bromine factories No.1, No. 4, No.7 and No. 9 in order to meet the needs of bromide products for epidemic prevention and control. With these two approvals, the Company was allowed to resume production at all four bromine factories. The Company received an oral notification from the government for its Factory No. 8, which permitted Factory No.8 to resume production in August 2022. Factory No.8 started to contribute revenue in the fourth quarter 2022. Pursuant to the notification from the government of Shouguang City, all bromine facilities in Shouguang City were temporarily closed from December 10, 2022 until February 1, 2023 8:00 AM China Time. To comply with such notification, the Company had temporarily stopped production at its bromine facilities during the aforesaid period and reopened the operating bromine and crude salt factories in February 2023. The Company is still waiting for governmental approval for factories No.2 and No.10. To the Company’s knowledge, the government is currently completing its planning process for all mining areas including that for prevention of flood. As a result, the Company may be required to make some modifications to our current wells and aqueducts prior to commencement of operations of these factories to satisfy the local government's requirements. On November 24, 2017, Gulf Resources received a letter from the People’s Government of Yangkou County, Shouguang City notifying the Company that due to the new standards and regulations relating to safety production and environmental pollution, from certain local governmental departments, such as the municipal environmental protection department, the security supervision department and the fire department, its chemical enterprises would have to be relocated to a new industrial park called Bohai Marine Fine Chemical Industry Park. Although our chemical companies were in compliance with regulations, they were also close to a residential area. As a result, the government determined we should relocate to the Bohai park. Chemical companies that are not being asked to move into the park are being permanently closed. Since our factories closed, the Company has secured from the government the land use rights for its chemical plant. On January 6, 2020, the Company received the environmental protection approval by the government of Shouguang City, Shandong Province for the proposed Yuxin Chemical factory. The Company began the construction on its new chemical facilities located at Bohai Marine Fine Chemical Industrial Park in June 2020. The construction was expected to take approximately one year and an additional six months to complete the equipment installation and testing, however due to the COVID epidemic and utility restrictions, the opening of the chemical factory has been delayed. The Company has received the refrigeration and air compressor units. The rest equipment is expected to be delivered by the second quarter or the third quarter of 2023. In January 2017, the Company completed the first brine water and natural gas well field construction in Daying located in Sichuan Province and commenced trial production in January 2019. On May 29, 2019, the Company received a verbal notice from the government of Tianbao Town,Daying County, Sichuan Province, whereby the Company is required to obtain project approval for its well located in Daying, including the whole natural gas and brine water project, and approvals for safety production inspection, environmental protection assessment, and to solve the related land issue. Until these approvals have been received, the Company has to temporarily halt trial production at its natural gas well in Daying. In compliance with the Chinese government new policies, the Company is also required to obtain an exploration license and a mining license for bromine and natural gas, respectively. Pursuant to the Opinions of the Ministry of Natural Resources on Several Issues in Promoting the Reform of Mineral Resources Management (Trial) promulgated by the Ministry of Natural Resources of PRC on January 9, 2020, which came into effect on May 1, 2020, privately owned enterprises are allowed to participate in the natural gas production. The Company plans to proceed with its applications for the natural gas and brine project approvals with related government departments after the government has finalized the land and resource planning for Sichuan Province. In April 2022, Shouguang Hengde Salt Industry Co. Ltd（“SHSI”）, our subsidiary, was incorporated in Shandong Province, China, for crude salt production and trading. On January 28, 2020 we completed a 1-for-5 reverse stock split of our common stock, such that for each five 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. 18 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, SYCI, SHSI and DCHC. The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto appearing elsewhere in this report. RESULTS OF OPERATIONS The following table presents certain information derived from the condensed consolidated statements of income, cash flows and stockholders’ equity for the three-month periods ended March 31, 2023 and 2022. Comparison of the Three-Month Periods Ended March 31, 2023 and 2022 Three-Month Period Ended March 31, 2023 Three-Month Period Ended March 31, 2022 Percent Change Increase/ (Decrease) Net revenue $ 9,302,007 $ 8,930,737 4 % Cost of net revenue $ (6,769,074 ) $ (4,549,968 ) 49 % Gross profit (loss) $ 2,532,933 $ 4,380,769 (42 %) Sales, marketing and other operating expenses $ (13,704 ) $ (10,360 ) 32 % Direct labor and factory overheads incurred during plant shutdown $ (2,408,736 ) (2,184,591 ) 10 % Other operating expense $ — (8,404 ) — General and administrative expenses $ (910,051 ) $ (2,242,501 ) (59 %) Loss from operations $ (799,558 ) $ (65,087 ) 1128 % Other income, net $ 41,255 $ 40,836 1 % Loss before taxes $ (758,303 ) $ (24,251 ) 3027 % Income tax benefit $ 200,556 $ (95,695 ) 310 % Net loss $ (557,747 ) $ (119,946 ) 365 % Net revenue The table below shows the changes in net revenue in the respective segment of the Company for the three-month period ended March 31, 2023 compared to the same period in 2022: Net Revenue by Segment Three-Month Period Ended Three-Month Period Ended Percent Change March 31, 2023 March 31, 2022 Increase Segment % of total % of total Bromine $ 8,470,372 91 % $ 8,126,015 91 % 4 % Crude Salt $ 748,681 8 % $ 754,044 8 % (1 %) Chemical Products $ — — $ — — — Natural Gas $ 82,954 1 % $ 50,678 1 % 64 % Total sales $ 9,302,007 100 % $ 8,930,737 100 % 4 % Three-Month Period Ended Percentage Change Bromine and crude salt segments product sold in tonnes March 31, 2023 March 31, 2022 Increase Bromine (excluded volume sold to SYCI) 2,020 1,005 101 % Crude Salt 20,360 15,460 32 % Bromine segment For the three-month periods ended March 31, 2023 and 2022, the net revenue for the bromine segment was $8,470,372 and $8,126,015. This increase was due to the 101% increase in tonnes sold and a 48% decrease in average selling price. Crude salt segment For the three-month periods ended March 31, 2023 and 2022, the net revenue for the crude salt was $748,681 and $754,044. This increase was due to the 32% increase in tonnes sold and a 25% decrease in average selling price. Chemical products segment For the three-month periods ended March 31, 2023 and 2022, the net revenue for the chemical products segment was $0 due to the closure of our chemical factories since September 1, 2017. 19 Natural gas segment For the three-month period ended March 31, 2023 and 2022, the net revenue for the natural gas production was $0. Equipment Lease For the three-month period ended March 31, 2023 and 2022, the net revenue for the equipment lease was $82,954 and $50,678. Cost of Net Revenue Cost of Net Revenue by Segment Percent Change Three-Month Period Ended Three-Month Period Ended of Cost of March 31, 2023 March 31, 2022 Net Revenue Segment % of total % of total Bromine $ 6,148,443 90.8 % $ 3,920,325 86.1 % 57 % Crude Salt $ 620,258 9.2 % $ 629,560 13.8 % (1.5 %) Chemical Products $ — — $ — — — Natural Gas $ 373 — $ 83 0.1 — Total $ 6,769,074 100 % $ 4,549,968 100 % 49 % Cost of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $6,769,074 for the three-month period ended March 31, 2023, an increase of $2,219,106 (or 49%) as compared to the same period in 2022 due to the increase of net revenue by 4% and the decline in the selling price for bromine and crude salt for the three-month period ended March 31, 2023 as compared to the same period in 2022. In May 2022, we separated the bromine and the crude salt business to conform with government regulations. This separation required different allocation of costs. The net impact was to increase the cost allocations to bromine and decrease the cost allocations to crude salt. Bromine production capacity and utilization of our factories The table below represents the annual capacity and utilization ratios for all of our bromine producing properties: Annual Production Capacity (in tonnes) Utilization Ratio (i) Three-month period ended March 31, 2022 31,506 — 19 % Three-month period ended March 31, 2023 31,506 — 39 % Variance of the three-month periods ended March 31, 2023and 2022 — 20 % (i) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the periods divided by the annual production capacity in tonnes. 20 Bromine segment For the three-month period ended March 31, 2023 the cost of net revenue for the bromine segment was $6,148,443. For the three-month period ended March 31, 2022 the cost of net revenue for the bromine segment was $3,920,325. Crude salt segment For the three-month period ended March 31, 2023 the cost of net revenue for the crude salt segment was $620,258. For the three-month period ended March 31, 2022 the cost of net revenue for the crude salt segment was $629,560. Chemical products segment Cost of net revenue for our chemical products segment for the three-month period ended March 31, 2023 and 2022 was $0. Natural gas segment Cost of net revenue for our natural gas segment for the three-month period ended March 31, 2023 and 2022 was $373 and $83. Gross Profit (Loss) Gross profit was $2,532,933, or 27%, of net revenue for three-month period ended March 31, 2023 compared to $4,380,769, or 49% of net revenue for three-month period ended March 31, 2022. Gross Profit (Loss) by Segment % Point Change Three-Month Period Ended Three-Month Period Ended of Gross March 31, 2023 March 31, 2022 Profit (Loss) Margin Segment Gross Profit Margin Gross Profit Margin Bromine $ 2,321,929 27 % $ 4,205,690 52 % (25 %) Crude Salt $ 128,423 17 % $ 124,484 17 % — Chemical Products $ — — $ — — — Natural Gas $ 82,581 100 % 50,595 99 1 % Total Gross Profit (Loss) $ 2,532,933 27 % $ 4,380,769 49 % (22 %) Bromine segment For the three-month period ended March 31, 2023, the gross profit margin for our bromine segment was 27%, compared to 52% in the three-month period ended March 31, 2022. The decrease in gross profit margin was primarily attributable to the lower average selling price of bromine of $4,193 per ton in the three-month period ended March 31, 2023 compared to $8,082 per ton in the three-month period ended March 31, 2022. For the three-month period ended March 31, 2022, the gross loss margin for our bromine segment was 52%. Crude salt segmen t For the three-month period ended March 31, 2023, the gross profit margin for our crude salt segment was 17%, compared to (17%) in three-month period ended March 31, 2022.This decrease was primarily attributable to the lower average selling price of crude salt of $37 per ton in three-month period ended March 31, 2023 compared to $49 per ton in three-month period ended March 31, 2022. For the three-month period ended March 31, 2022, the gross loss margin for our crude salt segment was 17%. Direct labor and factory overheads incurred during plant shutdown On September 1, 2017, the Company received notification from the government of Yangkou County, Shouguang City of PRC that stated that production at all its bromine and crude salt and chemical factories should be halted with immediate effect in order for the Company to perform rectification and improvement in accordance with the county’s new safety and environmental protection requirements. On November 24, 2017, the Company received a letter from the Government of Yangkou County, Shouguang City notifying the Company to relocate its two chemical production plants located in the second living area of the Qinghe Oil Extraction Plant to Bohai Park. As a result, direct labor and factory overhead costs (including depreciation of plant and machinery) in the amount of $2,408,736 and $2,184,591 incurred for the three-month periods ended March 31, 2023 and 2022, respectively, of factories that have not resumed production were presented as part of the operating expense. 21 General and Administrative Expenses General and administrative expenses were $910,051 for the three-month period ended March 31, 2023, an decrease of $1,332,450 (or 59%) as compared to $2,242,501 for the same period in 2022. The decrease was mainly due to the unrealized foreign currency transaction loss on intercompany balance recorded in three-month period ended March 31, 2023 compared to an unrealized foreign currency transaction gain on intercompany balance recorded in the same period in the previous year. Loss from Operations Loss from operations was $799,558 the three-month period ended March 31, 2023, compared to loss from operation of $65,087 in the same period in 2022. Loss from Operations by Segment Three-Month Period Ended March 31, 2023 Three-Month Period Ended March 31, 2022 Segment: % of total % of total Bromine $ (409,692 ) 53 % $ 1,348,834 470 % Crude Salt 42,930 (6 %) (521,921 ) (182 % Chemical Products (417,873 ) 54 % (513,282 ) (179 % Natural Gas 12,685 (1 %) (26,739 ) (9 %) Loss from operations before corporate costs (771,950 ) 100 % 286,892 100 % Corporate cost (59,960 ) (68,190 ) Unrealized gain (loss) on translation of intercompany balance 32,352 (283,789 ) Loss from operations $ (799,558 ) $ (65,087 ) Bromine segment Loss from operations from our bromine segment was $409,692 for the three-month period ended March 31, 2023, compared to income from operations of $1,348,834 in the same period in 2022. This decrease was due to the 101% increase in tonnes sold and a 48% decrease in average selling price as well as higher cost allocations due to the split off of our salt subsidiary in May 2022. Crude salt segment Income from operations from our crude salt segment was $42,930 for the three-month period ended March 31, 2023, compared to loss from operations of $521,921 in the same period in 2022, primarily due to the lower cost allocations due to the split off of our salt subsidiary in May 2022. Chemical products segment Loss from operations from our chemical products segment was $417,873 for the three-month period ended March 31, 2023, compared to loss from operations of $513,282 in the same period in 2022. Natural gas segment Income from operations from our natural gas segment was $12,685 for the three -month period ended March 31, 2023, compared to a loss of $26,739 in the same period in 2022. 22 Other Income Net Other income, net of $41,255 represented bank interest income, net of finance lease interest expense for the three -month period ended March 31, 2023, an increase of $419 (or approximately 1%) as compared to the same period in 2022. Net Loss Net loss was $557,747 for the three-month period ended March 31, 2023, compared to a net loss of $119,946 in the same period in 2022. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2023, cash and cash equivalents were $115,771,833 as compared to $108,226,214 as of December 31, 2022. The components of this increase of $7,545,619 are reflected below. Statement of Cash Flows Three-Month Period Ended March 31, 2023 2022 Net cash provided by operating activities $ 4,831,553 $ 8,445,682 Net cash used in investing activities $ (32,742 ) $ (395,060 ) Effects of exchange rate changes on cash and cash equivalents $ 2,746,808 $ 1,844,114 Net increase(decrease) in cash and cash equivalents $ 7,545,619 $ 9,894,736 For the three-month period ended March 31, 2023, we met our working capital and capital investment requirements mainly by using cash on hand. Net Cash Provided by Operating Activities During the three -month period ended March 31, 2023, cash flow provided by operating activities of approximately $4.8 million was mainly due to a net loss of $0.56 million, a decrease in accounts receivable of $0.2 million, a decrease in accounts payable of $0.8 million, an increase in deferred taxes of $0.2 million, and a non-cash adjustment related to depreciation and amortization of property, plant and equipment of $5.36 million, offset by increases in operating leases, and prepayments. During the three -month period ended March 31, 2022, cash flow provided by operating activities of approximately $8.4 million was mainly due to a decrease in accounts receivable of $3.5 million, and a non-cash adjustment related to depreciation and amortization of property, plant and equipment, reduced by a net loss of $0.12 million and an adjustment for income tax benefit of $0.1 million. 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 March 31, 2023 and December 31, 2022. March 31, 2023 December 31, 2022 % of total % of total Aged 1-30 days $ 5,223,995 99,98 % $ 2,792,156 52 % Aged 31-60 days 535 0.02 % 2,571,010 48 % Aged 61-90 days — — — — Aged 91-120 days — — — — Aged 121-150 days — — — — Aged 151-180 days — — — — Aged 181-210 days — — — — Aged 211-240 days — — — — Total $ 5,224,530 100 % $ 5,363,166 100 % The overall accounts receivable balance as of March 31, 2023 decreased by $138,636, as compared to those of December 31, 2022. We have policies in place to ensure that sales are made to customers with an appropriate credit history. We perform ongoing credit evaluation on the financial condition of our customers. No allowance for doubtful accounts for the three-month period ended March 31, 2023 is required. 23 Inventory Our inventory consists of the following: March 31, 2023 December 31, 2022 % of total % of total Raw materials $ 28,933 5 % $ 26,192 2 % Finished goods 559,076 95 % 1,572,380 98 % Total $ 588,009 100 % $ 1,598,572 100 % The net inventory level as of March 31, 2023 decreased by $1,010,563 (or 63%), as compared to the net inventory level as of December 31, 2022. Raw materials increased by $2,741 as of March 31, 2023 as compared to December 31, 2022. Our finished goods decreased by $1,013,304 as of March 31, 2023 as compared to December 31, 2022. Net Cash Used in Investing Activities For the three-month period ended March 31, 2023, we used approximately $0.04 million to acquire property, plant and equipment. For the three-month period ended March 31, 2022, we used approximately $0.4 million to acquire property, plant and equipment. Net Cash Used in Financing Activities We have no financing activities for the three-month periods ended March 31, 2023 and 2022. We believe that our available funds and cash flows generated from operations will be sufficient to meet our anticipated ongoing operating needs and our obligations as they full due in the next twelve (12) months. We had available cash of approximately $115.8 million at March 31, 2023, most of which is in highly liquid current deposits which earn no or little interest. We do not anticipate paying cash dividends in the foreseeable future. We intend to continue to focus our efforts on the activities of SCHC, SYCI, SHSI and DCHC as these segments continue to expand within the Chinese market. 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’s attention, inability to retain key personnel, risks associated with unanticipated events, risks associated with the COVID-19 pandemic 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. Our inability to implement and manage our expansion strategy successfully may have a material adverse effect on our business and future prospects. 24 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 March 31, 2023 is provided in the notes to our condensed consolidated financial statements. See “Notes to Condensed Consolidated Financial Statements, Note 18– Capital Commitment and Other Service Contractual Obligations”. Material Off-Balance Sheet Arrangements We do not currently have any off -balance sheet arrangements falling within the definition of Item 303(a) of Regulation S-K. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and this requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We base its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ significantly from these estimates under different assumptions or conditions. We have identified the following critical accounting policies and estimates used by us in the preparation of our financial statements: accounts receivable and allowance for doubtful accounts, inventories and allowance for obsolescence, assets retirement obligation, property, plant and equipment, recoverability of long-lived assets, mineral rights, leases, revenue recognition, income taxes, and loss contingencies. These policies and estimates are described in the Company’s Form 10-Q for the three months ended March 31, 2023. Item 3. Quantitative and Qualitative Disclosures About Market Risk Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1).