U.S. Securities and Exchange Commission Washington, D.C. 20549  Form 10-QSB  x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the quarterly period ended September 30, 2005  OR  o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934  For the transition period from _____ to _____  Commission file number 0-27937  DRAGON PHARMACEUTICAL INC.(Exact name of small business issuer as specified in its charter)  Florida

(State or other jurisdiction of

incorporation or organization)
65-0142474

(IRS Employer Identification No.)   1055 West Hastings Street, Suite 1900 Vancouver, British Columbia Canada V6E 2E9 (Address of principal executive offices)  (604) 669-8817 (Issuers telephone number)   (Former address if changed since last report)  Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 [ ]  Indicate by check mark whether the registrant is a shell company. Yes [ ] No [ X ]  Number of shares of common stock outstanding as of September 30, 2005: 62,878,004   1      PART I  FINANCIAL INFORMATION



Item 1. Financial Statements







CONTENTS





PAGE
3
CONSOLIDATED BALANCE SHEETS AS AT SEPTEMBER 30, 2005 AND DECEMBER 31, 2004PAGE
4
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004PAGE
5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY FOR THE PERIODS ENDED SEPTEMBER 30, 2005 AND DECEMBER 31, 2004PAGE
6
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004PAGES
7 - 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  SEPTEMBER 30, 2005



2


DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS AT SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars



ASSETS
Notes

September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004CURRENT ASSETSCash and cash equivalents
19
$
1,011,692
$
910,425Restricted cash
11

2,331,399

-Accounts receivable, net of allowances
2

6,605,720

6,675,298Inventories, net
3

17,194,695

16,623,906Value added tax receivable


-

162,443Due from related company
4

670,368

-Prepaid expenses


663,220

911,228Total Current Assets


28,477,094

25,283,300PROPERTY AND EQUIPMENT, NET
5

66,491,154

62,396,316OTHER ASSETSIntangible assets, net
7

2,392,095

432,769Other receivables


1,672,139

2,213,842Investments -cost


12,330

12,077Total Other Assets


4,076,564

2,658,688TOTAL ASSETS

$
99,044,812
$
90,338,304Liabilities and Stockholders' EquityCURRENT LIABILITIESAccounts payable

$
4,390,198
$
3,047,485Accrued retirement benefits
8

96,607

114,432Other payables and accrued liabilities
9

17,980,097

17,705,163Loans payable  short-term
10

6,988,903

12,884,057Notes payable
11

2,331,399

-Due to related companies
4

184,182

4,660,984Total Current Liabilities


31,971,386

38,412,121LONG-TERM LIABILITIESLong term accounts payable
12

21,729,744

21,873,147Long term retirement benefits
8

712,030

870,321Loans payable  long-term
10

13,230,580

6,316,426Due to related companies
4

-

1,328,502Total Long-Term Liabilities


35,672,354

30,388,396TOTAL LIABILITIES


67,643,740

68,800,517COMMITMENTS AND CONTINGENCIES (Note 15)STOCKHOLDERS EQUITYAuthorized: 200,000,000 common shares at par value of $0.001 each

Issued and outstanding: 62,878,004 (December 31, 2004: 44,502,004) common shares


62,878

44,502Additional paid-in capital


22,138,830

13,983,002Retained earnings


1,045,543

-Reserves


7,562,432

7,562,432Accumulated other comprehensive income


617,232

-Due from stockholders


(25,843)

(52,149)Total Stockholders Equity


31,401,072

21,537,787TOTAL LIABILITIES AND STOCKHOLDERS EQUITY

$
99,044,812
$
90,338,304

The accompanying notes are an integral part of these consolidated financial statements.

3
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED) Expressed in US Dollars







Note

Three Months Ended September 30, 2005

RESTATED

(NOTE 20)

Three Months Ended September 30, 2004

Nine

Months Ended September 30, 2005

RESTATED

(NOTE 20)

Nine

Months Ended September 30, 2004NET SALES
13
$
13,335,556
$
7,315,889
$
36,515,128
$
21,791,874COST OF SALES


10,260,256

3,629,896

27,048,883

10,871,180GROSS PROFIT


3,075,300

3,685,993

9,466,245

10,920,694OPERATING EXPENSESSelling expense


1,169,405

922,475

3,598,654

2,840,716General and administrative expenses


1,380,034

722,492

3,592,759

1,309,845Depreciation and amortization


290,220

107,964

810,741

202,451Total Operating Expenses


2,839,659

1,752,931

8,002,154

4,353,012INCOME FROM OPERATIONS


235,641

1,933,062

1,464,091

6,567,682OTHER INCOME (EXPENSE)Interest expense


(286,686)

(21,875)

(843,305)

(40,179)Other income


6,130

289

45,630

50,916Funds Released by Chinese Government Liquidator
14

-

-

885,864

-Other expense


(43,790)

(11,704)

(77,777)

(47,935)Total Other Income (Expenses)


(324,346)

(33,290)

10,412

(37,198)INCOME (LOSS) FROM OPERATIONS BEFORE TAXES


(88,705)

1,899,772

1,474,503

6,530,484INCOME TAX EXPENSE
1(M)

103,168

67,168

428,960

419,578NET INCOME (LOSS)


(191,873)

1,832,604

1,045,543

6,110,906OTHER COMPREHENSIVE INCOMEForeign currency translation


618,143

-

617,232

-COMPREHENSIVE INCOME

$
426,270
$
1,832,604
$
1,662,775
$
6,110,906Earnings per share - basic and diluted

$
0.00
$
0.04
$
0.02
$
$0.14Weighted average number of shares outstanding during the period - basic and diluted


62,878,004

44,502,004

62,070,268

44,502,004

The accompanying notes are an integral part of these consolidated financial statements.

4
DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

FOR THE PERIODS ENDED SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







Common Stock

Additional Paid-In

RESTATED

(NOTE 20)

Retained

RESTATED

(NOTE 20)

Accumulated other compre-

Due from

RESTATED (NOTE 20)Shares

Amount

Capital

Earnings

Reserves

hensive loss

Stockholder

TotalBalance, December 31, 2003, adjusted for the effect of recapitalization of reverse acquisition (Note 6(B))

44,502,004
$
44,502
$
7,841,363
$
6,054,864
$
1,286,784
$
-
$
(228,148)
$
14,999,365Registered capital appropriation

-

-

6,141,639

(6,141,639)

-

-

-

-Notes receivable  stockholders

-

-

-

-

-

-

175,999

175,999Net income for the year ended December 31, 2004

-

-

-

6,362,423

-

-

-

6,362,423Transfer from retained earnings for appropriated statutory and staff welfare reserves

-

-

-

(6,275,648)

6,275,648

-

-

-Balance, December 31, 2004

44,502,004
$
44,502

13,983,002

-

7,562,432

-

(52,149)

21,537,787Reverse acquisition (6(B))

18,376,000

18,376

5,740,370

-

-

-

-

5,758,746Related party debt exchanged for equity

-

-

2,415,458

-

-

-

-

2,415,458Notes receivable  stockholders

-

-

-

-

-

-

26,306

26,306Comprehensive income (loss)- foreign currency translation

-

-

-

-

-

617,232

-

617,232Net income for the nine months ended September 30, 2005

-

-

-

1,045,543

-

-

-

1,045,543Balance, September 30, 2005

62,878,004
$
62,878
$
22,138,830
$
1,045,543
$
7,562,432
$
617,232
$
(25,843)
$
31,401,072



The accompanying notes are an integral part of these consolidated financial statements.

5








DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005, AND 2004

(UNAUDITED) Expressed in US Dollars







2005

RESTATED

(NOTE 20)

2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income
$
1,045,543
$
6,110,906Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation and amortization

4,374,489

1,455,354Allowance for doubtful accounts

55,022

182,500Provision for (recovery from) obsolete inventories

(94,502)

(96,226)Loss on disposition of assets

165,875

-Funds Released by Chinese Government Liquidator (14)

(745,828)

-Changes in operating assets and liabilities, net of effect of reverse acquisition (Note 6(B)), (increase) decrease in:Accounts receivable

1,530,934

(2,024,893)Inventories

463,882

(4,588,973)Value added tax receivable

163,231

-Prepaid expenses

255,849

(407,678)Other assets

559,413

-Deposits

-

1,355,793Increase (decrease) in:Accounts payable

560,830

10,788,317Other payables and accrued expenses

(955,694)

591,428Net Cash Provided By (Used In) Operating Activities

7,379,044

13,366,528CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment

(5,985,932)

(27,567,650)Purchase of investment

-

(12,077)Cash acquired in connection with reverse acquisition (Note 6(B))

2,103,481

-Net Cash Provided By (Used In) Investing Activities

(3,882,451)

(27,579,727)CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from loans payable

606,796

13,438,698Due to related companies

(4,068,048)

601,311Due from stockholder

26,434

250,131Net Cash Provided By (Used In) Financing Activities

(3,434,818)

14,290,140(GAIN) LOSS ON TRANSLATION OF FOREIGN CURRENCY

39,492

-NET INCREASE IN CASH AND CASH EQUIVALENTS

101,267

76,941CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

910,425

515,791CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
1,011,692
$
592,732Cash paid during the period for interest expense
$
1,053,420
$
40,179Cash paid during the period for income taxes
$
494,676
$
-

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

During March 2005, $2,415,458 of loans payable to an entity related to a director of the Company was converted into equity of the Company.



The accompanying notes are an integral part of these consolidated financial statements.

6






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





NOTE 1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION

(A) Organization and Basis of Presentation



Pursuant to a share purchase agreement, dated June 11, 2004, Dragon Pharmaceutical Inc. (the Company) acquired 100% of the issued and outstanding shares of Oriental Wave Holding Limited (Oriental Wave) by issuing 44,502,004 common shares of the Company. This transaction was completed on January 12, 2005 and has been accounted for as a reverse acquisition (See Note 6(B)). Accounting principles applicable to reverse acquisition has been applied to record the acquisition. Under this basis of accounting, Oriental Wave is the acquirer and, accordingly, the consolidated entity is considered to be a continuation of Oriental Wave with the net assets of the Company deemed to have been acquired and recorded at its fair market value. The Statements of operations includes the results of Oriental Wave for the nine months ended September 30, 2005 and those of the Company from January 13 to
September 30, 2005.



Oriental Wave was incorporated in the British Virgin Islands on January 7, 2003. Shanxi Weiqida Pharmaceutical Company Limited (Shanxi Weiqida), a Peoples Republic of China limited liability company was incorporated on January 22, 2002. Shanxi Weiqida is principally engaged in research and development, manufacturing, and selling of pharmaceutical products in the Peoples Republic of China (PRC).



During 2003, Shanxi Weiqidas shareholders exchanged 100% of their ownership of Shanxi Weiqida for 50,000 shares of Oriental Wave under a reorganization plan. The transfer was accounted for as a reorganization of entities under common control as the companies were beneficially owned by identical shareholders and share common management. The financial statements have been prepared as if the reorganization had occurred retroactively.



The consolidated financial statements include the accounts of the Company and its 100% owned subsidiaries: Oriental Wave, Shanxi Weiqida, Allwin Newtech Ltd., Sanhe Kailong Bio-pharmaceutical Co., Ltd., Nanjing Huaxin Bio-pharmaceutical Co. Ltd. (Huaxin), Allwin Biotrade Inc. and Dragon Pharmaceuticals (Canada) Inc.. All significant intercompany balances and transactions have been eliminated upon consolidation.



The accompanying unaudited consolidated financial statements have been prepared in accordance with the instruction for Form 10-QSB pursuant to the rules and regulations of Securities and Exchange Commission and, therefore, do not include all information and notes normally provided in audited financial statements and should be read in conjunction with the Companys consolidated annual financial statements for the year ended December 31, 2004 included in the annual report previously filed on Form 10-KSB. In the opinion of management all adjustments consisting of normal recurring accruals considered necessary for fair presentation have been included.



The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.



7






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





(B) Use of Estimates

In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported period. Actual results could differ from those estimates.

(C) Cash and Cash Equivalents

For purposes of the cash flow statements, the Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents.

(D) Accounts Receivable

The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. An allowance for doubtful accounts is established and recorded based on managements assessment of the credit history with the customer and current relationships with them.



(E) Investments



During the twelve months ended December 31, 2004, the Company made an investment in a private company of $12,330. The investment represents less than 1% of the total equity outstanding of the private company outstanding as of September 30, 2005. The private company investment is carried at cost and written down to fair market value when indications exist that this investment has other than temporarily declined in value. As of September 30, 2005, no impairment in the value of the investment has been recorded.



(F) Inventories



Inventories are stated at the lower of cost and net realizeable value, cost being determined on a first-in, first-out method. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand and product expiration dates.





8






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





(G) Property and Equipment



Property and equipment are stated at cost, less accumulated depreciation. Expenditures for additions, major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred.



Depreciation is provided on a straight-line basis, less estimated residual value over the assets estimated useful lives. The estimated useful lives are as follows:



Buildings

50 YearsPlant and machinery

10 YearsMotor vehicles

8 YearsFurniture, fixtures and equipment

5 YearsLeasehold improvements
Term of lease (5 -10 years)

Land use rights are stated at cost, less accumulated amortization. The land use rights are amortized over the term of the relevant rights of 50 years from the date of acquisition.

Depreciable assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable based on projected undiscounted cash flows associated with the assets. A loss is recognized for the difference between the fair value and the carrying amount of the assets. Fair value is determined based upon market quote, if available, or is based on valuation techniques.

(H) Fair Value of Financial Instruments

The carrying amount of the Companys cash and cash equivalents, receivables, investments, amounts due to and from related parties and loans and other payables approximates their fair value. The fair value of the loans payables are estimated using discounted cash flow analysis, based upon the Companys current borrowing rates, and approximate their carrying value.

(I) Intangible Assets

Intangible assets represent licenses and permits for the production and sales of pharmaceutical products in China and are amortized on a straight-line basis over ten years.

Intangible assets are tested for impairment whenever events or circumstances indicate that a carrying amount may not be recoverable. An impairment loss would be recognized when the carrying amount of an asset exceeds the estimated un-discounted cash flows used in determining the fair value of the assets. The amount of the impairment loss to be recorded is calculated by the excess of the assets carrying value over its fair value. Fair value is generally determined using a discounted cash flow analysis.



9






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





(J) Revenue Recognition

The Company recognizes revenue, net of estimated provisions for returns, rebates and sales allowances from the sale of pharmaceutical products at the time when the product is shipped to the customer. Revenues are recognized only when the Company has transferred to the customer the significant risk and rewards of ownership of the goods, title to the products transfers, the amount is fixed and determinable, evidence of an agreement exists, and the customer bears the risk of loss. .

(K) Advertising Costs

Advertising costs are expensed as incurred. Advertising expense totaled $9,322 and $56,732 for the nine months ended September 30, 2005 and 2004, respectively and $1,468 and $43,691 for the three months ended September 30, 2005 and 2004, respectively.

(L) Research and Development

Research and development costs related to both present and future products are expensed as incurred. Total (recovery of) expenditures on research and development charged to selling, general and administrative expenses for the nine months ended September 30, 2005 and 2004 were $57,396 and $114,650, respectively and $(9,805) and $17,894 for the three months ended September 30, 2005 and 2004, respectively.

(M) Income Taxes

The Company accounts for income taxes under the Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Statement 109). Under Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company located its factories in a special economic region in China. This economic region allows foreign
enterprises a two-year income tax exemption from central government tax beginning in the first year after they become profitable, being the year commencing on January 1, 2003 to December 31, 2004 and a 50% income tax reduction for the following three years, being 2005 to 2007. The Company was approved as a wholly owned foreign enterprise in October 2002.





10




DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





(N) Foreign Currency Translation



The functional currency of the majority of the business of the Company is the Chinese Renminbi (RMB), however, the Company reports in U.S. dollars. Transactions denominated in currencies other than RMB are translated into United States dollars using period end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. Net gains and losses resulting from foreign exchange translations are included in the statements of operations and stockholders equity as other comprehensive gain (loss). The revenues and expenses of the Company which are maintained in RMB are translated to U.S. dollars at US$1.00 = RMB 8.24 during the nine month period with the assets and liabilities of the Company maintained in RMB translated to U.S. dollars at US$1.00 =
RMB 8.11.



(O) Other Comprehensive Income



The foreign currency translation gain or loss resulting from translation of the financial statements expressed in RMB to United States Dollar is reported as other comprehensive income in the statements of operations and stockholders equity.



(P) Segments



The Company operates in three reportable segments, Chemical Division, Pharma Division and Biotech Division.



(Q) Earnings Per Share



Earnings per share are computed using the weighted average number of shares outstanding during the period. Diluted earnings per share, as determined using the treasury method, is equal to the basic income per share as common stock equivalents consisting of options to acquire 6,737,500 common shares that are outstanding at September 30, 2005 are not significantly dilutive, however, they may be dilutive in the future.

(R) Reclassifications



Certain 2004 balances have been reclassified to conform to the 2005 presentation.



(S) Stock Based Compensation



The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-based Compensation", as amended by SFAS No. 148 "Accounting for Stock-based Compensation  Transition and Disclosure  An amendment of SFAS No. 123". SFAS 123 encourages, but does not require, companies to adopt a fair value based method for determining expense related to stock-based compensation. The Company continues to account for stock-based compensation



11






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





issued to employees and directors using the intrinsic value method as prescribed under Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" and related Interpretations.

(T) Recent Accounting Pronouncements



In November 2004, the FASB issued SFAS No. 151, Inventory Costsan amendment of ARB No. 43, Chapter 4, which is the result of the FASBs project to reduce differences between U.S. and international accounting standards. SFAS No. 151 requires idle facility costs, abnormal freight, handling costs, and amounts of wasted materials (spoilage) be treated as current-period costs. Under this concept, if the costs associated with the actual level of spoilage or production defects are greater than the costs associated with the range of normal spoilage or defects, the difference would be charged to current-period expense, not included in inventory costs. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005.  The adoption of SFAS No. 151 does not have an impact on the Companys consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123(R), "Accounting for Stock-Based Compensation". SFAS 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123(R) requires that the fair value of such equity instruments be recognized as expense in the historical financial statements as services are performed. Prior to SFAS 123(R), only certain pro-forma disclosures of fair value were required. SFAS 123(R) will be adopted by the Company effective as of the beginning of the first interim and annual reporting period that begins after December 15, 2005 and will result in the Company recording a non-cash stock based compensation based upon the fair value of the options at the
time.

In May 2005, the FASB issued Statement of Financial Accounting Standards SFAS No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be
accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. The adoption of this new accounting



12






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





pronouncement does not have a material impact on its consolidated financial position, results of operations or cash flows.

NOTE 2
ACCOUNTS RECEIVABLE

Accounts receivable at September 30, 2005 and December 31, 2004 consisted of the following:



September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Trade and other receivables
$
6,877,003
$
6,799,872Less: allowance for doubtful accounts

271,283

124,574Accounts receivable, net
$
6,605,720
$
6,675,298

For the three and nine months ended September 30, 2005, the Company recorded an allowance for doubtful accounts of $42,412 and $55,022, respectively in the Consolidated Statements of Operations compared to $182,500 for the three and nine months ended September 30, 2005 and 2004.



NOTE 3
INVENTORIES

Inventories at September 30, 2005 and December 31, 2004 consisted of the following:



September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Raw materials
$
4,241,790
$
4,287,604Work-in-progress

10,814,372

10,994,088Finished goods

3,084,149

2,302,07318,140,311

17,583,765Less: provision for obsolescence and impairment

945,616

959,859$
17,194,695
$
16,623,906

For the three and nine month periods ended September 30, 2005 , the Company recorded a provision for (recovery from) obsolete inventories of $191,679 and $(94,502), respectively, in the Consolidated Statements of Operations compared to recovery from obsolete inventories of $370,445 and $96,226 for the three and nine month periods ended September 30, 2004.



13






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







NOTE 4
DUE FROM, AND TO, RELATED PARTIES

(a)
The amounts due from a related party at September 30, 2005 is unsecured and non-interest bearing:September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Prepayment for raw materials to a company whose legal representative is a stockholder and director of the Company
$
670,368
$
-

(b)
The amounts due to related parties at September 30, 2005 and December 31, 2004 are unsecured and non-interest bearing:September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Due to a company owned by a stockholder and director due March 2006
$
-
$
1,328,502Due to a company owned by a stockholder and director due March 2006

184,182

4,660,984184,182

5,989,486Less: current maturities

184,182

4,660,984$
-
$
1,328,502



14






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







NOTE 5
PROPERTY AND EQUIPMENT

The following is a summary of property and equipment at September 30, 2005 and December 31, 2004:



September 30, 2005Accumulated

Net BookCost

Depreciation

ValuePlant and equipment
$
45,302,207
$
6,280,641
$
39,021,566Land use rights and buildings

19,203,429

651,046

18,552,383Motor vehicles

749,205

190,354

558,851Furniture and office equipment

3,042,904

1,100,879

1,942,025Leasehold improvements

1,015,964

1,010,905

5,059Idle equipment

555,339

454,164

101,175Construction in progress

6,310,095

-

6,310,095$
76,179,143
$
9,687,989
$
66,491,154

December 31, 2004RESTATED (NOTE 20)Accumulated

Net BookCost

Depreciation

ValuePlant and equipment
$
41,154,014
$
2,293,918
$
38,860,096Land use rights and buildings

18,552,438

370,169

18,182,269Motor vehicles

611,261

55,166

556,095Furniture and office equipment

2,499,188

392,511

2,106,677Construction in progress

2,691,179

-

2,691,179$
65,508,080
$
3,111,764
$
62,396,316

Depreciation expense for nine month periods ended the September 30, 2005 and 2004 was $3,936,684 and $1,410,064 respectively. Depreciation expense for three month periods ended the September 30, 2005 and 2004 was $1,349,436 and $558,630 respectively. Land use rights and equipment with a net book value of $23.7 million are pledged as collateral for $19.6 million in loans payable (Note 10)





15






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





NOTE 6ACQUISITIONS



(A)
Land Use Rights

During July 2003, the Company acquired Land Use Rights and buildings from a government liquidator in exchange for assuming certain future employment, healthcare and Land Use Rights acquisition costs of the factory and its former employees. The agreement requires the Company to pay certain minimum wages and health care costs until the date of their employment, retirement or death, whichever occurs first. The maximum amount of the liabilities assumed on the closing date was $8,897,685 which approximates the appraised value of the Land Use Rights acquired. The Company has calculated the related asset value by computing the estimated fair value of the future expected payments to the remaining employees assuming an interest rate of 3% and has recorded the Land Use Rights at $3,332,907 (See Notes 8 and 15(D)).Subsequent to the acquisition the
Company rehired a number of the former employees, reducing the expected future payments required. The Company has accounted for the reduction of the obligation by reducing the amount of Land Use Rights recorded.



The cost of Land Use Rights as at September, 2005 and December 31, 2004 is as follows:

September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Original Cost recorded
$
3,332,907
$
3,332,907Less: reduction of future accrued retirement benefit

1,163,387

1,135,238Cost of Land Use Rights
$
2,169,520
$
2,197,669

The Land Use Rights, which are included in Property and equipment in the consolidated balance sheet, have been reduced by $28,149 during the period ended September 30, 2005 and will be reduced in the future should payments be further reduced due to additional former employees being rehired.



(B)
Oriental Wave Holding Limited

The Company completed the acquisition of Oriental Wave on January 12, 2005 whereby the Company issued 44,502,004 common shares in exchange for all of the issued and outstanding shares of Oriental Wave. The acquisition represented an important strategic step in strengthening the competitive position of the Company. The transaction has been



16






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





approved by the Companys shareholders and the regulatory authorities, who also approved an increase in the authorized share capital to 200,000,000 common shares.

This transaction resulted in the former shareholders of Oriental Wave owning 68.35% of the issued and outstanding shares of the combined entity as of January 12, 2005. Accounting principles applicable to reverse acquisition has been applied to record the acquisition. Under this basis of accounting, Oriental Wave is the acquirer and, accordingly, the consolidated entity is considered to be a continuation of Oriental Wave with the net assets of the Company deemed to have been acquired and recorded at estimated market value. The Statement of operations includes the results of Oriental Wave for the nine months ended September 30, 2005 and those of the Company from January 13 to September 30, 2005.

The preliminary allocation of the net assets acquired is as follows:



Cash and short term securities
$
2,103,481Accounts receivable

1,382,119Inventories

585,565Prepaid and deposits

100,421Total Current Assets

4,171,586Fixed Assets

867,742Intangible and other assets, net

2,349,222Total Assets

7,388,550Less accounts payables and accrued liabilities

(1,629,804)Net assets acquired
$
5,758,746

A summarized statement of operations for the Company for the twelve days ended January 12, 2005 is as follows:



Sales
$
145,435Gross Profit

109,059Total operating expenses

166,881Loss for the period
$
(57,822)

Pro-forma financial information, assuming the acquisition occurred January 1, 2004, are as follows:



For the nine months ended September 30,

2005

RESTATED

(NOTE 20)

2004Sales

$36,660,563

$24,635,543Gross profit

9,575,304

13,041,330Net income

987,717

5,261,330Earnings per share

$ 0.02

$ 0.08



17






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







NOTE 7
INTANGIBLE ASSETS

The Company acquired $603,865 in licenses from a company related to a director in 2002 with the balance being recorded pursuant to the reverse acquisition of Oriental Wave (Note 6(B)).



Intangible assets consist of the following as of September 30, 2005 and December 31, 2004:



September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Licenses
$
2,984,201
$
603,865Less: accumulated amortization

592,106

171,096$
2,392,095
$
432,769

Amortization expense for the nine month periods ended September 30, 2005 and 2004 was $437,805 and $45,290, respectively. For the three month periods ended September 30, 2005 and 2004, amortization expense was $154,769 and $15,097, respectively.



NOTE 8
ACCRUED RETIREMENT BENEFITS

During July 2003, the Company acquired Land Use Rights and buildings from a government liquidator. The present value of the accrued retirement benefits assumed is recorded at September 30, 2005 and December 31, 2004 as follows:



September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Total liabilities assumed at closing date
$
8,897,685
$
8,897,685Less: reduction of liability due to re-employment

(4 ,949,474)

(4,949,474)Less: net present value of liabilities initially not expected to be paid

(615,304)

(615,304)Present value of expected liabilities at closing date

3,332,907

3,332,907Less: amounts paid and adjustment for liabilities not expected to be paid

2,524,270

2,348,154808,637

984,753Less: current portion

96,607

114,432$
712,030
$
870,321



18






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







Under the terms of the contract with the liquidator, the Company will remain contingently liable for these liabilities until the date of retirement or re-employment for each employee (See Notes 6(A) and 15).



NOTE 9
OTHER PAYABLES AND ACCRUED LIABILITIES

Other payables and accrued liabilities at September 30, 2005 and December 31, 2004 consist of the following:



September 30, 2005

RESTATED

(NOTE 20)

December 31,

2004Machinery and equipment payable
$
3,876,497
$
7,050,243Current portion of long term payables

8,442,746

5,693,464Accrued expenses

1,066,785

666,734Value added tax payables

280,256

-Income taxes payable

148,394

166,495Other taxes payable

110,937

121,054Deposits received from customers

4,054,482

4,007,173$
17,980,097
$
17,705,163

NOTE 10
LOANS PAYABLE

Balance at September 30, 2005 and December 31, 2004:



September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Loan payable to a bank, interest rate of 6.372% per annum, guaranteed by a third party, due June 2005
$
-
$
420,290Loan payable to a bank, interest rate of 6.372% per annum, guaranteed by a third party, due June 2005

-

386,473Loan payable to a bank, interest rate of 8.874% per annum, guaranteed by a third party, due October 2005

616,523

-



19






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







Loan payable to a bank, interest rate of 6.138% per annum, secured by fixed assets of $5,127,329, due November 2005

3,699,137

3,623,188Loan payable to a bank, interest rate of 6.039% per annum, secured by land use rights and fixed assets, due April 2005

-

8,454,106Loan payable to a bank, interest rate of 6.039% per annum, secured by land use rights and fixed assets of $3,110,259, due April 2006

1,849,568

-Loan payable to a bank, interest rate of 7.254% per annum, secured by land use rights and fixed assets of $1,224,636, due September 2006

616,523

-Loan payable to a bank, interest rate of 7.254% per annum, secured by land use rights and fixed assets of $718,272, due September 2006

207,152

-Loan payable to a bank, interest rate of 5.76% per annum, secured by fixed assets of $9,724,355, due November 2006

6,448,829

6,316,426Loan payable to a bank, interest rate of 6.039% per annum, secured by land use rights and fixed assets of $3,773,926, due April 2007

6,781,751

-20,219,483

19,200,483Less current maturities

6,988,903

12,884,057$
13,230,580
$
6,316,426

Maturities are as follows:

Fiscal year ended December 31,2005
$
4,315,6602006

9,122,0722007

6,781,751$
20,219,483



20






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







NOTE 11
NOTES PAYABLE

The Company has issued a number of notes payable to vendors totalling $2,331,399. These notes are due between November 2005 and March 2006, are non-interest bearing and are secured by $2,331,399 in bank deposits. The bank deposits may be used only for the purpose of repaying the notes.



NOTE 12
LONG TERM ACCOUNTS PAYABLELong term accounts payable balances at September 30, 2005 and December 31, 2004 is for the payment of construction contracts and will be settled as follows:



September 30, 2005

RESTATED

(NOTE 20)

December 31, 2004Settlement ArrangementAccounts payable due June 2007 to December, 2008
$
21,729,744
$
21,873,147

NOTE 13
SEGMENTSThe Company operates in three reportable segments, the Pharma Division, Chemical Division and Biotech Division. The Pharma Division produces chemical generic, mainly anti-infectious, drugs. The Chemical Division produces the bulk intermediate or ingredient to sell to other pharmaceutical companies for further processing and formulation into finished products. The Biotech Division produces Erythropoietin or EPO, an injection that stimulates red blood cell. Substantially all assets and operations of the Company are located in China, which is considered as one geographic location in an economic environment with similar risks and returns. The accounting policies of the segments are the same as described in the summary of significant accounting policies. The Company evaluates segment performance based on income from operations. All intercompany transactions between segments have been eliminated. As a
result, the components of operating income for one segment may not be comparable to another segment. The following is a summary of the Companys segment information for the periods ended September 30, 2005 and 2004 and as of September 30, 2005 and December 31, 2004.





21






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







Chemical

Pharma

BiotechDivision

Division

Division

Total2005Three months ended September 30, 2005Sales
$
5,975,284
$
6,064,671
$
1,295,601
$
13,335,556Gross profit

(226,184)

2,447,332

854,152

3,075,300Depreciation and amortizationRESTATED (NOTE 20)

1,108,407

174,436

221,362

1,504,205Nine months ended September 30, 2005Sales

16,559,330

17,072,272

2,883,556

36,515,128Gross profit

(7,286)

7,365,739

2,107,792

9,466,245Depreciation and amortizationRESTATED (NOTE 20)

3,225,375

513,147

635,967

4,374,489

As at September 30, 2005Total assets

RESTATED (NOTE 20)

71,152,977

23,327,980

4,563,855

99,044,812Additions to long-lived assets

5,865,821

114,931

5,180

5,985,932Intangible assets

19,236

395,600

1,977,259

2,392,0952004Three months ended September 30, 2004Sales

1,078,385

6,237,504

-

7,315,889Gross profit

393,201

3,292,793

-

3,685,993Depreciation and amortization

423,762

149,965

-

573,727Nine months ended September 30, 2004Sales

2,461,955

19,329,919

-

21,791,874Gross profit

842,692

10,078,003

-

10,920,694Depreciation and amortization

1,028,243

427,111

-

1,455,354As at December 31, 2004Total assets

RESTATED (NOTE 20)

66,726,390

23,611,914

-

90,338,304Additions to long-lived assets

27,295,156

852,773

-

28,147,929Intangible assets

-

432,769

-

432,769



22






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





NOTE 14
OTHER INCOME- Funds Released by Chinese Government LiquidatorIn July 2003, the Company, through Shanxi Weiqida, acquired out of bankruptcy the Land Use Rights of a state-owned enterprise. (Please also refer to Note 6(A))  After entering into this transaction, the Company was approached by an unrelated state agency to administer certain benefits payable to former employees of the agency (the government liquidator) as the Company had already established an infrastructure to make payments to these employees for settlement of liabilities related to the transaction.  As a result, during 2004, the Company received $1,751,208 from the government liquidator, for the settlement of human resources related expenses of the bankrupt enterprise. As well, during the first quarter of 2005, a separate municipal agency, the Datong Municipal Government, approved the transfer of a fund with a balance of $140,036 originally reserved for the employee housing welfare as part
of the liquidation process of the state-owned enterprise.  The two agencies, unrelated to the acquisition, allowed the Company to retain the cash balance of $745,828 as well as the reserve of $140,036 as payment for services provided by the Company.  As a result, the Company recorded other income of $885,864 during the current period to reflect the above transactions.



NOTE 15
COMMITMENTS AND CONTINGENCIES(A) Employee Benefits



The full time employees of Shanxi Weiqida are entitled to employee benefits including medical care, welfare subsidies, unemployment insurance and pension benefits through a Chinese government mandated multi-employer defined contribution plan. The Company is required to accrue for those benefits based on certain percentages of the employees salaries. The total provision for such employee benefits was $86,744 and $204,532 for the nine month periods ended September 30, 2005 and 2004, respectively and $29,473 and $62,802 for the three month periods ended September 30, 2005 and 2004, respectively. The Company is required to make contributions to the plans out of the amounts accrued for medical and pension benefits. The Chinese government is responsible for the medical benefits and the pension liability to be paid to these employees.



(B) Loan Guarantee



The Company has guaranteed a bank loan to a supplier in the amount of $2,415,000 (RMB20 million) due on July 16, 2006. Interest on the loan is charged at 7.905% and the bank has the right to seek settlement from the Company for payment should the two supplier fail to repay the loan. There is no recourse or possible recovery for the Company should the suppliers default on their bank loans. The maximum potential amount of future payments (undiscounted) that the Company could be required to make is $2,566,156. The Company provided the guarantees to these suppliers to maintain a good business relationship.





23






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





The Company has also issued a guarantee to a bank as security for loans to a third party vendor of $2,415,000 (RMB20 million) due on September 26, 2007 and $3,623,000 (RMB30 million) due on October 27, 2007. Interest is charged at the banks base rate plus 5.9475 %. The bank has the right to seek settlement from the Company for payment should the third party vendor fail to repay the loan. The maximum potential amount of future payments (undiscounted) that the Company could be required to make is $ 6,770,586. This vendor has pledged assets totaling $8,484,000 (RMB70.2 million) to the Company for this guarantee.



(C) Capital Commitments



According to the Articles of Association of Shanxi Weiqida, the Company has to fulfill registered capital of $19,205,116 (RMB 159,018,360) within five years from December 16, 2003. As of September 30, 2005, the Company has fulfilled $14,656,174 (RMB 121,353,123) of registered capital requirement and has registered capital commitments of $4,548,942 (See Note 16(A)).



(D) Contingent Employment Benefits

During July 2003, the Company acquired land and buildings from a government liquidator in exchange for assuming certain future employment, healthcare and land acquisition costs of the factory and its former employees. Under the terms of the contract with the liquidator, the Company will remain contingently liable for these liabilities until the earliest of date of retirement, re-employment or death for each employee. As of September 30, 2005, the Company has rehired 655 former employees, 236 employees have retired and 163 former employees remain unemployed. If the Company is unable to provide continued employment to these remaining unemployed individuals, it will be liable to pay them each approximately $49 per month until his or her date of retirement, at age 60 or 50, respectively, or death, whichever comes first (See Notes 6 & 8).



(E) Operating Leases



The Company has entered into an operating lease agreement for their administrative offices in Vancouver for an amount escalating from CDN$200,000 to CDN$232,000 (US$170,000 to US$198,000) per annum until March 31, 2007. Minimum payments required under the agreement are as follows:

2005
$ 48,2542006
197,4242007
49,724Total
$295,402

The Company closed Huaxin's production in Nanjing, effective July 31, 2005, and is building a new facility in Datong, China at the site of the manufacturing facilities of Oriental Wave, which is expected to be completed before December 31, 2005. The Company has renegotiated the termination of its lease, without penalty, though the Company agreed to relinquish some fixtures and equipment to the landlord and was required to pay approximately RMB 600,000 ($70,000) relating to severance and benefit costs associated with the closure.



24






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





(F) Cell Line Development

The Company has contracted with a European Institute of Biotechnology to develop a high yield proprietary cell line and production process technology for the Company. Product from this advanced technology will be used by the Company to enter the European market, once certain competitor's patents expire. The total cost of development is $648,800 (EUROS 500,000) of which $361,300 (EUROS 300,000) is yet to be incurred as of September 30, 2005.



NOTE 16
STOCKHOLDERS EQUITY

(A) Capital Contribution (See note 15(C))



On January 31, 2005 and on February 22, 2005 Oriental Wave paid Shanxi Weiqida $479,988 and $198,682, respectively, towards its registered capital requirement under Chinese law.



(B) Reserves



Pursuant to PRC regulations, Shanxi Weiqida is required to make appropriations to reserves funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the Peoples Republic of China (the PRC GAAP). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the Companys registered capital. The transfer to this reserve must be made before distribution of dividends to shareholders. Except for the reduction for losses incurred, any other usage should not result in this reserve balance falling below 25% of the registered capital. Appropriations to the statutory public welfare fund are at 5% to 10% of the after
tax net income determined in accordance with the PRC GAAP. The statutory public welfare fund is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable other than in liquidation. Appropriations to the discretionary surplus reserve are made at the discretion of the Board of Directors. These reserves are not available for distribution to owners under general operating conditions. The appopriations for reserves are made by the Board of Directors on an annual basis and the amount relating to the current year can not be estimated at this time and no provision has been made.



(C) Stock Options



The Company has adopted the 2005 Stock Option Plan, effective August 13, 2005, which allows for the granting of options to Directors and Employees for a period of up to ten years. The Company did not grant any options during the year ended December 31, 2004. During the period ended September 30, 2005, the Company granted options to its directors and employees to purchase 5,920,000 shares at a weighted average price of $0.91 per share, with 2,260,000 shares at exercise price of $1.18 (being the market price at the time) expiring on January 12, 2010 and 3,660,000 shares at exercise price of $0.74 (being the market price at the time) expiring on September 30, 2010. Options to purchase 4,320,000



25






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





shares were exercisable immediately with 400,000 options becoming available on January 12, 2006, 400,000 options becoming available on September 30, 2006, 400,000 options becoming available on January 12, 2007 and the balance of 400,000 options vesting on September 30, 2007.

The following summarizes stock option information for the period ended September 30, 2005:

Shares
Weighted Average

Exercise PriceOptions outstanding at December 31, 2003
2,599,000
$ 2.04Forfeited
(705,000)
$ 1.57Exercised
(145,000)
$ 0.50Options outstanding at December 31, 2004
1,749,000
$ 2.36Granted
5,920,000
$ 0.91Forfeited
(931,500)
$ 2.88

Options outstanding at September 30, 2005
6,737,500
$ 1.01

Options Outstanding

Options ExercisableWeightedAverage
Weighted


WeightedRange of

Remaining
Average


AverageExercise
Number
Contractual
Exercise

Number
ExercisePrices
Outstanding
Life
Price

Exercisable
Price$0.01 - $1.00
4,010,000
4.79
$0.73

3,197,500
$0.73$1.01 - $2.00
2,427,500
4.10
$1.22

1,627,500
$1.24$3.01 - $4.00
300,000
0.12
$3.13

300,000
$3.136,737,500
4.33
$1.01

5,125,000
$1.03



26






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





The Company accounts for its stock-based compensation plan in accordance with APB Opinion No. 25, under which no compensation is recognized in connection with options granted to employees and directors except if options are granted with a strike price below fair value of the underlying stock. The Company adopted the disclosure requirements SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, the Company is required to calculate and present the pro forma effect of all awards granted. For disclosure purposes, the fair value of each option granted to an employee has been estimated as of the date of grant using the Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 5.5%, dividend yield 0%, volatility of 90%, and expected lives of approximately 0 to 5 years. The weighted average fair value of the options granted during the period was $0.69 for the
options granted in January 2005 and $0.43 for the options granted in September 2005. Based on the computed option values and the number of the options issued, had the Company recognized compensation expense, the following would have been its effect on the Companys net income and earnings per share:

For the nine months ended September 30,
2005
RESTATED

(NOTE 20)

2004Net income for the period:- as reported
$1,045,543
$6,110,906- pro-forma
$(1,440,094)
$6,110,906Basic and diluted income per share:- as reported
$0.02
$0.14- pro-forma
$(0.02)
$0.14

NOTE 17
INCOME TAXESShanxi Weiqida and Huaxin are subject to income taxes in China on their taxable income as reported in their statutory accounts at a tax rate in accordance with the relevant income tax laws.

Oriental Wave, Allwin Newtech Ltd. and Allwin Biotrade Inc are BVI companies and are not subject to income taxes. Dragon Pharmaceutical Inc. and Dragon Pharmaceutical (Canada) Inc. are U.S. and Canadian companies, respectively, and are subject to taxes in those jurisdictions.



NOTE 18
RELATED PARTY TRANSACTIONS

See Notes 4 and 7.





27






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars





NOTE 19CONCENTRATIONS AND RISKS



80% and 86% of the Companys revenues for the three and nine months ended September 30, 2005, respectively, were derived from customers located in China and 99% of its assets at September 30, 2005 are located in China. Comparatively, 100% of the Companys revenues during the three and nine months ended September 30, 2004 were derived from customers located in China and 100% of its assets were located in China.



The Company is exposed to the risk arising from changing interest rates. A detailed analysis of the Companys Loans Payable, together with their respective interest rates and maturity dates, are included in Note 10.



The majority of the Companys assets, liabilities, revenues and expenses are denominated in Renminbi, which was tied to the US Dollar and is now tied to a basket of currencies of its largest trading partners,is not a freely convertible currency. The deregulation of the Renminbi resulting in an appreciation of the Renminbi against the US Dollar would result in an increase in the assets, liabilities, revenues and expenses of the Company and a foreign currency gain included in comprehensive income. Conversely, the devaluation of the Renminbi against the US Dollar would result in a decrease in the assets, liabilities, revenues and expenses of the Company and a foreign currency loss included in comprehensive income. At September 30, 2005, approximately US$906,536 of the cash and cash equivalents (December 31, 2004: US$885,681) and all of the restricted cash are held in Renminbi.



NOTE 20
RESTATEMENTAs a result of a review of its accounting policies and applicable accounting pronouncements, the Company has concluded that the reduction of a future retirement benefit obligation related to the acquisition of a Land Use Right from a former state-owned enterprise in China by Oriental Wave Holding Limited (Oriental Wave) in July 2003, should have been accounted for as a reduction to the recorded cost of the Land Use Right instead of as a non-operating gain from extinguishment of debt, as previously disclosed in Oriental Waves 2004 financial statements. As a result, Oriental Waves 2004 financial statements have been restated retroactive to June 2004 to reflect such change in accounting treatment.



The reduction of the future retirement benefit obligation during 2004, totaling $1,135,238 million, which was recognized as a non-operating gain, has been recorded as a reduction to the cost of the Land Use Right. On a going forward basis, any similar reduction of the retirement benefit obligation will be treated as a reduction to the recorded cost of the Land Use Right. The effect on the financial statements is as follows:



28






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







As at December 31, 2004PreviouslyRestated

ReportedCurrent assets


$ 25,283,300

$ 25,283,300Property and equipment

62,396,316

63,520,202Other assets


2,658,688

2,658,688Total assets


$ 90,338,304

$ 91,462,190Liabilities



$ 68,800,517

$ 68,800,517Share capital


14,027,504

14,027,504Retained earnings


7,562,432

8,686,318Due from shareholder/comp loss

(52,149)

(52,149)Total equity


21,537,787

22,661,673Total liabilities and equity

$ 90,338,304

$ 91,462,190



Three months ended September 30, 2004

Nine months ended

September 30, 2004Previously



PreviouslyRestated

Reported

Restated

ReportedNet Sales


$ 7,315,889

$ 7,315,889

$ 21,791,874

$ 21,791,874Cost of sales

3,629,896

3,629,896

10,871,180

10,871,180Gross profit

3,685,993

3,685,993

10,920,694

10,920,694Operating expenses

1,752,931

1,752,931

4,353,012

4,353,012Income from operations
1,933,062

1,933,062

6,567,682

6,567,682Other income (expense)
(33,290)

297,148

(37,198)

1,127,777Income before taxes

1,899,772

2,230,210

6,530,484

7,695,459Income tax expense

67,168

67,168

419,578

419,578Net income

$ 1,832,604

$ 2,163,042

$ 6,110,906

$ 7,275,881Net Income per share
$ 0.04

$ 0.05

$ 0.14

$ 0.16



29






DRAGON PHARMACEUTICAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004

(UNAUDITED) Expressed in US Dollars







Three months ended March 31, 2005PreviouslyRestated

ReportedNet Sales


11,828,663

11,828,663Cost of sales

8,619,484

8,619,484Gross profit

3,209,179

3,209,179Operating expenses

2,392,040

2,397,716Income from operations
817,139

811,463Other income (expenses)
620,363

620,363Income before taxes

1,437,502

1,431,826Income tax expense

196,746

196,746Net income

1,240,756

1,235,080Net Income per share
$ 0.02

$ 0.02





30






Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview



The following discusses the Companys financial condition and results of operations for the three and nine months ended September 30, 2005 based upon the Companys interim unaudited consolidated financial statements which have been prepared in accordance with the United States generally accepted accounting principles. It should be read in conjunction with the Companys audited financial statements and the notes thereto and other financial information included in the Companys Form 10-KSB for the fiscal year ended December 31, 2004. Due to the fact that Dragons acquisition of Oriental Wave Holding Limited (Oriental Wave) on January 12, 2005 is deemed to be a reverse-take-over transaction, the following discussion reflects the Companys results of operations for the three and nine months ended September 30, 2005, including the results of Oriental Wave for the full nine months and the
results of Dragons biotech business for the period of January 12, 2005 to September 30, 2005. Comparatively, the results of operations for the three and nine months ended September 30, 2004 only reflected the Pharma and Chemical businesses of Oriental Wave.



Incorporated in Florida, USA and headquartered in Vancouver, B.C., Canada, Dragon, prior to the acquisition of Oriental Wave, was formed for the purpose of developing, marketing and selling biologics such as Erythropoietin (EPO) in China and international markets outside of China. Through its wholly-owned drug manufacturing company Nanjing Huaxin Bio-pharmaceutical Co., Ltd. (Nanjing Huaxin) located in Nanjing City, China, Dragon manufactures and sells EPO. Dragons EPO has been approved and marketed in nine countries including China, India, Egypt, Brazil, Ecuador, Dominican Republic, Trinidad-Tobago, Peru, and Kosovo. In addition, we are preparing to enter the European market upon obtaining product approval of our newly developed EPO products.



On January 12, 2005, the Company or (Dragon) completed the acquisition of Oriental Wave Holding Ltd. ("Oriental Wave") in a reverse take over transaction. Dragon acquired all of the outstanding shares of Oriental Wave from Mr. Yanlin Han, Mr. Zhanguo Weng and Ms. Xuemei Liu. As a result of the acquisition, Mr. Han, Mr. Weng and Ms. Liu collectively owned 68.35% of Dragons outstanding shares of common stock at the date of the transaction. Oriental Wave, through its wholly owned subsidiary in China, Shanxi Weiqida Pharmaceutical Ltd. (Shanxi Weiqida), currently has three production facilities in China: two Chinese State Food and Drug Administration (SFDA) certified GMP production facilities consisting of a pharmaceutical facility with a capacity of producing 1.6 billion tablets and capsules, 80 million injectables and 10 million suppositories per year and a chemical
plant producing clavulanic acid. In addition, Oriental Wave has a third facility producing 7-ACA, an intermediate for Cephalosporin antibiotics by a fermentation process. As an intermediate, the 7-ACA facility doesnt require GMP certification. Oriental Wave currently has a total of approximately 318 drug approvals from the SFDA of which 99, mainly anti-infectious drugs, were actively exploited in China and India.



As a result of the acquisition of Oriental Wave, Dragon has been transformed into a diversified and growth oriented generic pharmaceutical company with three key business units consisting of a Biotech division for biologics products, such as Erythropoietin or EPO, a Chemical division for bulk pharmaceutical chemical and intermediate such as Clavulanic Acid and 7-ACA and a Pharma division for formulated drugs, including prescription and over-the-counter drugs, and sterilized bulk drugs. Through the acquisition, the Company has significantly increased the size of operations and now has four manufacturing facilities in Datong China, approximately 1,800 employees, with over 1,200 contract sales representatives in China, and approximately 61 key products in 99 different dosages and presentations



31
currently in the market. The Company now operates its three business divisions: a Pharma Division, a Chemical Division, and a Biotech Division, through two indirect wholly-owned subsidiaries in China, Shanxi Weiqida Pharmaceutical Ltd. (Shanxi Weiqida) and Nanjing Huaxin Bio-pharmaceutical Co., Ltd. (Nanjing Huaxin). The Company maintains a sales network of over 1,200 commissioned sales representatives in 63 contracted sales offices throughout China for Pharma products sales and marketing, while it uses a direct sales model through the in-house sales department to sell Chemical products to other domestic and international pharmaceutical companies. The Companys product development department in China works on R&D of new generic products and regulatory affaires of new products, presentations, and dosages approval, and cooperates with external research institutes and companies to develop new
products as well. 200 commissioned sales representatives in The Companys headquarters, located in Vancouver, has a finance department for financial reporting, SEC compliance, corporate finance and investor relations, an international sales department for international sales and marketing, a regulatory affairs department for international product approval, and a business development department for exploring new business opportunities. The Company also operates a European office on product development of new EPO for European market, Chemical bulk drugs and formulation drugs, technology acquisition, and international sales.



Pharma Division



The Pharma Divisions operations are located in the Datong Economic and Technology Development Zone, Datong City, Shanxi Province, China. Pharma Division produces chemical generic, mainly anti-infectious, drugs. The Pharma Division currently holds approximately 318 product approvals from the Chinese drug approval authority (SFDA), of which only 86 prescription, over-the-counter and sterilized bulk products are currently commercialized in China. The Company is in the final stage of completing a new workshop for the freeze-drying of temperature sensitive pharmaceutical products. (See liquidity section) Among these products is Levofloxacin, a product marketed by the Company whose production is currently outsourced to a third party contract manufacturer. The Pharma Division operates its business strategies to focus on the expansion and development of the Chinese market by managing its product portfolio
and selecting potential products for commercialization, to strengthen R&D and introduce generic drugs with market potential through cooperation and acquisition, and to conduct market research and product development for preparing the launching of OTC product branding strategy.



Chemical Division



The Chemical Divisions operations are located on Datong Gongnong Road, Datong City, Shanxi Province, China. The Chemical Division produces the bulk intermediate or ingredient to sell to other pharmaceutical companies for further processing and formulation into finished products. The Chemical Division manages the production of Clavulanic Acid, 7-ACA, and Abamectin for both the Chinese and the international markets. In January 2004, the Chemical Division began its operation of a production facility for Clavulanic Acid, and in July 2004, began producing 7-ACA. One of the key products in Chemical Division is Clavulanic Acid, a drug that combines with antibiotics to fight drug resistance. Dragon is currently the sole commercial producer of Clavulanic Acid in China. Two Clavulanic Acid products were approved for export to India and initial quantities of these two products to India were shipped in 2004.
Another key product in the Chemical Division is 7-ACA, an intermediate for Cephalosporin antibiotics. The 500-ton production capacity of 7-ACA positions Dragon among the main producers in the world. The export of 7-ACA to India commenced in 2004. In 2004, Dragons Chemical Division entered into a 3-year long term supply agreement with Aurobindo Pharma Limited, an Indian pharmaceutical company, to sell 50% of the products from Chemical Division. The Chemical Division operates its business strategies to upgrade its technology in order to improve yields and lower production



32
cost, to develop 7-ACA and Clavulanic Acid downstream bulk products, and to apply for DMF approvals in the US and EU to enter into international market.



Biotech Division



The Biotech Divisions operations are currently located in Nanjing City, Jiangsu Province, China. The sole product of the Biotech Division is Erythropoietin or EPO, an injection that stimulates red blood cell development. EPO is the best selling drug in the world with a market size of US$10 billion in 2004. Dragons EPO is the generic version of the originators product. Dragons Biotech Division develops, manufactures and markets generic biotech products with China and developing countries as the current core markets, and has already been approved and sold in 9 countries: China, India, Egypt, Brazil, Peru, Ecuador, Trinidad-Tobago, Dominican Republic and Kosovo. Currently, Dragons EPO only competes in countries where there is no patent protection. Dragon is in preparing to enter the European market with a new EPO product under development in Austria. The Company is also in the
final stage of completing a new EPO production facility in Datong city, China and will relocate the EPO production from its current facility in Nanjing city. The new EPO production site is adjacent to the campus of the Chemical division, which already includes the entire basic infrastructure such as power, steam, purified water supply and water treatment facilities. The relocation of the EPO production site to Datong will allow the Company to capitalize on the existing production infrastructure and the efficiency of unified operational management. In the new facility, it is anticipated that the capacity for bulk EPO will be doubled and the capacity for sterile vialing will be tripled. The Biotech Division operates its business strategies to increase market share through the integration of its sales network, to increase the sales in surgical usage as one of the two approved surgical indication suppliers, and to enter into European and other developed countries market with product developed in Europe.



Critical Accounting Policies and Estimates and Recent Accounting Pronouncements



The accompanying managements discussion and analysis of results of operations and financial condition are based upon the Dragons consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. Management evaluates estimates on an ongoing basis. Management bases its estimates on historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ materially from these estimates under different assumptions or conditions.



A summary of significant accounting policies and a description of accounting policies that are considered critical are described in Note 1 to the Consolidated Financial Statements contained in this report and in Note 3 to the Dragons Annual Report on Form 10-KSB for the year ended December 31, 2004. In addition, a description of Recent Accounting Pronouncements is contained in Note 1(T) to the Consolidated Financial Statements contained in this report and in Note 3(r) to the Consolidated Financial Statements to the Corporations Annual Report on Form 10-KSB for the year ended December 31, 2004.





33
Results of Operations



Results of Operations for the Three and Nine Months Ended September 30, 2005 and 2004



Sales.



Sales for the three months period ended September 30, 2005 increased 82% to $13.34 million from $7.32 million for the same period in 2004. $10.70 million or approximately 80% of the sales for the three months period ended September 30, 2005 were generated from the sales of products in the Chinese market, and the remaining $2.64 million or approximately 20% were generated from the sales of products in the international markets. All sales for the three months period ended September 30, 2004 were generated from the sale of products in the Chinese market. In the three months ended September 30, 2005, $6.06 million or approximately 45% of the sales were from the Pharma Division, $5.98 million or 45% of sales were from the Chemical Division, and $1.30 million or 10% of sales were from the Biotech Division. For the same period in 2004, 85% of sales were from the Pharma Division and 15% of sales were from the
Chemical Division which commenced operation on January 1, 2004.



Sales for the nine months period ended September 30, 2005 increased 68% to $36.52 million from $21.79 million for the same period in 2004. $31.31 million or approximately 86% of the sales for the nine months period ended September 30, 2005 were generated from the sales of products in the Chinese market, and the remaining $5.21 million or approximately 14% were generated from the sales of products in the international markets. All sales for the nine months period ended September 30, 2004 were generated from the sale of products in the Chinese market. In the nine months period ended September 30, 2005, $17.07 million or approximately 47% of the sales were from the Pharma Division, $16.56 million or 45% of sales were from the Chemical Division, and $2.88 million or 8% of sales were from the Biotech Division. For the same period in 2004, 89% of sales were from the Pharma Division and 11% of sales were from
the Chemical Division which commenced operation on January 1, 2004. The increase in sales during the three and nine months ended September 30, 2005 as compared to the same period for the prior year was primarily due to increase in sales from the Chemical and Biotech Division.



Cost of sales for the three months ended September 30, 2005 was $10.26 million compared to $3.63 million for the same period of 2004. The cost of sales is attributed to the production costs of Dragons pharmaceutical products with the increase in the cost of sales related to the growth in products and sales in the Chemical Division. Gross profit and gross margin for the three months ended September 30, 2005 were $3.08 million and 23% compared to $3.69 million and 50% for the same period of 2004.



Cost of sales for the nine months ended September 30, 2005 was $27.05 million compared to $10.87 million for the same period of 2004. Gross profit and gross margin for the nine months ended September 30, 2005 were $9.47 million and 26% compared to $10.92 million and 50% for the same period of 2004. The decrease in gross margin was mainly due to a change in the product mix from the previous year with the significant increase in the Chemical Division revenues. The Chemical Division, whose facilities were brand new in 2004 and is currently at the ramp up stage of the production which incurs higher production and operation cost, especially depreciation expenses, increased the cost of sales significantly during the three and nine months ended September 30, 2005.





34
Divisional Revenues and Gross Margin Analysis

The Companys businesses are organized under three business divisions: Pharma Division, Chemical Division and Biotech Division.



Pharma Division



Pharma Divisions revenues for the three months ended September 30, 2005 were $6.06 million, accounting for 45% of the total revenues of the Company. Comparatively, Pharma Divisions revenues were $6.24 million for the same period in 2004, contributing 85% of the total revenues of the Company. Pharma Divisions revenues for the nine months ended September 30, 2005 were $17.07 million, accounting for 47% of the total revenues of the Company. Comparatively, Pharma Divisions revenues were $19.33 million for the same period in 2004, contributing 89% of the total revenues of the Company. The lowering of percentage of revenues from the Pharma division to the Company was due to the tremendous growth of the brand new Chemical division achieved during the three and nine months ended September 30, 2005. The overall gross margin for the division for the three months ended September 30, 2005
was 40% as compared to 53% for the same period of 2004, and the overall gross margin for the division for the nine months ended September 30, 2005 was 43% as compared to 52% for the same period of 2004. The lowering of revenues and gross profit was mainly due to a change in sales model for Pharma Division products. The company implemented a new sales model for Pharma Division products to recognize selling prices and gross profits lower than those under the original sales model but, under the sales model, the Company also lowers the selling expenses with a faster payment collection cycle which will be reflected in lower account receivables.

Chemical Division

Chemical Divisions revenues for the three months ended September 30, 2005 were $5.98 million, representing a 454% increase from the revenues of 1.08 million during the same period in 2004. Chemical Divisions revenues for the nine months ended September 30, 2005 were $16.56 million, representing a 573% increase from the revenues of $2.46 million during the same period in 2004. The increase is due to the introduction of 7-ACA and the expansion of Clavulanic Acid sales outside China. The Chemical division was new in 2004 as only the Clavulanic Acid facility had started production and the sales during the first nine months of 2004 were only made to Chinese customers. Since then, the Company started the pilot production of the 7-ACA production facility and the Company has received export permits to sell two Clavulanic Acid products to the Indian market.



Chemical Divisions gross margin for the three and nine months ended September 30, 2005 was -3.79% and -0.04%, respectively, compared to 36% and 34% for the three and nine months ended September 30, 2004, respectively. The gross margin for the division was low as the Company has increased and expanded the infrastructure, and the fixed manufacturing costs associated, but is still in the process of ramping up production to cost efficient levels. The initial Chemical Division production in 2004 was limited to Clavulanic Acid and was produced with older, smaller scale production infrastructure. The Company constructed the new production infrastructure (power, steam, purified water supply and water treatment) during 2004 as the old production infrastructure was insufficient to produce the amount of Clavulanic Acid and 7-ACA desired. The new facilities have greatly increased production capacity but also
have significantly higher fixed costs in the form of depreciation cost ($1.11 million and $0.42 million for the three months ended September 30, 2005 and 2004, respectively and $3.23 million and $1.03 million for the nine months ended September 30, 2005 and 2004, respectively) of the new facilities constructed and overhead of the utilities costs to power the new facilities. These fixed costs are expected to fall significantly, on a percentage basis, when the anticipated production levels are achieved.



35
Biotech Division



Biotech Divisions revenues for the three and nine months ended September 30, 2005 were $1.30 million and $2.88 million, respectively, representing 10% and 8% of the Companys revenues for these periods, respectively. Gross margin for the three and nine months ended September 30, 2005 was at 66% and 73%, respectively. The acquisition of Oriental Wave by Dragon completed on January 12, 2005 was accounted for as a reverse-take-over transaction. As a result, only revenues from the Biotech Division from January 12, 2005 to September 30, 2005 were included in the Companys revenues for the first nine months of 2005 and no revenues from the Biotech Division were included in the 2004 financials.



On a pro-forma basis (assuming the reverse-take-over had occurred at the beginning of the year), for the three and nine months ended September 30, 2005, Biotech Divisions revenues were $1.30 million and $3.03 million, respectively, representing a 23% and 7% increase, respectively, from the same period of 2004. The increase in total sales for the three and nine months ended September 30, 2005 mainly came from the increase in the sales in the Chinese market. The international sales outside of China for the three months ended September 30, 2005 was about the same as the same period of 2004, while the 3% increase in international sales for the nine month ended September 30, 2005 contributed to the 7% increase in the total sales compared to the same period of 2004.



Biotech Divisions pro-forma gross margin for the three months ended September 30, 2005 was 66% compared to 73% for the same period of 2004. The decrease in gross margin was mainly due to a special sale to an international customer. The company recognized 30% of the sales ($32,400), being the non-refundable cash amount recorded by the company, and 100% of the cost of sales. The remaining 70% of the sales ($75,600), with no additional cost of sales, would be recognized subject to the award of a government tender to that customer. For the nine months ended September 30, 2005, Biotech Divisions pro-forma gross margin was 73% compared to 75% for the same period of 2004. The decrease in gross margin of international sales for the three months ended September 30, 2005 contributes the decrease of gross margin for the nine months ended September 30, 2005.



Other Income / ExpenseDuring the three months ended September 30, 2005, the Company recognized other expense of $0.32 million, consisting mainly of interest expense of $0.29 million, compared to other expense of $0.03 million for the same period of 2004.



During the nine months ended September 30, 2005, the Company recognized $0.01 million of other income. This amount primarily consisted of $0.89 million from funds released by a Chinese Government Liquidator related to Datong Pharmaceutical, which was offset by interest expense of $0.84 million. The other expense for the nine months ended September 30, 2004 was 0.04 million.



Expenses.Total operating expenses were $2.84 million for the three months ended September 30, 2005. The major category of operating expenses was General and Administration expenses of $1.38 million, Selling expense of $1.17 million, and Depreciation and Amortization expenses of $0.29 million. Total operating expenses were $1.75 million for the three months ended September 30, 2004. The major category of operating expenses was General and Administration expenses of $0.72 million, Selling expense of $0.92 million, and Depreciation and Amortization expenses of $0.11 million. During the three months ended September 30, 2005, the General and Administration expenses included $0.59 million for salaries, compensation and benefits, $0.20 million for travel and entertainment expenses and $0.15million



36
for rent compared to $0.24 million for salaries, compensation and benefits and $0.12 million for travel and entertainment expenses, and $0.05 million for rent for the same period of 2004.



Total operating expenses were $8.00 million for the nine months ended September 30, 2005. The major category of operating expenses was General and Administration expenses of $3.59 million, Selling expense of $3.60 million, and Depreciation and Amortization expenses of $0.81 million. Total operating expenses were $4.35 million for the nine months ended September 30, 2004. The major category of operating expenses was General and Administration expenses of $1.31 million, Selling expense of $2.84 million, and Depreciation and Amortization expenses of 0.20 million. During the nine months ended September 30, 2005, the General and Administration expenses included $1.67 million for salaries, compensation and benefits, $0.55 million for travel and entertainment expenses and $0.35 million for rent compared to $0.38 million for salaries, compensation and benefits and $0.32 million for travel and entertainment
expenses, and $0.06 million for rent for the same period of 2004.



The increase in operating expenses of $1.09 million and $3.65 million, respectively, for the three and nine months ended September 30, 2005 as compared to the same period for the prior year reflects the increased overhead related to the operations of both the Pharma and Chemical Divisions in 2005 (compared to just the Pharma Division and one of the two facilities of the Chemical Division in 2004) and the addition of the Biotech operations and the head office in Vancouver. In addition, depreciation and amortization expense increased during the three and nine months ended September 30, 2005 due to the increase in fixed assets of the Chemical Division in 2005.



Net Income.Dragon had a net loss of $0.19 million for the three months ended September 30, 2005 compared to a net income of $1.83 million for the same period in 2004. For the nine months ended September 30, 2005, Dragon had a net income of $1.05 million compared to $6.11 million for the same period in 2004.



Comprehensive Income.Dragon had foreign currency translation income of $0.62 million as other comprehensive income for the three and nine months ended September 30, 2005. The foreign currency translation income results from translation of the financial statements expressed in RMB to United States Dollar.



On July 22, 2005, the Chinese government decided to no longer peg the value of the Renminbi to the US dollar but rather to a basket of currencies of its largest trading partners. The result was an appreciation of the Renminbi of approximately 2% against the value of the US dollar. The effect of the revaluation was an increase in the assets, liabilities, revenues and expenses of the Company and a foreign currency gain included in comprehensive income.



Basic Net Income Per Share.Dragons net income per share has been computed by dividing the net income for the period by the weighted average number of shares outstanding during the same period. Net income per share for the three and nine months ended September 30, 2005 was $0.00 and $0.02 per share, respectively, and for the three and nine months ended September 30, 2004 was $0.04 and $0.14 per share, respectively. The weighted average number of shares outstanding during three and nine months ended September 30, 2005 was 62,878,004 and 62,070,269, respectively, and was 44,502,004 shares during three and nine months ended September 30, 2004. The outstanding common stock options have no significant dilutive effect on the weighted average number of shares outstanding.



Dividends of the PRC subsidiary may only be distributed after allowance has been made for i) recovery of losses, if any; ii) allocations to the statutory common reserve fund; iii) allocations to the



37
statutory common welfare fund; and iv) allocations to a discretionary common reserve fund if approved by the shareholders. Under current regulation, the minimum and maximum aggregate allocations to the statutory funds are 15% and 20%, respectively, of our net income determined in accordance with PRC accounting rules. However, once the aggregated amount of statutory common reserve fund equals 50% of the Companys registered capital, no further contributions to the fund need to be made. As at September 30, 2005, the Companys statutory common reserve fund is $10.69 million, 44% of the Companys registered capital.



Liquidity and Capital Resources



As of September 30, 2005, Dragon had current liabilities of $31.97 million and current assets of $28.48 million, including cash balance of $3.34 million and accounts receivables of $6.61 million. Its working capital deficiency is mainly due to the additional bank loan and payables incurred to finance its working capital requirement for the Chemical Division and investment in the new EPO workshop and Freeze-dry Injectable workshop.



As of September 30, 2005, Dragon had current liabilities of $31,971,385 as follows:



Accounts Payable

$4,390,198Accrued Retirement Benefits  current portion

$96,607Other Payables and Accrued Expenses

$17,980,097Due to Related Companies

$184,182Notes payable

$ 2,331,399Loans Payable-Short Term:Loan payable to a bank, interest rate of 8.874% per annum, guaranteed by a third party, due October 2005
$616,523Loan payable to a bank, interest rate of 6.138% per annum, secured by fixed assets of $5,127,329, due November 2005
$3,699,137Loan payable to a bank, interest rate of 6.039% per annum, secured by leasehold land and fixed assets of $3,110,259, due April 2006
$1,849,568Loan payable to a bank, interest rate of 7.254% per annum, secured by leasehold land and fixed assets of $1,224,636, due September 2006
$616,523Loan payable to a bank, interest rate of 7.254% per annum, secured by leasehold land and fixed assets of $718,272, due September 2006
$207,152Loans Payable - Short Term Subtotal

$6,988,903Total Current Liabilities

$31,971,386

The Accounts payable were incurred as part of the normal course of business of Dragon while other payables and accrued expenses were incurred as part of the investment in establishing the Chemical Division.



As of September 30, 2005, Dragon had outstanding short-term loans (less than one year term) totaling $6.99 million. Dragon believes that it will be successful in the renegotiating loans due based on



38
the assumption that the Company has enhanced its ability to generate additional cash flow from its operation since the loans were originally entered into. Since then, the Company's Chemical Division commenced production and began generating revenues and cash flow. Further, it entered into a three-year long term supply contract with Aurobindo Biopharma to supply specified amounts of Clavulanic Acid and 7-ACA produced from its Chemical Division.



Long-term Liabilities:



At September 30, 2005, Dragon had long-term liabilities of $35,672,354 as follows:



Long-term accounts payable

$21,729,744Long-term retirement benefits

$712,030Loan Payable  Long TermLoan payable to a bank, interest rate of 5.76% per annum, secured by fixed assets of $9,724,355, due November 2006
$6,448,829Loan payable to a bank, interest rate of 6.039% per annum, secured by leasehold land and fixed assets of $3,773,926, due April 2007
$6,781,751Loan Payable  Long Term

$13,230,580Total Long-term Liabilities

$35,672,354

As of September 30, 2005, the Company had long-term retirement benefits of $0.71 million, which was incurred in July 2003 when Shanxi Weiqida acquired land and buildings from a government liquidator in exchange for assuming certain future employment, healthcare and land acquisition costs of the factory and its former employees during July 2003. The Company is required to pay certain minimum wages and health care costs until the date of their employment, retirement or death, whichever occurs first. The total amount of the liabilities assumed on the closing date was $8.90 million, which approximated the appraised value of the land. As of September 30, 2005, Shanxi Weiqida had employed 655 former employees, and 236 former employees have retired. Shanxi Weiqida has calculated the related asset value by computing the net present value of the future expected payments to the remaining 163 employees assuming an
interest rate of 3%. As of September 30, 2005, 163 former employees of Datong Pharmaceutical remained as the obligation of Dragon.



Dragon had long-term loans payables (one to two years) totaling approximately $13.23 million of which $6.45 million which will be due November 2006 and $6.78 million due April 2007, in addition to long-term account payables of $21.73 million which will become due between June 2007 and December 2008.



During the nine months ended September 30, 2005, Dragon financed its operations, development of its new EPO and freeze-dry injectable facilities, and increased production level at its Chemical Division through operating revenues, accounts payables and short-term loans.  The Company had anticipated that it would increase its production level through an equity financing.  However, as discussed below, the anticipated financing has taken longer than expected.  As a result, Dragon was not able to increase its production level as quickly as anticipated.  However, during July 2005, Dragon was able to increase its production level of 7-ACA, one of the key products of the Chemical Division, from 30% to 80% and believes that its sales of the Chemical Division will increase.  In addition, certain vendors of Shanxi Weiqida have agreed to convert a total of $9.92 million receivables into
Dragon common stock upon the acceptance by Dragon.  Finally, in August 2005, Dragon received verbal approval of an approximately $3.6 million loan subject to completion of loan agreements.  Dragon intends to seek additional equity to improve its financial position.



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Further, as previously announced, Dragon intended to seek up to $25 million through the sale of its equity securities to accredited investors on a private basis.  The process to raise additional capital has taken longer than anticipated.  However, Dragon is in discussions with certain institutional investors who may be interested in investing in Dragon.  No assurance can be given that Dragon will be able to raise additional capital through the sale of its equity securities The Company has taken steps to improve its negative working capital and liquidity position and believes that it will be successful. However, no assurance can be given that Dragon will be successful in completing its plan. In the event the Company is not successful in improving its negative working capital and liquidity position, the Company may required to reduce its operations or take other alternatives. Accordingly,
Dragon's business and operations will be adversely affected.



Restatement



As a result of a review of its accounting policies and applicable accounting pronouncements, the Company has concluded that the reduction of a future retirement benefit obligation related to the acquisition of a land use right from a former state-owned enterprise in China by Oriental Wave Holding Limited (Oriental Wave) in July 2003, should have been accounted for as a reduction to the recorded cost of the land use right instead of as a non-operating gain from extinguishment of debt, as previously disclosed in Oriental Waves 2004 financial statements. As a result, Oriental Waves 2004 financial statements have been restated to reflect such change in accounting treatment.



The reduction of the future retirement benefit obligation during 2004, totaling $1,135,238 million, which was recognized as a non-operating gain, has been recorded as a reduction to the cost of the land use right, resulting in a reduction of depreciation expense of $11,352 during 2004.. The Land Use Rights have been further reduced by $28,149 during the period ended September 30, 2005 and, o n a going forward basis, any similar reduction of the retirement benefit obligation will be treated as a reduction to the recorded cost of the land use right.



Since Oriental Waves 2004 financial results became the opening balance of Dragons 2005 financials due to the reverse merger in January 2005, the Company has also restated its financial statements for the three months ended March 31, 2005 to reflect the impact from the restatement of Oriental Waves 2004 financial statements. As a result of this restatement, Dragons net income for the three months ended March 31, 2005 increased by $5,676 to $1,240,756, and total assets decreased by $1.12 million to $96.15 million at March 31, 2005, equivalent to 1.15% of total assets prior to the restatement. Earnings per share of $0.02 did not change for the three months ended March 31, 2005.



The restatement involved the accounting treatment of a non-cash transaction during the year ended December 31, 2004 and the three months ended March 31, 2005. The restatement did not have an effect on the cash flow or liabilities of the Company. As a result of the restatement, future amortization expense with respect to the land use right will decrease accordingly over the 50 year amortization period.



Item 3.
Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of



40
the design and operation of our disclosure controls and procedures (as defined by Exchange Act Rule 13a-15(e)) as of the end of our third fiscal quarter pursuant to Exchange Act Rule 13a-15(b)), and concluded that Dragons disclosure controls and procedures are effective to ensure that information required to be disclosed in Dragons reports filed with the Securities and Exchange Commission pursuant to the Exchange Act is accumulated and communicated to management, including Dragons Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, as of the end of the period covered by this report, the Chief Executive Officer and Chief Financial Officer concluded that Dragons disclosure controls and procedures were effective in recording, processing, summarizing and reporting information required to be disclosed by Dragon within the time periods specified in the Securities and Exchange
Commissions rules and forms.



There have been no changes in our internal control over financial reporting that occurred during such quarter 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

The Company is not currently involved in any legal proceedings.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.

None

Item 3.
Defaults Upon Senior Securities.

None

Item 4.
Submission of Matters to a Vote of Security Holders.

On August 12, 2005, we held our annual meeting of shareholders. The following proposals were presented and adopted by our shareholders.



Proposal
For
Against
Abstain1. To elect directors to serve for one-year terms or until their successors have been elected and qualified:Mr. Yanlin Han
54,694,704

124,002Mr. Zhanguo Weng
54,694,704

124,002Ms. Xumei Liu
54,767,954

50,752Dr. Alexander Wick
54,696,704

122,002Dr. Yiu Kwong Sun
55,767,954

50,75241
2. To amend the Company's Certificate of Incorporation to remove Article VII which sets forth the number of directors to be more than one and less than five.
54,709,735
88,383
20,5883. To amend the Company's By-laws to set forth the range in number of directors between one and eleven with the exact number to be determined by the Board of Directors
54,717,821
88,087
12,7984. To approve the 2005 Stock Option Plan
48,657,191
382,573
30,400

Item 5.
Other Information.

None

Item 6.
Exhibits and Reports on Form 8-K.

Exhibits.



Exhibit No.



31.1
Certification by the Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

31.2
Certification by the Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

32
Certificationbythe Principal Executive and Financial Officers Pursuant to Section 906 of the Sarbanes-Oxley Act.



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SIGNATURES



In accordance with the requirements 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.



DRAGON PHARMACEUTICAL INC.(registrant)



Date: November 10, 2005
/s/ Yanlin HanYanlin Han

Chief Executive Officer





Dated: November 10, 2005
/s/ Garry WongGarry Wong

Chief Financial Officer









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