Gulf Resources, Inc.: Form 10-Q for the period ended Sep 30, 2018

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 2017 Form 10-K, as amended. 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 2017 Form 10-K, as amended, and Item 1A, “Risk Factors” for the year ended December 31, 2017.

Overview

We are a 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.

On September 1, 2017, the Company received notification from the Government of Yangkou County, Shouguang City of PRC that production at all its 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. 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, the Company did not know how its facilities would fare under the new rules and that the Company expected to have a full understanding of the implications within the next two months. 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 can undergo the inspection and analysis in the most efficient manner by inspectors’ team. As a result, our facilities were closed on September 1, 2017.

Subsequently, the Safety Supervision and Administration Department and the Environmental Protection Departments of the local government conducted inspections of every bromine production enterprise within its jurisdiction, in order to improve security, environmental protections, pollution, and safety. The Company had been working closely with the County authorities to develop rectification plans for both its bromine and its chemical businesses. The Company and the government agreed on a rectification plan in October 2017 for SCHC, the Company’s bromine and crude salt businesses which is currently under rectification process.

Originally, six bromine factories completed their rectification process within factory areas (i.e. excluding crude salt field area) and were approved and scheduled for production commencement by April 2018 as verbally indicated by the local government. Subsequently, the Shandong Provincial government required the local government to conduct “four rating and one comprehensive evaluation” for all of the chemical companies within its jurisdiction. This has delayed the production commencement schedule of the six bromine and crude salt factories. As of the date of this report, the Company has not received any official approval from the government.

Subsequently on June 29 2018, the Company received a formal notice (dated June 25, 2018) jointly issued by various provincial government agencies in Shandong Province (the “Notice”) forwarded by the Weifang City Special Operations Leading Group Office of Safe Production, Transformation and Upgrading of Chemical Industry. In the Notice, the provincial government agencies set forth further requirements and procedures covering the following four aspects for the chemical industrial enterprises: project approval, planning approval, land use rights approval and environmental protection assessment approval. Those standards and procedures apply to all chemical industrial enterprises in Shandong Province including the Company’s bromine plants that have not completed project approval procedures, planning approval procedures, land use rights approval procedures and environmental protection assessment procedures. The Company believes that the government will not grant approval to the Company to allow its bromine and crude salt plants to resume operations until the Company has fully complied with the aforesaid rules set forth in the Notice.

The Shouguang City Bromine Association, on behalf of all the bromine plants in Shouguang, has 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 are not allowed to commence production prior to obtaining those approvals.

The Company is not certain how long the temporary delay will be due to the issuance and implement of the Notice. 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.

On September 21, 2018, the Company received a closing notice from the People's Government of Yangkou Town, Shouguang City informing it to close its three bromine factories (Number 3, Number 4, and Number 11.). The crude salt fields surrounding these factories have been reclaimed as cultivated or construction land and hence did not meet the requirement for bromine and crude salt co-production set by the relevant authority. In closing these factories, the Company wrote off net book value of these factories’ property, plant and equipment in the amount of $18,644,473 in the loss on demolition of factory in the condensed consolidated statements of income for the three and nine-month periods ended September 30, 2018, recorded an impairment loss on the related mineral rights of these three factories of $1,284,832 in the condensed consolidated statements of income for the three and nine-month periods ended September 30, 2018 and wrote off $52,926 of prepaid land lease recorded in other operating loss in the condensed consolidated statements of income for the three and nine-month periods ended September 30, 2018. The Company estimated the dismantling fees to be approximately $0.29 million. The Company will negotiate with the local villages over compensation for the payment already made for these land leases and mineral rights in the past. However, the Company is uncertain of the amount that it could recover and the timing when this would be accomplished.

The Company believes the issues related to crude salt and bromine at the remaining factories are almost resolved. While it still needs approvals for project approval, planning approval, land use rights approval and environmental protection assessment approval, the local government is actively working with us. Six of our factories previously passed inspections.

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 the Bohai Marine Fine Chemical Industrial Park (“Bohai Park”). This is because the two plants are located in a residential area and their production activities will impact the living environment of the residents. This is as a result of the country’s effort to improve the development of the chemical industry, manage safe production and curb environmental pollution accidents effectively, and ensure the quality of the living environment of residents. All chemical enterprises which do not comply with the requirements of the safety and environmental protection regulations will be ordered to shut down. The Company believes this relocation process will cost approximately $60 million in total. The Company incurred relocation cost in the amount of $10,925,081 and $9,732,118 as of September 30, 2018 and December 31, 2017 and estimated that the new factory will be fully operational by the beginning of 2020.

The Company does not anticipate that the Company’s new chemical factory will be significantly impacted by the Notice. The Company has secured from the government the land use rights for its chemical plants located at the Bohai Marine Fine Chemical Industry Park and presented a completed construction design draft and other related documents to the local authorities for approval. The Company expected to receive feedback from the local authorities. However, the Company does believe there could be a delay for the approval process given the ongoing rectification and approvals process for the Company’s other plants.

In January 2017, the Company completed the first brine water and natural gas well field construction in Sichuan Province and announced the commencement of trial production. The Company has been working with Xinan Shiyou Daxue (Southwest Petroleum University) and developed a solution to DHCH’s technical drilling problem. In resolving the problem, the Company purchased customized equipment for its natural gas project. The installation of such equipment, including providing piping and electricity, was completed in July 2018. The Company is preparing to test the equipment and anticipates to begin the trial production in the fourth quarter of 2018.

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 and DCHC. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.

RESULTS OF OPERATIONS

The following table presents certain information derived from the condensed consolidated statements of income for the three-month and nine-month periods ended September 30, 2018 and 2017.

Comparison of the Three-Month Period Ended September 30, 2018 and 2017

Net revenue. The table below shows the changes in net revenue in the respective segment of the Company for the three-month period ended September, 2018 compared to the same period in 2017:

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Bromine segment

For the three-month period ended September 30, 2018, the net revenue for the bromine segment was $0 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All bromine goods in the inventory were sold as of December 31, 2017.

The decrease in net revenue from our crude salt segment was due to the decrease in the sales volume of crude salt. The sales volume of crude salt decreased by 86% from 64,362 tonnes for the three-month period ended September 30, 2017 to 8,828 tonnes for the same period in 2018. This decrease was primarily attributable to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. As a result, there was limited crude salt for sale for the three-month period ended September 30, 2018.

The average selling price of crude salt increased by 22% from $31.92 per tonne for the three-month period ended September 30, 2017 to $38.86 per tonne for the same period in 2018.

The table below shows the changes in the average selling price and changes in the sales volume of crude salt for three-month period ended September 30, 2018 from the same period in 2017.

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Chemical products segment

For the three-month period ended September 30, 2018, the net revenue for the chemical products was $0 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All chemical products inventories were sold as of June 30, 2018.

Cost of Net Revenue.

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 $68,456 for the three-month period ended September 30, 2018, a decrease of $1,033,604 (or 94%) as compared to the same period in 2017. The decrease is because there is no production and all costs related to direct labor costs and factory overheads were classified in operating expense. See commentary on these costs incurred during plant shutdown in page 28.

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:

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

Our annual production capacity decreased 11,302 in tones for the three-month period ended September 30, 2018 as compared to the same period in 2017 due to the permanent closure of Factory No.3, 4 and 11. See Note 1 (b) in the Notes to the Condensed Financial Statement.

Our utilization ratio was 0% for the three-month period ended Septmeber 30, 2018 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017.

Bromine segment

For the three-month period ended Septmeber 30, 2018, the cost of net revenue for the bromine segment was $0 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All bromine goods in the inventory were sold as of December 31, 2017. As a result, there was no bromine for sale for the three-month period ended September 30, 2018.

The cost of net revenue for our crude salt segment for the three-month period ended September 30, 2018 was $68,456, representing a decrease of $1,033,604, or 94%, compared to $1,102,060 for the same period in 2017. This was primarily attributable to lower volume of crude salt sold in the three-month period ended September 30, 2018 compared to the same period in 2017.

Chemical products segment

For the three-month period ended September 30, 2018, the cost of net revenue for the chemical products segment was $0 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All chemical products inventories were sold as of June 30, 2018. As a result, there were no chemical products for sale for the three-month period ended September 30, 2018.

Gross Profit. Gross profit was $274,624 or 80%, of net revenue for three-month period ended September 30, 2018 compared to $9,321,952, or 39%, of net revenue for the same period in 2017.

Bromine segment

For the three-month period ended September 30, 2018, the gross profit margin for our bromine segment was 0% due to the closure of all of our plant and factories to perform rectification and improvements since September 1, 2017. All bromine goods in the inventory were sold as of December 31, 2017. As a result, there was no bromine for sale for the three-month period ended September 30, 2018.

For the three-month period ended September 30, 2018 the gross profit margin for our crude salt segment was 80% compared to 46% for the same period in 2017. This 34% increase is mainly due to the increased average selling price as mentioned in cost of net revenue of crude salt.

Chemical products segment

For the three-month period ended September 30, 2018, the gross profit margin for our chemical segment was 0% due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All chemical products inventories were sold as of June 30, 2018. As a result, there were no chemical products for sale for the three-month period ended September 30, 2018.

Research and Development Costs. The total research and development costs incurred for the three-month period ended September 30, 2018 and 2017 were $0 and $42,074, respectively, a decrease of 100%. Due to the closure of our chemical factories since September 1, 2017, there were no research and development costs incurred for the three-month period ended September 30, 2018. Research and development costs for the three-month period ended September 30, 2017 represented raw materials used by SYCI for testing the manufacturing routine.

Write-off/Impairment on property, plant and equipment. Write-offs on property, plant and equipment for the three-month period ended September 30, 2018 and 2017 were $1,397,313 and $0, respectively. Write-offs on property, plant and equipment of $1,397,313 for the three-month period ended September 30, 2018 represented the impairment for the mineral rights for the factories that have to be permanently closed due to a closing notice on September 21, 2018 from the People's Government of Yangkou Town, Shouguang City (See Note 1 (b) in the Notes to the Condensed Financial Statement), and write-offs of certain wells and equipments damaged by flood from a typhoon during the third quarter 2018.

Loss on demolition of factory On September 21, 2018, the Company received a closing notice from the People's Government of Yangkou Town, Shouguang City informing it to close its three bromine factories (Number 3, Number 4, and Number 11.). The crude salt fields surrounding these factories have been reclaimed as cultivated or construction land and hence did not meet the requirement for bromine and crude salt co-production set by the relevant authority. In closing these factories, the Company wrote off net book value of these factories’ property, plant and equipment in the amount of $18,644,473 in the loss on demolition of factory in the condensed consolidated statements of income for the three-months period ended September 30, 2018.

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 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 the Bohai Park. As such, direct labor and factory overhead costs (including depreciation of plant and machinery) of a total amount of $5,563,494 and $1,873,722 incurred for the three-month period end September 30, 2018 and 2017, respectively, which would have been presented in the cost of net revenue were presented as part of the operating expense. The Company did not lay off any workers during the shutdown period and continued to depreciate the plant and machinery as it intends to use these plant and machinery when the factories resume production.

General and Administrative Expenses. General and administrative expenses were $1,323,933 for the three-month period ended September 30, 2018, a decrease of $1,253,372 (or 49%) as compared to $2,577,305 for the same period in 2017. This decrease in general and administrative expenses was primarily due to (i) the unrealized exchange gain of $1,029,229 in relation to the translation of current portion of inter-company balance owing in RMB for the three-month period ended September 30, 2018, as compared to the unrealized exchange loss for the same period in 2017 in the amount of $536,453; and(ii) a non-cash expense related to stock options granted to employees was $0 for three-month period ended September 30, 2018 compared to $343,000 for the same period of 2017; which was offset by the increased property tax and land use right tax in the amount of $779,613 due to the increased tax rate by the government.

Other Operating Income(loss). Other operating loss was $134,216 for the three-month period ended September 30, 2018 for the write-off of some of prepaid land lease for the closed factories and raw material due to the flood damages happened during the third quarter 2018, compared to other operating income of $72,000 for the three-month period ended September 30, 2017 for sales of wastewater.

Income (loss) from Operations. Loss from operations was $26,798,917 for the three-month period ended September 30, 2018, compared to an income of $4,835,252 in the same period in 2017.

28

Bromine segment

Loss from operations from our bromine segment was $24,369,917 for the three-month period ended September 30, 2018, compared to an income of $2,257,069 in the same period in 2017. This decrease is due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017.The direct labor and factory overheads incurred during the plant shutdown were expensed in the three-month period ended September 30, 2018.

Loss from operations from our crude salt segment was $2,611,203 for the three-month period ended September 30, 2018, compared to an income of $497,783 in the same period in 2017. This decrease is due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. The direct labor and factory overheads incurred during plant shutdown were expensed in the three-month period ended September 30, 2018.

Chemical products segment

Loss from operations from our chemical products segment was $698,693 for the three-month period ended September 30, 2018, compared to an income of $3,176,458 in the same period in 2017. This decrease was attributable to the closure of our chemical factories since September 1, 2017. We are setting up a new factory in the Bohai Park.

Other Income, Net. Other income, net of $124,362 represented bank interest income, net of capital lease interest expense for the three -month period ended September 30, 2018, an increase of $24,653 (or approximately 25%) as compared to the same period in 2017.

Net Income (loss). Net loss was $19,493,034 for the three-month period ended September 30, 2018, compared to an net income of $3,425,640 in the same period in 2017. This decrease was attributable to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017, there are no bromine and chemical products in inventory, except for limited crude salt products for selling for the three-month period ended September 30, 2018.

Effective Tax Rate. Our effective tax rate for the three-month period ended September 30, 2018 and 2017 was 27% and 31%, respectively. The effective tax rate of 27% for the three-month period ended September 30, 2018 differs from the PRC statutory income tax rate of 25% mainly due to non-taxable item in connection with the unrealized exchange loss for the Company and non-deductible expense for the Company. The effective tax rate of 31% for the three-month period ended September 30, 2017 differs from the PRC statutory income tax rate of 25% mainly due to non-deductible item in connection with the unrealized exchange loss for the Company.

Comparison of the Nine-Month Period Ended September 30, 2018 and 2017

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Net revenue. The table below shows the changes in net revenue in the respective segment of the Company for the nine-month period ended September, 2018 compared to the same period in 2017:

Bromine segment

For the nine-month period ended September 30, 2018, the net revenue for the bromine segment was $0 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All bromine goods in the inventory were sold as of December 31, 2017.

The decrease in net revenue from our crude salt segment was due to the decrease in the sales volume of crude salt. The sales volume of crude salt decreased by 76% from 206,289 tonnes for the nine-month period ended September 30, 2017 to 50,407 tonnes for the same period in 2018. This decrease was attributable to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. As a result, there was limited crude salt for sale for the nine-month period ended September 30, 2018.

The average selling price of crude salt increased by 27% from $30.98 per tonne for the nine-month period ended September 30, 2017 to $39.31 per tonne for the same period in 2018.

The table below shows the changes in the average selling price and changes in the sales volume of crude salt for nine-month period ended September 30, 2018 from the same period in 2017.

Chemical products segment

Net revenue from our chemical products segment decreased from $55,875,179 for the nine-month period ended September 30, 2017 to $613,368 for the same period in 2018, a decrease of approximately 99%. This decrease was attributable to the closure of our chemical factories since September 1, 2017. We are setting up a new factory in the Bohai Park. As a result there were limited chemical products for sale for the nine-month period ended September 30, 2018 and no chemical product in inventory at the end of September 30, 2018. Net revenue from our pesticides manufacturing additives decreased from $6,953,930 for the nine-month period ended September 30, 2017 to $98,200 for the same period in 2018, a decrease of approximately 99%. Net revenue from our byproducts decreased from $9,307,756 for the nine-month period ended September 30, 2017 to $154,666 for the same period in 2018, a decrease of approximately 98%. Since we do not expect our new chemical factory to be fully operational until the beginning of 2020, we sold our raw materials in the amount of $360,502 for the nine-month period ended September 30, 2018.

Cost of Net Revenue.

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 $1,310,272 for the nine-month period ended September 30, 2018, a decrease of $60,353,772 (or 98%) as compared to the same period in 2017.

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:

(i) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the period divided by the annual production capacity in tonnes. The product produce below reflect the annualized production.

Our annual production capacity decreased 11,302 in tones for the nine-month period ended September 30, 2018 as compared to the same period in 2017 due to the permanent closure of Factory No.3, 4 and 11. See Note 1 (b) in the Notes to the Condensed Financial Statement.

Our utilization ratio was 0% for the nine-month period ended September 30, 2018 was due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017.

Bromine segment

For the nine-month period ended September 30, 2018, the cost of net revenue for the bromine segment was $0 due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. All bromine goods in the inventory were sold as of December 31, 2017. As a result, there was no bromine for sale for the nine-month period ended September 30, 2018.

The cost of net revenue for our crude salt segment for the nine-month period ended September 30, 2018 was $765,944, representing a decrease of $2,531,120, or 77%, compared to $3,297,064 for the same period in 2017. This decrease was attributable to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. As a result, there was limited crude salt for sale for the nine-month period ended September 30, 2018.

Chemical products segment

Cost of net revenue for our chemical products segment for the nine-month period ended September 30, 2018 was $544,328, representing a decrease of $36,989,301 or 99% over the same period in 2017. This decrease was attributable to the sale of lower margin raw material items as the chemical factories were closed in September 2017 for relocation and is not expected to resume operations until early 2020.

Gross Profit. Gross profit was $1,284,669, or 50%, of net revenue for nine-month period ended September 30, 2018 compared to $42,496,829, or 41%, of net revenue for the same period in 2017.

Bromine segment

For the nine-month period ended September 30, 2018, the gross profit margin for our bromine segment was 0% due to the closure of all of our plant and factories to perform rectification and improvements since September 1, 2017. All bromine goods in the inventory were sold as of December 31, 2017. As a result, there was no bromine for sale for the nine-month period ended September 30, 2018.

For the nine-month period ended September 30, 2018 the gross profit margin for our crude salt segment was 61%, as compared to of 48% for the same period in 2018. This 13% increase is mainly due to the increased average selling price.

Chemical products segment

For the nine-month period ended September 30, 2018, the gross profit margin for our chemical segment was 11% because the sale of lower margin raw materials as the chemical factories were closed in September 2017 for relocation and is not expected to resume operations in 2020.

Research and Development Costs. The total research and development costs incurred for the nine-month period ended September 30, 2018 and 2017 were $0 and $169,246, respectively, a decrease of 100%. Due to the closure of our chemical factories since September 1, 2017, there were no research and development costs incurred for the nine-month period ended September 30, 2018. Research and development costs for the nine-month period ended September 30, 2017 represented raw materials used by SYCI for testing the manufacturing routine.

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 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 such, direct labor and factory overhead costs (including depreciation of plant and machinery) of a total amount of $16,948,499 and $1,873,722 incurred for the nine-month period end September 30, 2018 and 2017 which would have been presented in the cost of net revenue were presented as part of the operating expense.

Write-off/Impairment on property, plant and equipment. Write-offs on property, plant and equipment for the nine-month period ended September 30, 2018 and 2017 were $1,397,313 and $0, respectively. Write-offs on property, plant and equipment of $1,397,313 for the nine-month period ended September 30, 2018 represented the impairment for the mineral rights for the factories that have to be permanently closed due to closure notice from the People's Government of Yangkou Town, Shouguang City (See Note 1 (b) in the Notes to the Condensed Financial Statement), and write-offs of certain wells and equipments damaged by flood from a typhoon during the third quarter 2018.

Loss on demolition of factory On September 21, 2018, the Company received a closing notice from the People's Government of Yangkou Town, Shouguang City informing it to close its three bromine factories (Number 3, Number 4, and Number 11.). The crude salt fields surrounding these factories have been reclaimed as cultivated or construction land and hence did not meet the requirement for bromine and crude salt co-production set by the relevant authority. In closing these factories, the Company wrote off net book value of these factories’ property, plant and equipment in the amount of $18,644,473 in the loss on demolition of factory in the condensed consolidated statements of income for the nine-month period ended September 30, 2018.

General and Administrative Expenses. General and administrative expenses were $6,021,561 for the nine-month period ended September 30, 2018, a decrease of $341,147 (or 5%) as compared to $6,362,708 for the same period in 2017. This decrease in general and administrative expenses was primarily due to (i) a non-cash expense related to stock options granted to employees decreased from $357,700 for the nine-month period ended September 30, 2017 to $0 for the same period of 2018; and (ii) the unrealized exchange gain in relation to the translation difference of inter-company balance in RMB for the nine-month period ended September 30,2018 amounted to $1,374,315, as compared to the unrealized exchange loss for the same period in 2017 of $1,140,363; which was offset by the increased property tax and land use right tax in the amount of $2,603,538 due to the increased tax rate by the government

Other Operating Income (loss). Other operating loss was $134,216 for the nine-month period ended September 30, 2018 for the write-off of some of prepaid land lease for the closed factories and raw material due to the flood damages happened during third quarter 2018, compared to other operating income of $281,613 for the nine-month period ended September 30, 2017 for sales of wastewater.

Income (loss) from Operations. Loss from operations was $41,927,504 for the nine-month period ended September 30, 2018, compared to an income of 34,130,721 in the same period in 2017.

Bromine segment

Loss from operations from our bromine segment was $35,537,744 for the nine-month period ended September 30, 2018, compared to an income of $17,269,984 in the same period in 2017. This decrease is due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017.The direct labor and factory overheads incurred during the plant shutdown were expensed in the nine-month period ended September 30, 2018.

Crude salt segment

Loss from operations from our crude salt segment was $5,150,679 for the nine-month period ended September 30, 2018, compared to an income of $2,434,872 in the same period in 2017. This decrease is due to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017. The direct labor and factory overheads incurred during plant shutdown were expensed in the nine-month period ended September 30, 2018.

Chemical products segment

Loss from operations from our chemical products segment was $2,101,059 for the nine-month period ended September 30, 2018, compared to an income of $16,441,115 in the same period in 2017. This decrease was attributable to the closure of our chemical factories since September 1, 2017. We are setting up a new factory in the Bohai Park. As a result, there were no chemical products, except for limited raw materials for sale for the nine-month period ended September 30, 2018.

Other Income, Net. Other income, net of $385,989 represented bank interest income, net of capital lease interest expense for the nine -month period ended September 30, 2018, an increase of $111,675 (or approximately 41%) as compared to the same period in 2017.

Net Income(loss). Net loss was $31,283,007 for the nine-month period ended September 30, 2018, compared to an net income of $25,252,438 in the same period in 2017. This decrease was attributable to the closure of all of our plant and factories to perform rectification and improvement since September 1, 2017, there are no bromine and chemical products in inventory, except for limited raw materials for selling for the nine-month period ended September 30, 2018.

Effective Tax Rate. Our effective tax rate for the nine-month period ended September 30, 2018 and 2017 was 25% and 27%, respectively. The effective tax rate of 25% for the nine-month period ended September 30, 2018 is consistent with the PRC statutory income tax rate.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2018, cash and cash equivalents were $208,245,940 as compared to $208,906,759 as of December 31, 2017. The components of this decrease of $660,819 are reflected below.

Statement of Cash Flows

For the nine-month period ended September 30, 2018, we met our working capital and capital investment requirements mainly by using cash flow from operations and cash on hand.

Net Cash Provided by Operating Activities

During the nine-month period ended September 30, 2018 and 2017, we had positive cash flow from operating activities approximately of $23.0 million and $23.5 million, respectively, primarily attributable to net income.

During the nine-month period ended September 30, 2018, cash flow from operating activities of approximately $23.0 million was more than our net loss of approximately $54.3 million mainly due to (i) cash used in working capital of approximately $31.0 million, which mainly consisted of the decrease in accounts receivable and decrease in inventories and increase in tax payable; and (ii) substantial non-cash charges of approximately $23.3 million, mainly in the form of depreciation and amortization of property, plant and equipment and loss on demolition of factory, which was offset by increased deferred tax assets.

During the nine-month period ended September 30, 2017, cash flow from operating activities of approximately $23.5 million was less than our net income of approximately $25.3 million, mainly due to (i) cash used in working capital of approximately $20.2 million, which mainly consisted of the increase in accounts receivable and decrease in accounts payable and accrued expenses and tax payable, partially offset by the decrease in inventories; partially offset by (ii) substantial non-cash charges of approximately $18.4 million, mainly in the form of depreciation and amortization of 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 September 30, 2018 and December 31, 2017.

The overall accounts receivable balance as of September 30, 2018 decreased by $29,369,390 (or 99%), as compared to those as of December 31, 2017. 100% of the balances of accounts receivable as of September 30, 2018 were settled by Oct 31, 2018. 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 debts for the nine-month period ended September 30, 2018 is required.

Inventory

Our inventory consists of the following:

The net inventory level as of September 30, 2018 decreased by $1,131,764 (or 95%), as compared to the net inventory level as of December 31, 2017.

Raw materials decreased by 100% as of September 30, 2018 as compared to December 31, 2017. There are no raw materials in inventory at the end of the third quarter of 2018.

Our finished goods consist of bromine, crude salt and chemical products. There are no bromine and chemical products in inventory at the end of the third quarter of 2018.

As of September 30, 2018, the crude salt included in the inventory is approximately $0.07 million. The annual loss of crude salt due to evaporation is approximately 3%. The average selling price of crude salt per tonne increased from $30.55 for fiscal year 2017 to $38.86 for the third quarter of 2018. We believe that there will be no realization problem for crude salt as we do not expect selling price to be lower than the current price.

Net Cash Used in Investing Activities

In the nine-month period ended September 30, 2018, we used approximately $0.68 million cash for the prepayment of land leases. We also used approximately $11.41 million to perform the rectification and improvements of our bromine and crude salt factories and the relocation of our chemical factories for the nine-month period ended September 30, 2018.

In the nine-month period ended September 30, 2017, we used approximately $0.86 million cash for the prepayment of land leases. We also used approximately $0.06 million to acquire property, plant and equipment for the nine-month period ended September 30, 2017.

The investing activities described above were financed by opening cash balances as of December 31, 2017, and cash generated from operation during the nine-month period ended September 30, 2018.

Net Cash Used in Financing Activities

We repaid approximately $0.3 million cash for our capital lease obligation for the nine-month period ended September 30, 2018 and 2017.

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.

Working capital was approximately $208.6 million at September 30, 2018 as compared to approximately $237.8 million at December 31, 2017. The decrease was mainly attributable to net loss for the nine-month period ended September 30, 2018.

We had available cash of approximately $208.2 million at September 30, 2018, most of which is in highly liquid current deposits which earn no or little interest. We intend to retain the cash for the rectification and improvements of our bromine and crude salt factories, the relocation of our chemical factories (See note 1(b) in the notes to the consolidated financial statements), future expansion of our bromine and crude salt businesses through acquisition, enhancements to our existing bromine and crude salt business, and further development of the new resources in Sichuan Province. 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, SYCI 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 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 September 30, 2018 is provided in the notes to our condensed consolidated financial statements. See “Notes to Condensed Consolidated Financial Statements, Note 17 – 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 2017 Form 10-K, as amended.

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).

(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 due to the material weakness identified below, our disclosure controls and procedures were ineffective as of the end of the period covered by this Form 10-Q.

(b) Changes in internal controls

There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) under the Exchange Act) during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

On November 9, 2108, the Company filed Amendment No.2 on Form 10K/A for fiscal year ended December 31, 2017, Amendment No.1 on Form 10Q/A for the quarterly period ended March 31, 2018 and Amendment No.1 on Form 10Q/A for the quarterly period ended June 30, 2018 to correct an error related to the one-time mandatory federal transition tax on accumulated foreign earnings.

Management is actively engaged in the planning for, and implementation of, remediation efforts to address the material weakness identified above. The remediation plan includes i) the implementation of new controls designed to evaluate the appropriateness of foreign tax recognition policies and procedures, ii) new controls over recording of foreign tax transactions, and iii) additional training for the accounting and financial reporting personnel.

Management believes the measures described above and others that may be implemented will remediate the material weakness that we have identified. As management continues to evaluate and improve internal control over financial reporting, we may decide to take additional measures to address control deficiencies or determine to modify, or in appropriate circumstances not to complete, certain of the remediation measures identified.