UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




þ
            
            ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the fiscal year ended December 31, 2008




OR





o
            
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the transition period
from    
to




Commission file
number 001-33537




CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.





(Exact
Name of Registrant as Specified in Its Charter)





Delaware
                  
                  20-2903562(State or Other Jurisdiction
                    of Incorporation or Organization)
                  
                  (IRS Employer
                    Identification No.)




No. 2,
Jing You Road, Kunming National Economy & Technology Developing
District,


People’s
Republic of China 650217


(Address
of Principal Executive Offices) (Zip Code)




0086-871-728-2628


(Registrant’s
Telephone Number, Including Area Code)




SECURITIES
REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:





Title
      of Each Class
              
              Name
      of Each Exchange on Which RegisteredCommon
      Stock, $0.0001 par value
              
              NYSE
      Amex Equities




SECURITIES
REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:




None.









Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes  o   No 
þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  Yes  o   No 
þ




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes þ   No o




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.     o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large Accelerated Filer   ̈
                
                Accelerated Filer   ̈
                
                Non-Accelerated Filer   ̈
                
                Smaller Reporting Company  þ





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).     ̈  Yes    þ  No





The
aggregate market value of the registrant’s issued and outstanding shares of
common stock held by non-affiliates of the registrant as of June 30, 2008
(based on the price at which the registrant’s common stock was last sold on such
date) was approximately $12,863,232.





The
number of shares outstanding of the registrant’s common stock as of
March 24, 2009 was 19,679,400.





Documents incorporated by reference:
Portions of the registrant’s Proxy Statement related to the 2009 Meeting of
Stockholders, which is expected to be filed with the Securities and Exchange
Commission on or before April 30, 2009, are incorporated by reference into
Part III of this Form 10-K.









TABLE OF
CONTENTS




PART
      I
                                                                                                                                                    
                                                                                                                                                    2ITEM
      1.
                                                                                                                                                    BUSINESS.
                                                                                                                                                    2ITEM
      1A.
                                                                                                                                                    RISK
      FACTORS.
                                                                                                                                                    14ITEM
      1B.
                                                                                                                                                    UNRESOLVED
      STAFF COMMENTS.
                                                                                                                                                    31ITEM
      2.
                                                                                                                                                    PROPERTIES.
                                                                                                                                                    31ITEM
      3.
                                                                                                                                                    LEGAL
      PROCEEDINGS.
                                                                                                                                                    31ITEM
      4.
                                                                                                                                                    SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS.
                                                                                                                                                    31PART
      II
                                                                                                                                                    
                                                                                                                                                    31ITEM
      5.
                                                                                                                                                    MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES.
                                                                                                                                                    31ITEM
      6.
                                                                                                                                                    SELECTED
      FINANCIAL DATA.
                                                                                                                                                    33ITEM
      7.
                                                                                                                                                    MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.
                                                                                                                                                    33ITEM
      7A.
                                                                                                                                                    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
                                                                                                                                                    46ITEM
      8.
                                                                                                                                                    FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA.
                                                                                                                                                    46ITEM
      9.
                                                                                                                                                    CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.
                                                                                                                                                    46ITEM
      9A.
                                                                                                                                                    CONTROLS
      AND PROCEDURES.
                                                                                                                                                    46ITEM
      9B.
                                                                                                                                                    OTHER
      INFORMATION.
                                                                                                                                                    48PART
      III
                                                                                                                                                    
                                                                                                                                                    48ITEM
      10.
                                                                                                                                                    DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
                                                                                                                                                    48ITEM
      11.
                                                                                                                                                    EXECUTIVE
      COMPENSATION.
                                                                                                                                                    49ITEM
      12.
                                                                                                                                                    SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS.
                                                                                                                                                    49ITEM
      13.
                                                                                                                                                    CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE.
                                                                                                                                                    49ITEM
      14.
                                                                                                                                                    PRINCIPAL
      ACCOUNTING FEES AND SERVICES.
                                                                                                                                                    49PART
      IV
                                                                                                                                                    
                                                                                                                                                    49ITEM
      15.
                                                                                                                                                    EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES.
                                                                                                                                                    49Signatures
                                                                                                                                                    
                                                                                                                                                    52




i




CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS




The
information contained in this report, including in the documents incorporated by
reference into this report, includes some statements that are not purely
historical and that are “forward-looking statements.” Such forward-looking
statements include, but are not limited to, statements regarding our company’s
and our management’s expectations, hopes, beliefs, intentions or strategies
regarding the future, including our financial condition, and results of
operations. In addition, any statements that refer to projections, forecasts or
other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. The words “anticipates,”
“believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,”
“might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,”
“should,” “will,” “would” and similar expressions, or the negatives of such
terms, may identify forward-looking statements, but the absence of these words
does not mean that a statement is not forward-looking.




The
forward-looking statements contained in this report are based on current
expectations and beliefs concerning future developments and the potential
effects on the parties and the transaction. There can be no assurance that
future developments actually affecting us will be those anticipated. These
forward-looking statements involve a number of risks, uncertainties (some of
which are beyond the parties’ control) or other assumptions that may cause
actual results or performance to be materially different from those expressed or
implied by these forward-looking statements, including the
following:




·
            our
      reliance on one product for over 87% of our
  revenues;


·
            our
      reliance on limited suppliers for Sanchi, a scarce plant that is the
      primary ingredient in almost all of our
  products;


·
            replacement
      of our primary product by other medicines or the removal of our primary
      product from China’s Insurance
Catalog;


·
            our
      ability to raise additional capital needed for working capital, future
      operations and research and
development;


·
            our
      ability to collect on advances to sales
  representatives;


·
            our
      reliance on our three largest customers for a significant percentage of
      our sales;


·
            our
      ability to effectively grow
management;


·
            our
      dependence on key personnel;


·
            our
      ability to establish and maintain a strong
  brand;


·
            the
      ability of our products to effectively compete with those of our
      competitors;


·
            continued
      receipt and maintenance of regulatory approvals, certificates, permits and
      licenses required to conduct business in
China;


·
            our
      ability to collect on trade
receivables;


·
            our
      ability to develop and market new products, including those with high
      profit margins;


·
            subjection
      of additional products to price controls by the Chinese
      government;


·
            our
      ability to obtain all necessary government certifications and/or licenses
      to conduct our business;


·
            protection
      of our intellectual property
rights;


·
            loss
      of certain tax concessions;


·
            our
      lack of insurance to cover losses due to fire, casualty or
      theft;


·
            changes
      in the laws of the PRC that affect our
  operations;


·
            changes
      in the foreign currency exchange rate between U.S. dollars and
      Renminbi;


·
            cost
      of complying with current and future governmental regulations and the
      impact of any changes in the regulations on our
  operations;


·
            the
      effect on our operations of costs associated with the Restatement,
      including litigation costs;


·
            a
      downturn in the economy of the PRC or inflation in the
  PRC;


·
            our
      ability to establish and maintain adequate management, legal and financial
      controls, including effective internal controls over financial
      reporting;


·
            volatility
      of the market for our common stock;


·
            the
      possibility of substantial sales of our common
  stock;


·
            influence
      of our principal stockholder;


·
            cooperation
      of the minority shareholder of our principal operating subsidiary;
      and


·
            other
      factors referenced in this report, including, without limitation, under
      the sections entitled “Risk Factors,” “Management’s Discussion and
      Analysis or Plan of Operation,” and “Description of
    Business.”




1




The risks
included above are not exhaustive. Other sections of this report may include
additional factors that could adversely impact our business and operating
results. Moreover, we operate in a very competitive and rapidly changing
environment. New risk factors emerge from time to time and we cannot predict all
such risk factors, nor can we assess the impact of all such risk factors on our
business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward looking
statements.




You
should not rely upon forward-looking statements as predictions of future events.
We cannot assure you that the events and circumstances reflected in the
forward-looking statements will be achieved or occur. Although we believe that
the expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Moreover, neither we nor any other person assume responsibility
for the accuracy and completeness of the forward-looking statements. Except as
required by law, we undertake no obligation to update publicly any
forward-looking statements for any reason after the date of this report to
conform these statements to actual results or to changes in our
expectations.




You
should read this report, and the documents that we reference in this report and
have filed as exhibits to this report with the Securities and Exchange
Commission, completely and with the understanding that our actual future
results, levels of activity, performance and achievements may materially differ
from what we expect. We qualify all of our forward-looking statements by these
cautionary statements.




PART
I




ITEM
1. BUSINESS.




Unless
the context otherwise requires, the terms “Shenghuo,” the “Company,” “we,” “us,”
or “our” as used throughout this report refer to China Shenghuo Pharmaceutical
Holdings, Inc., our 94.95%-owned subsidiary Kunming Shenghuo Pharmaceutical
(Group) Co., Ltd. (“Shenghuo China”) and the three foreign owned subsidiaries of
Shenghuo China that are organized under the laws of the People’s Republic of
China (“PRC” or “China”).




Overview




We are
primarily engaged in the research, development, manufacture, and marketing of
pharmaceutical, nutritional supplement and cosmetic products. Almost all of our
products are derived from the medicinal herb Panax notoginseng, also known as
Sanqi, Sanchi or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow
plant that only grows in a few geographic locations on Earth, one of which is
Yunnan Province in southwest China, where our operations are located. The main
root of Panax notoginseng are cylindrical shaped and are most commonly one to
six centimeters long and one to four centimeters in diameter. Panax notoginseng
saponins (PNS), the active ingredient in Panax notoginseng, is extracted from
the plant using high-tech equipment and in accord with Good Manufacturing
Practice (GMP) standards. Our main product, Xuesaitong Soft Capsules, accounted
for approximately 87% of our sales for the year ended December 31,
2008.




Since our
establishment, we have focused primarily on the development of products to serve
three major markets—cardiovascular and cerebrovascular disease, peptic ulcer
disease and health products. Our goal has been to focus on the development of
pharmaceutical products and over the counters products based on traditional
Chinese medicines designed to address these areas.




2




Market
Focus




Since our
establishment, we have focused primarily on the development of products to serve
three major markets—cardiovascular and cerebrovascular disease, peptic ulcer
disease and health products. Our goal has been to focus on the development of
pharmaceutical products and over the counters products based on traditional
Chinese medicines designed to address these areas.




·
            Cardiovascular
      and Cerebrovascular Disease.  Hyperlipemia, which is high
      circulating blood levels of fats such as cholesterol and triglycerides,
      has ranked high on the list of modern health diseases. The primary effect
      of hyperlipemia is the development of cardiovascular and cerebrovascular
      diseases, including heart attacks and
strokes.




·
            Peptic
      Ulcer Disease.  A peptic ulcer is an erosion of the
      lining of the stomach or the upper part of the small intestine. The
      causative factors may include excess stomach acid, excess pepsin,
      Helicobacter Pylori infection, poor health and eating habits, and
      psychological stress. There is no radical cure for peptic ulcers, which
      may eventually lead to gastric hemorrhage, gastric perforation and even
      cancer. People of all ages can be affected by peptic ulcers, but they are
      most prevalent in persons between the ages of 45 and 55, with incidences
      in men being slightly higher than in
women.




·
            Health and
      Food Products.  The health products industry, which
      consists of non-prescription traditional Chinese medicines and
      supplements, has grown as a result of quality improvements in products and
      the introduction of new products to the market in China. Over the past two
      decades, health product sales in Chinese urban areas have increased. The
      Chinese Ministry of Health has approved several uses for health products
      and a substantial number of the products on the market are designed to aid
      in immunoregulation, blood fat regulation and fatigue resistance. In
      addition, China’s market for cosmetics products is one of the largest in
      Asia and within the top ten in the
world.




3




Products




We are
primarily engaged in the research, development, manufacture, and marketing of
pharmaceutical, nutritional supplement and cosmetic products. Almost all of our
products are derived from the medicinal herb Panax notoginseng, also known as
Sanqi, Sanchi or Tienchi. Panax notoginseng is a greyish-brown or greyish-yellow
plant that only grows in a few geographic locations on Earth, one of which is
Yunnan Province in southwest China, where our operations are located. The main
root of Panax notoginseng are cylindrical shaped and are most commonly one to
six centimeters long and one to four centimeters in diameter. Panax notoginseng
saponins (PNS), the active ingredient in Panax notoginseng, is extracted from
the plant using high-tech equipment and in accord with Good Manufacturing
Practice (GMP) standards.




Pharmaceutical
Products




Our
pharmaceutical product, Xuesaitong Soft Capsule, is marketed under the Lixuwang
brand name and other products are marketed under the Shenhuo brand name, which
has been granted Famous Trademark status in Yunnan Province. Famous Trademark is
granted by the Administration of Industry and Commerce of Yunnan Province after
being approved by the Provincial Brand Attestation Council. This trademark
represents that the Company and its products have the key support of the
provincial government of Yunnan Province as a provincial leading enterprise and
its product has a strong reputation in quality, after-sale services and market
sales.   The following is a list of our approved pharmaceutical
products and their intended uses:





Product
      Name
              
              Intended
      UseXuesaitong
      Soft Capsules
              
              Designed
      to invigorate the circulation of blood and improve microcirculation. Used
      for the treatment of symptoms of cardiovascular and cerebrovascular
      disease, such as angina pectoris, strangulation, squeezing and crushing of
      chest, acute and chronic peripheral vascular-metabolic disorders, brain
      occlusion, occlusion of retina central vein, acute and chronic cerebral
      vascular-metabolic disorders caused by arteriosclerosis. This product
      accounted for approximately 87% of our sales for the year ended December
      31, 2008.Qiye
      Shen’an Tablets
              
              Designed
      to help relieve headache, insomnia, and palpitation. Designed to
      invigorate the circulation of blood, improve microcirculation and improve
      liver functionality.Banlangen
      Tablets
              
              Designed
      for the treatment of parotitis, pharyngitis, mastitis, swollen and sore
      throat due to cold and influenza.Bergenini
      Tablets
              
              Designed
      to help relieve cough and phlegm due to bronchial
  ailments.Huangtengsu
      Tablets (film tablets)
              
              Designed
      to treat the symptoms of dysentery, enteritis, respiratory tract
      infections, uncomplicated urethral, surgery infections and
      conjunctivitis.Danshen
      Tablets
              
              Designed
      to regulate blood circulation and treat the symptoms of blood stasis.
      Designed to treat the symptoms of coronary arteriosclerosis, angina
      pectoris and hyperlipemia.Triperygium
      hypoglaucum Hutch Tablet
              
              An
      immunosuppressant designed to treat the symptoms of rheumatoid
      arthritis.Huangtengsu
      Soft Capsules
              
              Designed
      to treat symptoms of dysentery, enteritis, respiratory tract infections,
      surgery infections and conjunctivitis.  4
  Product
      Name
                    
                    Intended
      UseTian
      Xin Soft Capsules (formerly known as Li Xu Wang Shu Tong Soft
      Capsules)
                    
                    Designed
      to reduce blood viscosity and improve blood
circulation.Radix
      Polygoni Multiflori Capsules
                    
                    Designed
      to treat effects of weakness of the kidney and liver, fatigue, and
      dizziness due to blood
deficiencies.





We have
the following additional drugs that are currently in Phase II clinical trials
for prescription use:




·
            Wei Dingkang Soft
      Capsules are a type of traditional Chinese medicine designed to
      treat peptic ulcer disease by inhibiting bacterial growth, relieving
      stomach muscle spasms, and reducing inflammation of the intestinal lining.
      The product is designed to be effective for upset stomach, vomiting, pain
      and degradation of the stomach lining. The product has been approved by
      the State Food and Drug Administration (SFDA) for clinical testing. Phase
      II clinical trials were completed in December 2007.  Phase II
      exploratory and enhanced clinical trials have commenced and are expected
      to be completed by August 2009, after which Phase III will start. We
      anticipate obtaining production approval by the end of
    2011.




·
            Dencichine Hemostat is
      designed to be a non-toxic product that addresses a range of
      anti-hemorrhagic applications, such as stopping bleeding without causing
      clotting. We anticipate receiving governmental approval for the production
      and marketing of the product in 2011. Assuming required governmental
      approvals are obtained in a timely fashion, we anticipate that production
      and marketing of the product will begin no sooner than 2012. Dencichine
      Hemostat is a drug requiring extensive testing by the national SFDA,
      including neurotoxicity testing, which may take a significant amount of
      time. In addition, clinical testing and audit processes are out of our
      control, so we must allow for additional
time.




·
            Other drugs that we
      have in the clinical testing application process are Levofloxacin
      Hydrochloride Soft Capsules, which are designed for antibiotic
      applications, and Brufen Soft Capsules, which are intended to treat fever
      and headache caused by influenza, colds and acute pharyngitis.
      Levofloxacin Hydrochloride Soft Capsules have received SFDA approval for
      clinical testing, which has completed the bioequivalence trial and has
      obtained the Notification of acceptance of Re-trial. We expect to receive
      production approval no later than before the end of 2009. Brufen Soft
      Capsules completed the centralized test and appraisal for production
      approval, which we hope to receive
shortly.




Health
and Food Products




We offer
a wide array of over the counter supplements as well as vitamin capsules and
pills. The following are some of our non-prescription products and their
intended uses. We have received government approval and currently market each of
the supplements listed below.




Product
      Name
              
              Intended
      UseBanlangen
      Grains
              
              Health
      product designed to treat swollen and sore throat due to cold and
      influenza.Gegenqinlian
      Tablets
              
              Health
      product designed to reduce stomach discomfort and treat
      diarrhea.Huangtensu
      Soft Capsules
              
              Designed
      to treat symptoms of dysentery, enteritis, respiratory tract infections,
      surgery infections and conjunctivitis.Luotongding
      Tablets
              
              Health
      product designed to reduce visceral pain, headache, and
      cramping.Paracetamol
      Caffeine and Aspirin Powders
              
              Health
      product designed to treat headaches, migraines and fevers caused by
      influenza and cold.  5
  Product
      Name
                  
                  Intended
      UseSiji
      Sanhuang Tablets
                  
                  Health
      product designed to relieve inflammation and alleviate fever, commonly in
      connection with pharyngitis.Sulfadiazine
      Silver Ointment
                  
                  Health
      product designed to assist in the prevention of infections related to
      burns.Tianqi
      Tongjing Capsules
                  
                  Health
      product designed to treat dysmenorrhea and emmeniopathy caused by
      colds.Vitamin
      AD Soft Capsules
                  
                  Health
      product designed to treat deficiencies of Vitamin A and
  D.Vitamin
      C Tablets
                  
                  Health
      product designed to treat deficiencies of Vitamin C.Vitamin
      B6 Tablets
                  
                  Health
      product designed to treat deficiencies of Vitamin B6.Vitamin
      E Soft Capsules
                  
                  Health
      product designed to treat deficiencies of Vitamin E.Yinhuang
      Capsules
                  
                  Health
      product designed to relieve inflammation and sore of
    throat.Lycopene
      Soft Capsules
                  
                  Food
      product designed to treat side effects of and act as a general deterrent
      to certain carcinogens.Oil
      of Purple Perilla Soft Capsules
                  
                  Food
      product designed to treat effects of cough, asthma and
      astriction.Rhizoma
      Aspidii and Chinese Wampi leaf Grains
                  
                  Designed
      to treat effects of fever, aversion, headache, cough with excessive
      sputum.Soya
      Lecithin Soft Capsules
                  
                  Food
      product designed to treat effects of high blood fat, hypertension and
      other diseases of cardiovascular and cerebrovascular
    systems.Spirulina
      Soft Capsules
                  
                  Food
      product designed to normalize stomach and intestinal
      functions.


The SFDA
issues certificates of medicine production approval that include the names,
specifications, approval numbers and other information about the approved
medicines. According to the law of the Drug Administration of the People’s
Republic of China, a drug-manufacturing factory must acquire both the
certificate of medicine production permit and medicine production approval,
before the drug-manufacturing factory has the necessary qualifications to
manufacture, market and sell the medicine.




Our
anticipated timelines for introduction and marketing of our new drugs depend, in
large part, on government approval as well as our experience in the approval
process and our communications with the SFDA. Therefore, there is no assurance
that such approvals will be obtained at all, or that the anticipated timelines
will be met. For instance, we intended to introduce and market certain generic
non-prescription supplements such as Fructus Ligustri Lucidi, Radix Astragali
Soft Capsules, Ginseng and Pilose Antler Soft Capsules, and Tranquilization Soft
Capsules and had applied for approvals that were anticipated to be obtained
during 2008. However, in July 2007, China’s former drug and food safety watchdog
chief, Xiaoyu Zheng, was executed after being found guilty of corruption and
dereliction of duty. Mr. Zheng’s failure to maintain proper standards and carry
out correct pharmaceutical safety inspections led to approval of many medicines
that should have been blocked or taken from the market. In order to cure Mr.
Zhang’s dereliction, SFDA adapted a series of measures to tighten safety
controls and strengthen its safety procedures for the pharmaceutical approval
process. For these reasons, many drugs that had applications pending were forced
to carry out re-examination and approvals have been delayed.  In
response to this changed regulatory process, the Company determined not to
pursue their applications on proposed products further, and instead to shift
research and development efforts from making generic drugs to high-tech ones
like Wei Dingkang Soft
Capsules as well as Dencichine Hemostat.




6




In 2008,
we have obtained SFDA approval for two non-prescription supplements, as
indicated in the table below. In the table below, the “Application Submission
Date” column indicates the month and year in which we submitted a formal
registration application to the State Food and Drug Supervision Administration
for the product we have researched and developed. That is, we have applied to
the State Food and Drug Supervision Administration for a production approval,
which we must obtain prior to the production and sale of each of our products.
The “Approved Date” indicates the date on which we received the production
approval for manufacturing the products from the State Food and Drug Supervision
Administration.




Anticipated
                  Product
      Name
              
              Intended
      Use
              
              Application
      Submission
                  Date
              
              Approved
                  DateTian
      Xin Soft Capsules
              
              Designed
      to reduce blood viscosity and improve blood circulation. This product is
      currently being tested and appraised for production approval, which we
      hope to receive shortly.
              
              February
      2006
              
              January
      2008Radix
      Polygoni Multiflori Capsules
              
              Designed
      to treat effects of weakness of the kidney and liver, fatigue, and
      dizziness due to blood deficiencies. This product is currently being
      tested and appraised for production approval which we hope to receive
      shortly.
              
              January
      2006
              
              June
      2008




Cosmetic
Products




We also
offer an expanding line of cosmetic products including lotions, creams and other
cosmetic items. We have conducted extensive research and have specifically
formulated our cosmetic products to meet the cosmetic and skincare needs of our
female consumers. Our “12 WaysTM Chinese Traditional Medicine Beauty Salon
Series” (12 Ways) is a line of over 100 cosmetic products that includes facial
masks and creams, skin and eye creams, and shampoos. Our line of products has
acquired production approval to be sold only in China. Each of our cosmetic
skincare products contains natural ingredients including herbal anti-irritants
and anti-oxidants, as well as Sanchi. Our comprehensive line of skincare
includes a mixture of basic products (e.g., creams and gels), treatment products
(e.g., firming treatments), specialty helpers (e.g., masks), and beauty
supplements. The use of supplements is an important element of skincare,
nurturing the skin’s health using vital nutrients. Our cosmetic line combines
the strength of several skincare methods to achieve healthy skin and
beauty.




We have
expanded the geographic region in which our 12 Ways products were sold from our
native Yunnan province to a number of cities and provinces outside our local
region. We have opened a number of retail specialty counters to offer our
cosmetic products at pharmacies throughout Eastern China, and we hope to
eventually expand our retail presence across China. As of December 31, 2008, we
have opened approximately 550 retail specialty counters in more than 26
provinces throughout China, including main cities such as Beijing, Shanghai,
Hangzhou, Dongwan, Shengzhen, and Shaoguang, and main provinces such as Hubei,
Shanxi, Yunnan, Shangdong, Anhui. We believe that this retail counter strategy
will allow us to increase our brand recognition, as well as sell and market our
newest cosmetics products developed using our experience in traditional Chinese
medicine.




Our line
of cosmetic products includes the following food products and health
supplements.




Product
      Name
            
            Intended
      UseJasmine
      Tea
            
            Food
      product designed to help and promote healthy skin affected by
      acne.Rose
      Tea
            
            Food
      product designed to help promote healthy skin and
    complexion.SHEN
      HUO Beauty Soft Capsules
            
            Health
      supplement designed to help with balancing water in the
    body.  7
  Product
      Name
              
              Intended
      UseSHEN
      HUO Brighten Soft Capsules
              
              Health
      supplement designed to help promote healthy skin affected by
      spotting.SHEN
      HUO Immaculacy Soft Capsules
              
              Health
      supplement designed to help promote healthy skin affected by
      acne.12
      Ways Yunnan Bamboo Anti-Acne Cream
              
              Health
      supplement designed to help promote healthy skin affected by
      acne.12
      Ways DanShen Spot Fade Light Cream
              
              Health
      supplement designed to lighten skin discoloration.12
      Ways Eye care series
              
              Health
      supplement designed to improve the appearance of fine lines, dark circle,
      and puffiness.12
      Ways Sunscreen Series
              
              Sunscreen
      product.12
      Ways Panax Notoginseng Moisturizer Series
              
              Moisturizer.12
      Ways Snow Poria Whiten Series
              
              Health
      supplement designed to lighten and whiten the
  skin.




Growth
Strategies




We
believe that our business has opportunities for growth through the following
growth strategies:




·
            New Product
      Development. We have traditionally
      focused on research and development of products serving the cardiovascular
      and cerebrovascular disease, peptic ulcer disease and health products
      markets. We intend to devote additional resources to research and
      development and to continue to evaluate and develop high-tech and
      efficient Traditional Chinese Medicine (“TCM”), where we perceive an unmet
      need and commercial potential, and to improve existing products to enhance
      their efficacy.




·
            Focus on
      Brand Development. With intense price competition among many
      similar or identical products in the industry, we believe that building
      brand equity is the primary means to generate and sustain profitable
      growth in the future. Our brand strategy is centered on “Lixuwang”—the
      brand under which most of our products are sold. We believe that our
      relationships within the Chinese pharmaceutical industry is key to
      building brand equity, which we can benefit from by developing and
      maintaining relationships with professionals within the industry,
      especially with physicians and
hospitals.




·
            Domestic
      Growth (China). We intend to grow our internal marketing and sales
      function and increase our relationships with other national distributors
      to expand the distribution and presence of our non-prescription brands and
      cosmetics. In expanding market share of our products, we intend to take
      advantage of our large manufacturing scale and reasonable cost control
      mechanisms, and our strong sales network. In addition, our goal is to
      establish our products as a preferred choice for prescription drugs in
      major hospitals. We believe that establishing a strong reputation with
      major hospitals may open the market for smaller, community and rural
      hospitals because patients from large hospitals also receive services from
      smaller hospitals.  We hope to add other prescription drugs,
      some of which are now in late-stage clinical trial, into this channel over
      the next few years.




·
            International
      Growth. In addition to China, we have sold our products in Asian
      countries such as Indonesia, Singapore, Japan, Malaysia, Thailand and
      European Countries such as United Kingdom, Tajikistan, Russia and
      Kyrgystan. We hope to expand sales into other countries where our products
      could be affordable treatment
options.




8




·
            Growth of
      Cosmetics Market Share. We intend to focus on the expansion of our
      cosmetics product line and devote additional marketing and sales
      resources. We hope that our cosmetics products will account for a larger
      percentage of our revenue in the
future.




In
2009, we developed the followingfour
strategies to stabilize and further expand the market:
(1) attractingfurther
investment, especially forprovinces
with low coverage,
by implementing apolicy
of inviting investment, enhancingsales
teams’ construction as well as professional training and marketing
promotion;
(2) developing a plan and budget to exploit the hospitals, which are not selling
our products; (3) widening commercial channelsby
focusing on (i) strengthening the assessment of sales representative/agent’s
commercial credits and accounts receivable management,(ii)
integrating the resources of commercial channels on the basis of market
conditions,
and(iii)
taking advantage of commercial channels to promote terminal
distribution;
and (4) expanding the over the countermarket,
based on the reputation of Li Xu Wang Soft Capsules, by launchingover
the counter products to the market,increasing
market sharesandsales
scope and maximizingprofit.




Research
and Development




As of
December 31, 2008, we employed 58 technicians, including 15 senior
researchers, 22 mid-level researchers, and 21 junior analysts. The
technicians’ specializations include medicine, pharmacology, chemistry, biology,
and medicine production equipment.




In an
attempt to capitalize on the natural resource of Sanchi in Yunnan Province and
to develop a strong medical industry in the Yunnan Province, we established an
enterprise technology center – Kunming Beisheng Science and Technology
Development Company – in cooperation with the Shijia Research Center of
Beijing University. However, the project has not generated revenues or conducted
operations.  Accordingly, the Company has established its own
Technology Center, which has been equipped with advanced instruments and has
recruited highly educated and experienced senior technicians to carry
on  the projects intended for the Shijia Research Center, such as
developing new techniques of extraction, purification and quality control.
Moreover the objectives of our Technology Center are same as we set with Shijia:
modernizing Chinese medicine development techniques; improving technological
skill and processing techniques; industrialization of Chinese herbal medicine;
creation of intellectual property rights; and deepening research into high-end
Yunnan Province medicine. The business scope of the project includes development
and technology transfer of bulk pharmaceuticals, prepared Chinese medicine,
chemicals, biologicals, health food, and medical cosmetic products; importation
of scientific instruments and medical technology, and communication with foreign
and domestic research centers.




Establishment
of the Company owned Technology Center has greatly enhanced the Company’s
R&D efforts by encouraging independent innovation, strengthening independent
research and development capacity, and boosting international competitiveness
and reduced R&D expenses.




Marketing
and Sales




As of
December 31, 2008, our marketing team maintains sales offices or agents in
approximately 26 provinces throughout China. The sales network covers
approximately 186cities and is staffed by
approximately 600 sales representatives.




We also
use a distribution system comprised of independent regional distributors. In a
typical distribution contract, a distributor will be provided with certain sales
targets for a particular period according to a set retail price. If the
distributor completes the sales task within the prescribed period, the agent
distributor will be given greater economic incentives and future distribution
opportunities. If the distributor fails to complete the sales task within the
prescribed period, we will cancel our contract with the distributor and sign
with other competent distributors. We also sign reselling contracts with
franchise drug companies for the distribution of our products. The franchise
drug company, as a reseller, resells our products to local hospitals, drug
stores, and other channel distributors. In addition, we sell our products
directly to distributors and retail drug stores. Our three largest customers
accounted for approximately 19.4%, 32.1%, and 21.7% of our sales for the years
ended December 31, 2008, 2007, and 2006, respectively.




Prices
for our products are fixed and determinable. Each time products are purchased, a
specific price is agreed upon, a contract is signed and we and the customer are
legally bound and neither can change the price. Prices for products are normally
derived from our standard price lists; however, larger, more established
customers are given quantity discounts. There are no instances in which payment
for products sold is contingent on re-sell to or otherwise used by end-user
patients.




9




We
establish selling offices in many cities in China, and the selling offices
manage sales representatives according to our internal management rules and
sales policy. Because the main product “Xuesaitong” capsule is sold to hospitals
through distributors located in the various cities of China and because China
has thousands of distributors and hospitals we employ a large number of sales
representatives to expand into new markets and gain new customers.




In order
to encourage sales representatives to increase sales, we make cash advances to
sales representatives. We accomplish this by having the selling offices sign
advance agreements with sales representatives to determine the conditions of the
advances, specifying the purpose, the amounts and the term. According to our
sales policy, sales representatives earn commissions from us based on the sale
amount and the amount collected, less expenses paid by sales representatives.
The remaining amount is the net commission to the sales representatives.
However, the sales representatives still have the obligation of paying off
advances. We believe the sales representatives are able to expand into new
markets and obtain new customers if they have advanced funds for their travel,
meals, and other incidental expenses that arise.  Our finance
department records the advances and tracks remaining balances with sales
representatives every month. Management supervises the repayment of advances.
For sales representatives who refuse to pay off the advances, we attempt to
collect on the advances and decrease the risk of bad debt as much as possible by
withholding sales commissions, warning delinquent sales representatives, and by
other valid means of collection. The advance agreement includes punitive
measures for overdue balances. In compliance with established policy to reserve
an allowance for specific percentages of our aged receivables, we accrued a
larger allowance for the increased sales representative advances as of December
31, 2008.




Production




We
manufacture and package our products at our factory located in Kunming, China.
The factory, which was built in 2000, is approximately 161,460 square feet and
includes a clean area that occupies approximately 86,110 square feet. Our clean
area in the production facilities includes approximately 52,500 square feet of
Class 10,000 certified area and 2,350 square feet of Class 100,000 certified
area. The cleanliness classification is based on the number of dust particles
and bacteria per cubic meter, so lower numbers indicate a higher cleanliness
class. According to the Regulation for Quality Control of Drug Production issued
by the SFDA, oral preparations of traditional Chinese medicines must be produced
in a Class 300,000 certified or lower area. Our production facilities use
equipment imported from the U.S. and are designed to meet American standards, so
our Class 10,000 and Class 100,000 certified areas are cleaner than the Chinese
national standard. The production facilities have more than 600 machines and
supporting parts for pharmaceutical production from domestic and foreign
suppliers. The factory has a total of 28 complete production lines for
semi-finished and finished hard capsules, tablets, granules, powder, electuary,
and emulsifier. The key facilities are two soft capsule production lines
obtained from GIC Company, an American producer of industrial machinery,
and an automatic packaging production line purchased from Klockner Haensel GmbH,
a German company. In addition, all of our precision testing machines are
supplied by Sharp Document Systems, U.S.A. Our production facilities were
certified to be in compliance with Good Manufacturing Practice (GMP) standards.
Our GMP certifications is renewed through July 18, 2012, for the production of
health food products and supplements, including soft capsules, hard capsules,
tablets and granule productions. We also received an additional GMP
certification for production of pharmaceutical ointment products.




We
utilize a complex process in extracting active components from the Sanchi plant,
purifying the components and manufacturing our products. A typical manufacturing
process begins by obtaining the Sanchi plant from our supplier, washing, and
dividing it into main root, branch root and rhizome. The branch root known as
“Sanchi Jintiao” and rhizome is known as “Sanchi Jiankou.” The Sanchi Jiankou is
the portion of the Sanchi that contains the active ingredient, Panax Notoginseng
Saponins. The Sanchi Jiankou is then sent to heavy pulverizing machinery to
crush it into a specified powder size. The Sanchi Jiankou powder then undergoes
a complex extracting process in which the powder is mixed with extracting
solvents and the resulting solution is percolated and filter processed. The
solution is concentrated by vacuum equipment while the extracting solvent is
recollected and the active ingredient condensate is collected. The active
ingredient condensate is then separated and purified through a chromatographic
column, and the Sanchi polysaccharides and Sanchi saponins are collected
separately. The solutions of Sanchi saponins and Sanchi polysaccharides are then
separately purified by second chromatographic column to remove pigments and
other useless compounds and obtain the pure saponins and polysaccharides,
respectively. The Sanchi saponins and Sanchi polysaccharides are then separately
dried by a spray-dryer.  The resulting powders are weighed and
packaged into separate contamination resistant plastic bags, which undergo
quality control inspections and are stored in a warehouse for use in our line of
products. Production of each product varies depending on the ingredients and
form of the product.  Production usually includes mixing of the Sanchi
powder and the delivery agent, such as oil for soft capsules.  The
ingredients are then processed using advanced pressing, drying, polishing and
blister packaging equipment.




10




Quality
Control




Our
production facilities are designed and maintained with a view towards conforming
with good practice standards. To comply with GMP operational requirements, we
have implemented a quality assurance plan setting forth our quality assurance
procedures. Our Quality Control department is responsible for maintaining
quality standards throughout the production process. Quality Control executes
the following functions:




·
            setting
      internal controls and regulations for semi-finished and finished
      products;




·
            implementing
      sampling systems and sample files;




·
            maintaining
      quality of equipment, instruments, reagents, test solutions, volumetric
      solutions, culture media and laboratory
animals;




·
            auditing
      production records to ensure delivery of quality
  products;




·
            monitoring
      the number of dust particles and microbes in the clean
    areas;




·
            evaluating
      stability of raw materials, semi-finished products and finished products
      in order to generate accurate statistics on storage duration and shelf
      life;




·
            articulating
      the responsibilities of Quality Control staff;
  and




·
            on-site
      evaluation of supplier quality control
systems.




Competition




The
pharmaceutical industry both within China and globally is increasingly
competitive and is characterized by rapid and significant technological
progress. Our competitors, both domestic and international, include large
pharmaceutical companies, universities, and public and private research
institutions that currently engage in or may engage in efforts related to the
discovery and development of new pharmaceuticals. Many of these entities have
substantially greater research and development capabilities and financial,
scientific, manufacturing, marketing and sales resources than we do, as well as
more experience in research and development, clinical trials, regulatory
matters, manufacturing, marketing and sales.




Competition
in the manufacture and sale of medical products for cardiovascular and
cerebrovascular disease in China is also intense. There are a large number of
companies that are licensed to manufacture and sell these type of medical
products in China. Western drugs such as lovastatins and nitroglycerine have
more than half of the market share of medications used to treat cardiovascular
and cerebrovascular disease in China.  Chinese traditional medicines
make up the next largest part of the market. On the whole, Chinese patent
medicine still generally has many problems such as complex and unclear
ingredients, inconsistent quality, slow action and ineffectiveness. As a result,
new Chinese medicines tend not to stay on the market for very long.




There are
also many Chinese traditional medicines available to treat peptic ulcers. While
they are inexpensive and readily available, they are not as effective as western
medicines. In China, peptic ulcers are usually treated with western medicines
such as H2 blockers (e.g., Zantac), proton pump inhibitors (e.g., Nexium) and
bismuth (e.g., Pepto-Bismol). In addition, amoxicillin and other antibiotics are
now commonly used in conjunction to treat peptic ulcers.




11




The
market for health and cosmetic products in China is also highly competitive.
Both industries have a high number of competitors, some of which overlap, and
many of which have a longer operating history and higher visibility, name
recognition and financial resources than we do. Our competitors include
manufacturers and marketers of personal care and nutritional products,
pharmaceutical companies and other organizations.




Intellectual
Property




We rely
on a combination of trademark, copyright and trade secret protection laws in
China, as well as confidentiality procedures and contractual provisions to
protect our intellectual property. Our primary product, Xue Saitong Soft
Capsules, first received patent protection and production and new medicine
certification in 1999 which will continue until April 25, 2012. We also have
protections for our technology methods of using Sanchi to help stop bleeding and
combination methods, production and function of the medicine to treat intestinal
disease. Xue Saitong Soft Capsules receive protections from the SFDA, which will
not issue additional drug permits other than those already issued during the
protection period. We have eight registered trademarks and have applied for
registration of another two trademarks in China. Other than the foregoing, we do
not have any measures to prevent any infringement of our intellectual property
rights.




Seasonality




Sales in
the first quarter are usually lower due to people traveling and taking vacations
during the traditional Chinese New Year and Chinese Spring Festival holidays.
Sales in the fourth quarter are usually higher.




Government
Regulations of Pharmaceuticals




Testing,
approval, manufacturing, labeling, advertising, marketing, post-approval safety
reporting, and export of our products or product candidates are extensively
regulated by governmental authorities in the PRC and other countries. Our
principal sales market is presently in China. We are subject to the Drug
Administration Law of China, which governs the licensing, manufacturing,
marketing and distribution of pharmaceutical products in China and sets
penalties for violations. Additionally, we are subject to various regulations
and permit systems by the Chinese government.




The
application and approval procedure in China for a newly developed drug product
has numerous steps. New drug applicants prepare the documentation of
pharmacological study, toxicity study and pharmacokinetics and drug metabolism
(PKDM) study and new drug samples. Documentation and samples are then submitted
to provincial food and drug administration (“provincial FDA”). The provincial
FDA sends its officials to the applicant to check the applicant’s research and
development facilities and to arrange new drug examination committee meeting for
approval deliberations. This process usually takes three months. After
documentation and sample approval, the provincial FDA will submit the approved
documentation and samples to SFDA. SFDA examines the documentation and tests the
samples and arranges new drug examination committee meeting for approval
deliberations. If the application is approved by SFDA, SFDA will issue a
clinical trial license to the applicant for clinical trials. The clinical trial
license approval typically takes one year. The applicant completes the clinical
trial process and prepares documentation and files submitted to SFDA for new
drug approval. The clinical trial process usually takes one to two years,
depending on the category and class of the new drug. SFDA examines the
documentation, gives final approval for the new drug, and issues the new drug
license to the applicant. This process usually takes eight months. The whole
process for new drug approval usually takes three to four years.




Insurance
Catalogue




Pursuant
to the Decision of the State Council on the Establishment of the State Basic
Medical Insurance System for Urban Employees and the Implementation Measures for
the Administration of the Scope of Medical Insurance Coverage for
Pharmaceuticals for Urban Employees, the Ministry of Labor and Social Security
in China established the Insurance Catalogue. The Insurance Catalogue is divided
into Parts A and B. The medicines included in Part A are designated by the
Chinese governmental authorities for general application. Local governmental
authorities may not adjust the content of medicines in Part A. Although the
medicines included in Part B are designated by Chinese governmental authorities
in the first instance, provincial level authorities may make limited changes to
the medicines included in Part B, resulting in some regional variations in the
medicines included in Part B from region to region.




12




Patients
purchasing medicines included in Part A are entitled to reimbursement of the
costs of such medicines from the social medical fund in accordance with relevant
regulations in China. Patients purchasing medicines included in Part B are
required to pay a predetermined proportion of the costs of such
medicines.




The
medicines included in the Insurance Catalogue are selected by the Chinese
government authorities based on various factors including treatment
requirements, frequency of use, effectiveness and price. Medicines included in
the Insurance Catalogue are subject to price control by the Chinese government.
The Insurance Catalogue is supposed to be revised every two years. In connection
with each revision, the relevant provincial drug authority collects proposals
from relevant enterprises before organizing a comprehensive appraisal. The SFDA
then makes the final decision on any revisions based on the preliminary opinion
suggested by the provincial drug administration. Other than completing a normal
application process, we have no role in the selection of products for inclusion
in the Insurance Catalog. We do not pay any fee in order to be
listed.




Since
2005, our primary product, Xuesaitong Soft Capsules has been listed in Part B of
the Insurance Catalogue. Xuesaitong Soft Capsules represented approximately 87%
of our sales for the year ended December 31, 2008. Removal of the product from
the Insurance Catalogue would adversely affect our total revenue.




We are
seeking to have other products listed in the Insurance Catalogue. At present,
Xuesaitong Soft Capsules and Sulfadiazine Silver Ointment have already been
listed in the Insurance Catalogue. The China Society and Labor Security
Department plans to update the Insurance Catalogue every two years, but since
2000, the catalog has only been updated once. It has been updated again after
2007 and we have received approval for listing of our Huangtensu Soft Capsules
based on its medicinal attributes and sales.




Price
Controls




Drugs
that are listed in the Insurance Catalogue and whose production or trading will
constitute monopolies are commonly subject to price control by the Chinese
government. The maximum prices of such medicine products are published by the
state and provincial administration authorities from time to time. The prices of
other medicines that are not subject to price control are determined by the
pharmaceutical manufacturers, subject, in certain cases, to providing notice to
the provincial pricing authorities. Our primary product, Xuesaitong Soft
Capsules, is subject to retail and wholesale price controls.




The price
of Xuesaitong Soft Capsules is determined by The National Development and Reform
Commission of the PRC. The original price, as approved by the government, was 45
RMB (U.S. $5.63) per box of 24 capsules. As of December 31, 2008, its maximum
price has been adjusted to 44.2 RMB (U.S. $5.53)per
box of 24 capsules. Our application to The National Development and Reform
Commission (The "NDRC") of the PRC requesting that the Xuesaitong Soft Capsules
be placed into the category of "Higher Price for Better Quality" was approved in
March 2007. Therefore, the drug benefits from price protection and is exempted
from price reduction. Moreover, the category has become a standard of choosing
medicines for cardiovascular and cerebrovascular disease.


Employees




As of
December 31, 2008, we had 540 full-time, salaried employees and 367of these employees receive
labor insurance.These employees are organized into a union under
the labor laws of China and can bargain collectively with us. In addition, we
employ over 600 sales representatives who are paid on a commission basis. These
representatives are not part of the union. We maintain good relations with our
employees.




We are
required to contribute a portion of our employees’ total salaries to the Chinese
government’s social insurance funds, including medical insurance, unemployment
insurance and job injuries insurance, and a housing assistance fund, in
accordance with relevant regulations. We expect the amount of our contribution
to the government’s social insurance funds to increase in the future as we
expand our workforce and operations.




13




Additional
Information




We are
subject to the information and periodic reporting requirements of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”) and in accordance with the
Exchange Act, we file annual, quarterly and special reports, and other
information with the Securities and Exchange Commission. These periodic reports
and other information are available for inspection and copying at the regional
offices, public reference facilities and website of the Securities and Exchange
Commission referred to below.




Statements
contained in this report about the contents of any contract or any other
document that is filed as an exhibit are not necessarily complete, and we refer
you to the full text of the contract or other document filed as an exhibit. A
copy of annual, quarterly and special reports and related exhibits and schedules
may be inspected without charge at the Public Reference Room maintained by the
Securities and Exchange Commission at 100 F Street, N.E., Washington, D.C.
20549.  Copies of such reports may be obtained from the Securities and
Exchange Commission upon payment of the prescribed fee. Information regarding
the operation of the Public Reference Room may be obtained by calling the
Securities and Exchange Commission at 1-800-SEC-0330 or visiting their website
at www.sec.gov. The Securities and Exchange Commission maintains a web site that
contains reports, proxy and information statements, and other information
regarding registrants that file electronically with the SEC.




ITEM
1A.  RISK FACTORS.




Any
investment in our common stock involves a high degree of risk. Investors should
carefully consider the risks described below and all of the information
contained in this report before deciding whether to purchase our common stock.
Our business, financial condition or results of operations could be materially
adversely affected by these risks if any of them actually occur. The trading
price of our common stock could decline due to any of these risks, and an
investor may lose all or part of his investment. Some of these factors have
affected our financial condition and operating results in the past or are
currently affecting our company. This report also contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including the risks we face as described below and
elsewhere in this report. With respect to this discussion, the terms “Shenghuo,”
the “Company,” “we,” “us,” or “our” refer to China Shenghuo Pharmaceutical
Holdings, Inc., our 94.95%-owned subsidiary Kunming Shenghuo Pharmaceutical
(Group) Co., Ltd. (“Shenghuo China”) and the three foreign owned subsidiaries of
Shenghuo China that are organized under the laws of the People’s Republic of
China (“PRC” or “China”).




RISKS
RELATED TO OUR OPERATIONS




We
May Not Be Able To Refinance or Repay Loans We Have Received.




As of
December 31, 2008, we had approximately $ 9.8 million of loans maturing in 2009
(including $3.6 million in April 2009 and $5.8 million in August 2009).There
can be no assurance that we will be able to refinance the loans on acceptable
terms or at all, and we do not have at this time the cash necessary to repay the
loans as they mature.  If we do not refinance or cannot repay our
outstanding loans and we default on our obligations, the lenders can demand
accelerated payment and foreclose on collateral, our financial condition would
be materially adversely affected, and we could be forced to cease
operations.  Furthermore, even if we are able to obtain extensions on
our existing loans, such extensions may include operational and financial
covenants significantly more restrictive than our current loan covenants, which
would adversely affect our plans and business goals.




14




We Incurred A Net Loss For The Year Ended December 31,
2008, And Our Business Condition Is Uncertain.
 
 Although we have had a history of positive income,
working capital and retained earnings, we incurred a net loss for the year ended
December 31, 2008 of $4.6 million and net cash provided by operating activities
of $1.9 million and used funds in financing activities of $3.0 million. As a
result, during the year ended December 31, 2008, our cash and cash equivalents
have decreased $1.2 million. We have $9.5 million in short term loans that
mature in 2009. Additionally, putative class action lawsuits have been asserted
against us, and we are responding to a voluntary document request from the SEC
regarding the restatement.
 
 We have expended significant efforts to expand our
revenues by assisting our sales representatives and increasing our marketing in
fiscal 2008. The net loss in 2008 was primarily caused by increased legal,
auditing, expenses related to assisting sales representatives and marketing
expenses. In addition, we have been forced to give significant attention to the
internal investigation conducted by the Audit Committee and have to defend
against a consolidated putative class action lawsuit that alleges that we
failed to take adequate steps to ensure our financial reporting comported with
U.S. Generally Accepted Accounting Principles ("GAAP") and that, as a result, we
were required to restate what are alleged to be materially false and misleading
financials for accounting periods during the alleged class period from August
2007 through August 20, 2008, and further alleges, among other things, that
certain of our SEC filings and other public statements contained false and
misleading statements which resulted in damages to the plaintiffs and the
members of the purported class when they purchased our securities. We believe
that we will remedy these matters and will be able to return to our normal
operations in the near future, but we cannot give any assurance that this will
be the case.


Our
Current Business Is Primarily Based On A Single Product, Which Currently
Accounts For More Than 87% Of Our Revenues, And We May Not Be Able To Generate
Significant Revenue If This Product Fails.




Approximately
87% of our sales for the year ended December 31, 2008 comes from a single
product, Xuesaitong Soft Capsules, and our business may fail if this product
fails or generates materially less sales revenues. If we experience delays,
increased expenses, or other difficulties in the manufacture and sale of the
Xuesaitong Soft Capsules, or if our licenses and government approvals are
revoked to sell the product, or this product is no longer carried in the
Insurance Catalog, then we may not be able to generate significant revenues or
profitability, and our business and financial condition would be materially
adversely affected and we could be forced to cease operations, in which case
investors may lose all or part of their investment in our company.




We
Rely On A Few Suppliers For Sanchi, The Primary Ingredient in Most of Our
Products, And Any Disruption With Our Suppliers Could Delay Product Shipments
And Have a Material Adverse Impact on Our Business Operations And
Profitability.




Due to
the limited availability of Sanchi, we currently rely on a small number of
suppliers as our source for Sanchi, the primary raw material that is needed for
us to produce our products. We believe that there are few alternative suppliers
available to supply the Sanchi plant, and should any of our current suppliers
terminate their business arrangements with us or increase their prices of
materials supplied, it would delay product shipments and adversely affect our
business operations and profitability. In addition, if the suppliers refused to
sell Sanchi, or increased the sales prices of Sanchi, this would also have a
material adverse impact on the results of operations.




If
Our Primary Product Is Replaced By Other Medicines Or Is Removed From China’s
Insurance Catalogue In The Future, Our Revenue Will Suffer
Substantially.




Under
Chinese regulations, patients purchasing medicines listed by China’s state
and/or provincial governments in the Insurance Catalogue may be reimbursed, in
part or in whole, by a social medicine fund. Accordingly, pharmaceutical
distributors prefer to engage in the distribution of medicines listed in the
Insurance Catalogue. Since 2005, our main, Xuesaitong Soft Capsules, has been
listed in the Insurance Catalogue. The content of the Insurance Catalogue is
subject to change by the Ministry of Labor and Social Security of China, and new
medicines may be added to the Insurance Catalogue by provincial level
authorities as part of their limited ability to change certain medicines listed
in the Insurance Catalogue. Xuesaitong Soft Capsules accounted for approximately
87% of our sales for the year ended December 31, 2008, and if this product is
replaced by other medicines or removed from the Insurance Catalogue in the
future, our total revenue will suffer substantially and we could be forced to
cease operations.




We
May Need To Raise Additional Capital To Fund Our Operations And Failure To Raise
Additional Capital May Force Us To Delay, Reduce, Or Eliminate Our Product
Development Programs.




Due to
the large amount of funds required for research and development and the
subsequent marketing of products, the pharmaceutical industry is very capital
intensive. The industry is characterized by small receivable turnovers, which
could mean that we will need more working capital if our revenues increase. We
have traditionally been committed to research and development and it is possible
that we will need to raise additional capital within the foreseeable future.
Additional capital may be needed for the development of new products or product
lines, advances to sales representatives, financing of general and
administrative expenses, licensing or acquisition of additional technologies,
and marketing of new or existing products. There are no assurances that we will
be able to raise the appropriate amount of capital needed for our future
operations. Failure to obtain funding when needed may force us to delay, reduce,
or eliminate our product development programs.




Currently,
all of the Company’s land, buildings and machinery are collateral securing
certain bank loans. If we default on the repayment obligations when due, the
properties may be foreclosed upon by the lenders, and our operations would be
materially adversely affected and we might cease to be able to operate as a
going concern.




We
May Have Difficulty Establishing Adequate Management, Legal And Financial
Controls In The PRC.




PRC
companies have historically not adopted a Western style of management and
financial reporting concepts and practices, which includes strong corporate
governance, internal controls, and computer, financial and other control
systems. In addition, we have had difficulty in hiring and retaining a
sufficient number of qualified employees to work in the PRC, including employees
trained in U.S. GAAP. As a result of these factors, we have had and continue to
have difficulty in establishing management, legal and financial controls,
collecting financial data and preparing financial statements, books of account
and corporate records and instituting business practices that meet Western
standards. We have experienced difficulties in implementing and maintaining
adequate internal controls as required under Section 404 of the Sarbanes-Oxley
Act of 2002, resulting in significant deficiencies and material weaknesses in
our internal controls which could impact the reliability of our financial
statements and prevent us from complying with SEC rules and regulations and the
requirements of the Sarbanes-Oxley Act of 2002.  This occurred in
2008, and caused the restatement of our financial statements for fiscal 2007 and
the first quarter of 2008, and the temporary suspension of trading in our stock
on the NYSE Amex Equities Exchange. Any such deficiencies, weaknesses or lack of
compliance could have a materially adverse effect on our business.




15




Matters
Relating To Or Arising From Our Recent Restatement And Weaknesses In Our
Internal Controls Has Had and May Continue to Have A Material Adverse Effect On
Our Business, Operating Results And Financial Condition, Including Increased
Costs and Diversion of Management’s Attention.




In
connection with the restatement of our previously issued financial statements
for the fiscal year ended December 31, 2007 and the fiscal quarter ended March
31, 2008 and our assessments of our disclosure controls and procedures under
Item 307 of Regulation S-K, management concluded that as of December 31, 2007
and December 31, 2008, our disclosure controls and procedures were not effective
and that we had material weaknesses in our internal control over financial
reporting. Please refer to the discussion under Item 9A, "Controls and
Procedures" for further discussion of our material weaknesses as of December 31,
2008. Should we be unable to remediate those or any other material weaknesses
promptly and effectively, such weaknesses could harm our operating results,
result in a material misstatement of our financial statements, cause us to fail
to meet our financial reporting obligations or prevent us from providing
reliable and accurate financial reports or avoiding or detecting fraud. This, in
turn, could result in a loss of investor confidence in the accuracy and
completeness of our financial reports, which could have an adverse effect on our
stock price. Any litigation or other proceeding or adverse publicity relating to
the restatement or material weaknesses could have a material adverse effect on
our business and operating results. In addition, we have incurred substantial
unanticipated costs for accounting and legal fees and may continue to incur
accounting and legal fees in connection with these matters, and our management’s
time and attention has been diverted from our other business operations, which
could harm our business.




We
Make Cash Advances To Our Sales Representatives, And If We Are Not Able To
Collect These Advances In A Timely Manner, Or At All, Then It Will Decrease The
Amount Of Working Capital That We Have Available To Effectively Operate Our
Business.




We have
experienced a significant growth in the amount of outstanding advances to sales
representatives, and if we are unable to collect such advances in a timely
manner, or at all, it will reduce our available cash and restrict our ability to
effectively operate our business. We make cash advances to our sales
representatives in an attempt to encourage and assist them in expanding the
marketing and sales of our products into new regions. We employ a large number
of sales representatives and, as a result, the aggregate amount advanced to
sales representatives is a significant amount. By making such cash advances, we
will have reduced cash availability and liquidity to operate our business,
forcing us to look to other, possibly unfavorable means and sources of capital
to fund our operations. In addition, if we are unable to collect the amounts
advanced, or if it takes a significant amount of time and resources to collect
such advances, our results of operation may suffer, and the value of our stock
may decline.




Our
Three Largest Customers Account For A Significant Percentage of Our Sales. We
Cannot Be Certain That These Sales Will Continue; If They Do Not, Our Revenues
Will Likely Decline.




Our three
largest customers accounted for approximately 21.7%, 32.1% and 19.4% of
our sales for the years ended December 31, 2006, 2007 and 2008, respectively. We
do not have any long-term contracts with these customers, each of whom orders
only on a “purchase order” basis. There can be no assurances that any of these
customers will continue to purchase products from us. The loss of any or all of
these customers or a significant reduction in their orders would have a
materially adverse effect on our revenues.




The
Failure To Manage Growth Effectively Could Have An Adverse Effect On Our
Business, Financial Condition, And Results Of Operations.




The rapid
market growth, if any, of our pharmaceutical products may require us to expand
our employee base for managerial, operational, financial, and other purposes. As
of December 31, 2008, we had 540 full-time, salaried employees, in addition to
our employment of over 600 sales representatives who are paid on a commission
basis. The continued future growth will impose significant added
responsibilities upon the members of our management to identify, recruit,
maintain, integrate, and motivate new employees. Aside from increased
difficulties in the management of human resources, we may also encounter working
capital issues, as we need increased liquidity to finance the purchases of raw
materials and supplies, research and development of new products, acquisition of
new businesses and technologies, and the hiring of additional employees. For
effective growth management, we will be required to continue improving our
operations, management, and financial systems and control. Our failure to manage
growth effectively may lead to operational and financial inefficiencies that
will have a negative effect on our profitability.




16




Our
Planned Expansion Of Sales Into Overseas Markets Could Fail, Reduce Operating
Results And/Or Expose Us To Increased Risks Associated With Different Market
Dynamics And Competition In Any Of The Foreign Countries Where We Attempt To
Sell Our Products.




We would
face many new obstacles in our planned expansion of product sales in overseas
markets. These markets are untested for our products and we face risks in
expanding our business overseas, which include differences in regulatory product
testing requirements, patent protection, taxation policy, legal systems and
rules, marketing costs, fluctuations in currency exchange rates and changes in
political and economic conditions. We may not be as successful as our
competitors in generating revenues in international markets due to the lack of
recognition of our products or other factors. Developing product recognition
overseas is expensive and time-consuming and our international expansion efforts
may be more costly and less profitable than we expect. If we are not successful
in our target markets, our sales could decline, our margins could be negatively
impacted and we could lose market share, any of which could materially harm our
business, results of operations and profitability.




We
Are Dependent On Certain Key Personnel And Loss Of These Key Personnel Could
Have A Material Adverse Effect On Our Business, Financial Condition And Results
Of Operations.




Our
success is, to a certain extent, attributable to the management, sales and
marketing, and pharmaceutical factory operational expertise of key personnel.
Gui Hua Lan, our Chief Executive Officer, Zheng Yi Wang, our Executive Director
of Exports, Feng Lan, our President, Lei Lan, our Executive Director of Sales,
and Wendy Fu, our Chief Financial Officer, perform key functions in the
operation of our business. There can be no assurance that we will be able to
retain these officers after the term of their employment contracts expire. The
loss of these officers could have a material adverse effect upon our business,
financial condition, and results of operations. We must attract, recruit and
retain a sizeable workforce of technically competent employees. Our ability to
effectively implement our business strategy will depend upon, among other
factors, the successful recruitment and retention of additional highly skilled
and experienced management and other key personnel. We cannot assure that we
will be able to hire or retain such employees.




Our
Business And The Success Of Our Products Could Be Harmed If We Are Unable To
Maintain Our Brand Image.




We
believe that establishing and strengthening our Lixuwang brand is critical to
achieving widespread acceptance of our products and to establishing key
strategic relationships. The importance of brand recognition will increase as
current and potential competitors enter the Chinese pharmaceutical market with
competing products. Our ability to promote and position our Lixuwang brand
depends largely on the success of our marketing efforts and our ability to
provide high quality products and customer service. These activities are
expensive and we may not generate a corresponding increase in sales to justify
these costs. If we fail to establish and maintain our brand, or if our brand
value is damaged or diluted, we may be unable to maintain or increase our sales
or revenue.




We
Face Intense Competition In The Pharmaceutical Industry And Such Competition
Could Cause Our Sales Revenue And Profits To Decline.




The
pharmaceutical industry both within China and globally is intensely competitive
and is characterized by rapid and significant technological progress, and our
operating environment is increasingly competitive. We face intense competitors
that will attempt to create or are marketing products in the PRC that are
similar to our products. Our competitors, both domestic and international,
include large pharmaceutical companies, universities, and public and private
research institutions that currently engage in or may engage in efforts related
to the discovery and development of new pharmaceuticals. Many of these entities
have substantially greater research and development capabilities and financial,
scientific, manufacturing, marketing and sales resources than we do, as well as
more experience in research and development, clinical trials, regulatory
matters, manufacturing, marketing and sales. There can be no assurance that our
products will be either more effective in their therapeutic abilities and/or be
able to compete in price with that of our competitors. Failure to do either of
these may result in decreased profits.




17




If
Our Pharmaceutical Products Fail To Receive Regulatory Approval Or Are Severely
Limited In These Products’ Scope Of Use, We May Be Unable To Recoup Considerable
Research And Development Expenditures.




The
production of our pharmaceutical products is subject to the regulatory approval
of the State Food and Drug Administration (SFDA) in China. The regulatory
approval procedure for pharmaceuticals can be quite lengthy, costly, and
uncertain. Depending upon the discretion of the SFDA, the approval process may
be significantly delayed by additional clinical testing and require the
expenditure of resources not currently available; in such an event, it may be
necessary for us to abandon our application. Even where approval of the product
is granted, it may contain significant limitations in the form of narrow
indications, warnings, precautions, or contra-indications with respect to
conditions of use. If approval of our product is denied, abandoned, or severely
limited in terms of the scope of products use, it may result in the inability to
recoup considerable research and development expenditures. In this regard, in
2008 10non-prescription supplemental
pharmaceutical products for which we had applied for production approval and for
which we had expended significant amounts of R&D expense, were rejected by
SFDA under its new, stricter regulatory procedures, and we are now unable to
recoup those R&D investments.




Currently,
two of our products, Wei Dingkang Soft Capsules and Dencichine Hemostat, have
pending applications with the SFDA. Phase II clinical testing for Wei DingKang
Soft Capsules was completed in December 2007.  Phase II exploratory
and enhanced clinical trials have commenced and are expected to be completed by
August 2009, after which Phase III will start.  We anticipate
obtaining production approval by the end of 2011. Dencichine Hemostat completed
a second review and was required to undergo neurotoxicity testing which may take
a significant amount of time.  In addition, clinical testing and audit
processes are out of our control, so we must allow for additional time. The
Chinese Military Medical Institute performs these tests. The risk is that if we
do not receive timely approval for either of these drugs, then production will
be delayed and sales of the products cannot be planned for.




If
All Or A Significant Portion Of Our Customers With Trade Receivables Fail To Pay
All Or Part Of The Trade Receivables Or Delay The Repayment, Our Net Income Will
Decrease And Our Profitability Will Be Adversely Affected.




As of
December 31, 2008, our accounts receivable (less allowance for doubtful accounts
of $4.83 million) were $9.11 million. The standard credit period for most of our
new clients is two months. For certain clients, such as long-standing clients or
large clients, we will extend the credit period. Currently, most of our clients
have established a long-term corporate relationship with us, so their credit
periods are generally six months. Within the medical industry in China, the
collection period is generally longer than for other industries. Our estimated
average collection period for the year ended December 31, 2008 was 90 to 180
days. There is no assurance that our trade receivables will be fully repaid on a
timely basis. If all or a significant portion of our customers with trade
receivables fail to pay all or part of the trade receivables or delay the
payment due to us for whatever reason, our net profit will decrease and our
profitability will be adversely affected, and our liquidity will be adversely
affected.




Our
Success Is Highly Dependent On Continually Developing New And Advanced Products,
Technologies, And Processes And Failure To Do So May Cause Us To Lose Our
Competitiveness In The Pharmaceutical Industry And May Cause Our Profits To
Decline.




To remain
competitive in the pharmaceutical industry, it is important to continually
develop new and advanced products, technologies, and processes. There is no
assurance that our competitors’ new products, technologies, and processes will
not render our existing products obsolete or non-competitive. Our
competitiveness in the pharmaceutical market therefore relies upon our ability
to enhance our current products, introduce new products, and develop and
implement new technologies and processes. The research and development of new
products and technologies is costly and time consuming, and there are no
assurances that our research and development of new products will either be
successful or completed within the anticipated timeframe, if at all. Our failure
to technologically evolve and/or develop new or enhanced products may cause us
to lose our competitiveness in the pharmaceutical industry and may cause our
profits to decline.




18




If
We Fail To Develop New Products With High Profit Margins And Our High Profit
Margin Products Are Substituted By Competitor’s Products, Our Gross And Net
Profit Margins Will Be Adversely Affected.




The
pharmaceutical industry is very competitive, and there may be pressure to reduce
sale prices of products without a corresponding decrease in the price of raw
materials. In addition, the medical industry in China is highly competitive and
new products are constantly being introduced to the market. In order to increase
the sales of our products and expand our market, we may be forced to reduce
prices in the future, leading to a decrease in gross profit margin. To the
extent that we fail to develop new products with high profit margins and our
high profit margin products are substituted by competitors’ products, our gross
profit margins will be adversely affected.




The
Commercial Success Of Our Products Depends Upon The Degree Of Market Acceptance
Among The Medical Community And Failure To Attain Market Acceptance Among The
Medical Community May Have An Adverse Impact On Our Operations And
Profitability.




The
commercial success of our products depends upon the degree of market acceptance
among the medical community, such as hospitals and physicians. Even if our
products are approved by the SFDA, there is no assurance that physicians will
prescribe or recommend our products to patients. Furthermore, a product’s
prevalence and use at hospitals may be contingent upon our relationship with the
medical community. The acceptance of our products among the medical community
may depend upon several factors, including but not limited to, the product’s
acceptance by physicians and patients as a safe and effective treatment, cost
effectiveness, potential advantages over alternative treatments, and the
prevalence and severity of side effects. Failure to attain market acceptance
among the medical community may have an adverse impact on our operations and
profitability.




Our
Primary Product Is Subject To Price Controls By The China Government, Which May
Affect Both Our Revenues And Net Income.




The laws
of the PRC provide for the government to fix and adjust prices. Our primary
product Xuesaitong Soft Capsules was subject to price controls which affected
our gross profit, gross margin and net income. It is possible that additional
products may be subject to price control, or that price controls may be
increased in the future. To the extent that we are subject to price control, our
revenue, gross profit, gross margin and net income will be affected since the
revenue we derive from our sales will be limited and it may face no limitation
on our costs. Further, if price controls affect both our revenue and costs, our
profitability will be effectively subject to regulatory authorities in the
PRC.




Our
Certificates, Permits, And Licenses Related To Our Pharmaceutical Operations Are
Subject To Governmental Control And Renewal And Failure To Obtain Renewal Will
Cause All Or Part Of Our Operations To Be Terminated.




We are
subject to various PRC laws and regulations pertaining to the pharmaceutical
industry. We have attained certificates, permits, and licenses required for the
operation of a pharmaceutical enterprise and the manufacturing of pharmaceutical
products in the PRC. We also obtained pharmaceutical products and health food
GMP certificates. The pharmaceutical production permit and GMP certificates are
valid for a term of five years and the health food certifications are valid for
four year terms, and each must be renewed before their expiration. We originally
obtained our Medicine Production Permit on November 4, 1996, which is valid
until December 31, 2010. The Medicine Production Permit applies to products
described as tablet, granule, capsule, soft capsule, powder, ointment and
medicinal. If the permit expires without renewal, we will not be able to operate
medicine production which will cause our operations to be terminated. We intend
to apply for a renewed Medicine Production Permit before our current production
permit expires on December 31, 2010.




19




We hold
numerous GMP certificates that expire, as follows:




·
            a
      GMP certificate for ointment products that expires on June 12,
      2011;




·
            a
      GMP certificate for powder products that expires on April 21,
      2013;




·
            a
      GMP certificate for products in the form of tablet, granule, capsule, and
      soft capsule that expires on July 12, 2012;
  and




·
            a
      GMP certificate for health food products in the form of tablets, capsules,
      soft capsules, and granules that expires on December 25,
    2012.






We intend
to apply for renewal of these GMP certificates prior to expiration. During the
renewal process, we will be re-evaluated by the appropriate governmental
authorities and must comply with the then-prevailing standards and regulations
which may change from time to time. In the event that we are not able to renew
the certificates, permits and licenses, all or part of our operations may be
terminated. Furthermore, if escalating compliance costs associated with
governmental standards and regulations restrict or prohibit any part of our
operations, our operations and profitability may be materially adversely
affected.




We
Cannot Guarantee The Protection Of Our Intellectual Property Rights And If
Infringement Or Counterfeiting Of Our Intellectual Property Rights Occurs, Our
Reputation And Business May Be Adversely Affected.




To
protect the reputation of our products, we have registered and applied for
registration of our trademarks in the PRC where we have a major business
presence. Our products are sold under these trademarks. There is no assurance
that there will not be any infringement of our brand name or other registered
trademarks or counterfeiting of our products in the future. Should any such
infringement or counterfeiting occur, our reputation and business may be
adversely affected. We may also incur significant expenses and substantial
amounts of time and effort to enforce our intellectual property rights in the
future. Such diversion of our resources may adversely affect our existing
business and future expansion plans.




The
Success of Our Expansion Into the Retail Distribution Of Our Cosmetic Products
Thought Counters Depends On Our Ability To Open And Operate A Certain Number Of
New Counters On An Ongoing Basis, Which Could Strain Our Resources And Cause The
Performance Of Our Existing Operations To Suffer.




We have
been opening a number of retail specialty counters to offer our cosmetic
products at pharmacies throughout Eastern China, with plans to eventually expand
our retail presence across China. Our retail strategy will largely depend on our
ability to find sites for, open and operate retail locations successfully. Our
ability to open and operate retail locations successfully depends on several
factors, including, among others, our ability to:




·
            identify
      suitable counter locations, the availability of which is outside our
      control;




·
            purchase
      and negotiate acceptable lease
terms;




·
            prepare
      counters for opening within budget;




·
            source
      sufficient levels of inventory at acceptable costs to meet the needs of
      counters;




·
            hire,
      train and retain personnel;




·
            secure
      required governmental permits and
approvals;




·
            successfully
      integrate counters into our existing
operations;




·
            contain
      payroll costs; and




·
            generate
      sufficient operating cash flows or secure adequate capital on commercially
      reasonable terms to fund our retail strategy
  plans.




Any
failure to successfully open and operate retail counters for our cosmetic
products could have a material adverse effect on our results of operations. In
addition, our proposed retail plan will place increased demands on our
operational, managerial and administrative resources. These increased demands
could cause us to operate our business less effectively, which, in turn, could
cause deterioration in the financial performance of our overall
business.




20




We
Expect to Lose Certain Preferential Tax Concessions, Which May Cause Our Tax
Liabilities To Increase And Our Profitability To Decline.




We enjoy
preferential tax concessions in the PRC as a high-tech enterprise. We had a tax
preference for 2008, as determined by the PRC government and the regional tax
authorities. On March 16, 2007, the National People’s Congress of China enacted
a new PRC Enterprise Income Tax Law (the “EIT Law”), under which
domestic-invested enterprises and foreign-invested entities will be subject to
enterprise income tax at a uniform rate of 25% unless they qualify under certain
limited exceptions.  The new law became effective on January 1,
2008.  During the transition period for enterprises established before
March 16, the tax rate will gradually increase starting in 2008 and will be
equal to the new tax rate in 2012.All subsidiaries which are non-manufacturers will be subject to the EIT
Law.




Because
of the EIT Law, our tax liabilities will increase and our profits may
accordingly decline as our reduced income tax rate is no longer applicable
and/or the tax relief on investment in PRC is no longer available. Any future
increase in the enterprise income tax rate applicable to us or other adverse tax
treatments will increase our tax liabilities and reduce our net income. Further,
any future increase in the enterprise income tax rate applicable to us or other
adverse tax treatments, such as the discontinuation of preferential tax
treatments for high and new technology enterprises altogether, would have a
material adverse effect on our results of operations and financial
condition.




We
Do Not Carry Insurance To Cover Any Losses Due To Fire, Casualty Or Theft At Our
Production Facility Located In Kunming, China.




We have
not obtained fire, casualty and theft insurance, and there is no insurance
coverage for our raw materials, goods and merchandise, furniture and buildings
in China. Any losses incurred by us will have to be borne by us without any
assistance, and we may not have sufficient capital to cover material damage to,
or the loss of, our production facility due to fire, severe weather, flood or
other cause, and such damage or loss would have a material adverse effect on our
financial condition, business and prospects.




The
internal investigation of our accounting practices and the restatement of our
previous financial statements may result in additional litigation and could
adversely affect our business, financial condition and results of
operations.




The Audit
Committee conducted an internal investigation of our recently disclosed
accounting errors, and we have restated our previously filed financial
statements for fiscal year 2007 and the quarter ended March 31, 2008. The
internal investigation and restatement have exposed us to risks and expenses
associated with litigation, regulatory proceedings and government enforcement
actions. Certain putative class action lawsuits have been asserted against us
and certain of our officers and directors. No assurance can be given regarding
the outcome of such litigation, and additional claims may arise. The
investigation and Restatement and any settlements, payment of claims and other
costs could lead to substantial expenses, may materially affect our cash balance
and cash flows from operations and may divert management's attention from the
Company's business. In addition, the Restatement of our financial statements
could impact our reputation, including our relationships with our investors and
our customers, our ability to hire and retain qualified personnel and,
ultimately, our ability to generate revenue. Furthermore, considerable legal and
accounting expenses related to these matters have been incurred to date and
significant expenditures may continue to be incurred in the future. We could be
required to pay damages and might face remedies that could harm our business,
financial condition and results of operations.




21


We
Do Not Carry Directors and Officers Liability Insurance To Cover Any Expenses
and Losses Due to Lawsuits Related to Financial Reporting Errors. Our
indemnification obligations could adversely affect our business, financial
condition and results of operations.




We have
not obtained D&O Liability insurance to cover lawsuit expenses and losses
related to financial reporting errors. Our bylaws require us to indemnify our
current and former directors, officers, employees and agents against most
actions of a civil, criminal, administrative or investigative nature. Generally,
we are required to advance indemnification expenses prior to any final
adjudication of an individual’s culpability. The expense of indemnifying our
current and former directors, officers and employees and agents in their defense
or related expenses as a result of any actions related to the internal
investigation and financial restatement may be significant. Therefore, our
indemnification obligations could result in the diversion of our financial
resources and may adversely affect our business, financial condition and results
of operations.





We
May Suffer As A Result Of Product Liability Or Defective Products.





We may
produce products which inadvertently have an adverse pharmaceutical effect on
the health of consumers despite proper testing. Existing PRC laws and
regulations do not require us to maintain third party liability insurance to
cover product liability claims. However, if a product liability claim is brought
against us, it may, regardless of merit or eventual outcome, result in damage to
our reputation, breach of contract with our customers, decreased demand for our
products, costly litigation, product recalls, loss of revenue, and the inability
to commercialize some products.




We
Rely On The Cooperation With Research Laboratories And Universities, And If
These Institutions Cease To Cooperate With Us And We Cannot Find Other Suitable
Substitute Research And Development Partners, Our Ability To Develop New
Products May Be Hindered And Our Business May Be Adversely
Affected.




We
cooperate with several research institutions. We rely to a certain extent on
these institutions for our development of new products. There is no assurance
that these institutions will continue cooperating with us to develop new
products. In the event that these institutions cease to cooperate with us and it
cannot find other suitable substitute research and development partners, our
ability to develop new products may be hindered and our business may be
adversely affected.




RISKS
RELATED TO CONDUCTING BUSINESS IN CHINA




All
Of Our Assets Are Located In China And Substantially All Of Our Revenues Are
Derived From Our Operations In China, And Changes In The Political And Economic
Policies Of The PRC Government Could Have A Significant Impact Upon The Business
We May Be Able To Conduct In The PRC And Our Results Of Operations And Financial
Condition.




Our
business operations may be adversely affected by the current and future
political environment in the PRC. The PRC has operated as a socialist state
since the mid-1900s and is controlled by the Communist Party of China. The
Chinese government exerts substantial influence and control over the manner in
which we must conduct our business activities. The PRC has only permitted
provincial and local economic autonomy and private economic activities since the
1970s. The government of the PRC has exercised and continues to exercise
substantial control over virtually every sector of the Chinese economy,
particularly the pharmaceutical industry, through regulation and state
ownership. Our ability to operate in China may be adversely affected by changes
in Chinese laws and regulations, including those relating to taxation, import
and export tariffs, raw materials, environmental regulations, land use rights,
property and other matters. Under our current leadership, the government of the
PRC has been pursuing economic reform policies that encourage private economic
activity and greater economic decentralization. There is no assurance, however,
that the government of the PRC will continue to pursue these policies, or that
it will not significantly alter these policies from time to time without
notice.




22




The
PRC Laws And Regulations Governing Our Current Business Operations Are Sometimes
Vague And Uncertain. Any Changes In Such PRC Laws And Regulations May Have A
Material And Adverse Effect On Our Business.




The PRC’s
legal system is a civil law system based on written statutes, in which system
decided legal cases have little value as precedents unlike the common law system
prevalent in the United States. There are substantial uncertainties regarding
the interpretation and application of PRC laws and regulations, including but
not limited to the laws and regulations governing our business, obtaining
government approvals, and the enforcement and performance of our arrangements
with customers in the event of the imposition of statutory liens, death,
bankruptcy and criminal proceedings. The Chinese government has been developing
a comprehensive system of commercial laws, and considerable progress has been
made in introducing laws and regulations dealing with economic matters such as
foreign investment, corporate organization and governance, commerce, taxation
and trade. However, because these laws and regulations are relatively new, and
because of the limited volume of published cases and judicial interpretation and
their lack of force as precedents, interpretation and enforcement of these laws
and regulations involve significant uncertainties. There is no assurance that
the PRC government will continue to pursue these policies or that its position
on these issues will not change without notice. New laws and regulations that
affect existing and proposed future businesses may also be applied
retroactively. We are considered a foreign persons or foreign funded enterprises
under PRC laws, and as a result, we are required to comply with PRC laws and
regulations. We cannot predict what effect the interpretation of existing or new
PRC laws or regulations may have on our businesses. If the relevant authorities
find that we are in violation of PRC laws or regulations, they would have broad
discretion in dealing with such a violation, including, without
limitation:




·
            levying
      fines;




·
            revoking
      our business and other licenses;




·
            requiring
      that we restructure our ownership or operations;
  and




·
            requiring
      that we discontinue any portion or all of our
  business.




The
Ability Of Our Chinese Operating Subsidiaries To Pay Dividends May Be Restricted
Due To Foreign Exchange Control Regulations Of China.




The
ability of our Chinese operating subsidiaries to pay dividends may be restricted
due to the foreign exchange control policies and availability of cash balance of
the Chinese operating subsidiaries. Because substantially all of our operations
are conducted in China and substantially all of our revenues are generated in
China, our revenue being earned and currency received are denominated in
Renminbi (RMB). RMB is subject to the exchange control regulation in China, and,
as a result, we may be unable to distribute any dividends outside of China due
to PRC exchange control regulations that restrict our ability to convert RMB
into US Dollars. Accordingly, we may not be able to access the Company’s PRC
funds which may not be readily available to us to satisfy obligations which have
been incurred outside the PRC, which could adversely affect our business and
prospects or our ability to meet our cash obligations.




The
Foreign Currency Exchange Rate Between U.S. Dollars And Renminbi Could Adversely
Affect Our Financial Condition.




To the
extent that we need to convert dollars into Renminbi for our operational needs,
our financial position and the price of our common stock may be adversely
affected should the Renminbi appreciate against the U.S. dollar at that time.
Conversely, if we decide to convert our Renminbi into dollars for the
operational needs or paying dividends on our common stock, the dollar equivalent
of our earnings from our subsidiary in China would be reduced should the dollar
appreciate against the Renminbi. We currently do not hedge our exposure to
fluctuations in currency exchange rates.




23




Until
1994, the Renminbi experienced a gradual but significant devaluation against
most major currencies, including dollars, and there was a significant
devaluation of the Renminbi on January 1, 1994 in connection with the
replacement of the dual exchange rate system with a unified managed floating
rate foreign exchange system. As a result, from 1994 to July 2005, the value of
the Renminbi relative to the U.S. dollar remained stable.  Countries,
including the United States, argued that the Renminbi was artificially
undervalued due to China’s monetary policies and pressured China to allow the
Renminbi to float freely in world markets. In July 2005, the PRC government
changed its policy of pegging the value of the Renminbi to the dollar, and the
value of the Renminbi relative to the U.S. dollar has appreciated since then.
Under the new policy the Renminbi is permitted to fluctuate within a narrow and
managed band against a basket of designated foreign currencies. While the
international reaction to the Renminbi revaluation has generally been positive,
there remains significant international pressure on the PRC government to adopt
an even more flexible currency policy, which could result in further and more
significant appreciation of the Renminbi against the dollar.




Inflation
In The PRC Could Negatively Affect Our Profitability And Growth.




While the
PRC economy has experienced rapid growth, such growth has been uneven among
various sectors of the economy and in different geographical areas of the
country. Rapid economic growth can lead to growth in the money supply and rising
inflation. During the past two decades, the rate of inflation in China has been
as high as approximately 20%. According to the National Bureau of Statistics of
China, the inflation rate in China reached a 4.8% in 2007 and increased to a
high point of 5.9% in 2008. If prices for our products rise at a rate that is
insufficient to compensate for the rise in the costs of supplies such as raw
materials, it may have an adverse effect on our profitability. In order to
control inflation in the past, the PRC government has imposed controls on bank
credits, limits on loans for fixed assets and restrictions on state bank
lending. The implementation of such policies may impede economic growth.
Repeated rises in interest rates by the central bank would likely slow economic
activity in China which could, in turn, materially increase our costs and also
reduce demand for our products.




Recent
PRC Regulations Relating To Acquisitions Of PRC Companies By Foreign Entities
May Create Regulatory Uncertainties That Could Restrict Or Limit Our Ability To
Operate. Our Failure To Obtain The Prior Approval Of The China Securities
Regulatory Commission, Or The CSRC, For The Listing And Trading Of Our Common
Stock On NYSE Amex Equities Could Have A Material Adverse Effect On Our
Business, Operating Results, Reputation And Trading Price Of Our Common
Stock.




The PRC
State Administration of Foreign Exchange, or SAFE, issued a public notice in
January 2005 concerning foreign exchange regulations on mergers and acquisitions
in China. The public notice states that if an offshore company controlled by PRC
residents intends to acquire a PRC company, such acquisition will be subject to
strict examination by the relevant foreign exchange authorities. The public
notice also states that the approval of the relevant foreign exchange
authorities is required for any sale or transfer by the PRC residents of a PRC
company’s assets or equity interests to foreign entities for equity interests or
assets of the foreign entities.




In April
2005, SAFE issued another public notice further explaining the January notice.
In accordance with the April notice, if an acquisition of a PRC company by an
offshore company controlled by PRC residents has been confirmed by a Foreign
Investment Enterprise Certificate prior to the promulgation of the January
notice, the PRC residents must each submit a registration form to the local SAFE
branch with respect to their respective ownership interests in the offshore
company, and must also file an amendment to such registration if the offshore
company experiences material events, such as changes in the share capital, share
transfer, mergers and acquisitions, spin-off transaction or use of assets in
China to guarantee offshore obligations. The April notice also provides that
failure to comply with the registration procedures set forth therein may result
in restrictions on our PRC resident shareholders and our subsidiaries. Pending
the promulgation of detailed implementation rules, the relevant government
authorities are reluctant to commence processing any registration or application
for approval required under the SAFE notices.




24




In
addition, on August 8, 2006, the Ministry of Commerce (“MOFCOM”), joined by the
State-Owned Assets Supervision and Administration Commission of the State
Council, State Administration of Taxation, State Administration for Industry and
Commerce, CSRC and SAFE, amended and released the Provisions for Foreign
Investors to Merge and Acquire Domestic Enterprises, new foreign-investment
rules which took effect September 8, 2006, superseding much, but not all, of the
guidance in the prior SAFE circulars. These new rules significantly revise
China’s regulatory framework governing onshore-offshore restructurings and how
foreign investors can acquire domestic enterprises. These new rules signify
greater PRC government attention to cross-border merger, acquisition and other
investment activities, by confirming MOFCOM as a key regulator for issues
related to mergers and acquisitions in China and requiring MOFCOM approval of a
broad range of merger, acquisition and investment transactions. Furthermore, the
new rules establish reporting requirements for acquisition of control by
foreigners of companies in key industries, and reinforce the ability of the
Chinese government to monitor and prohibit foreign control transactions in key
industries.




Specifically,
this regulation, among other things, has some provisions that purport to require
that an offshore special purpose vehicle, or SPV, formed for listing purposes
and controlled directly or indirectly by PRC companies or individuals shall
obtain the approval of the CSRC prior to the listing and trading of such SPV’s
securities on an overseas stock exchange. On September 21, 2006, the CSRC
published on its official website procedures specifying documents and materials
required to be submitted to it by SPVs seeking CSRC approval of their overseas
listings. However, the application of this PRC regulation remains unclear with
no consensus currently existing among the leading PRC law firms regarding the
scope and applicability of the CSRC approval requirement.


Because
we completed our restructuring before September 8, 2006, the effective date of
the new regulation, we believe it is not necessary for us to submit the
application to the CSRC for its approval, and the listing and trading of our
Common Stock on NYSE Amex Equities does not require CSRC approval.




If the
CSRC or another PRC regulatory agency subsequently determines that CSRC approval
was required for our initial public offering that was completed in June 2007, we
may face regulatory actions or other sanctions from the CSRC or other PRC
regulatory agencies. These regulatory agencies may impose fines and penalties on
our operations in the PRC, limit our operating privileges in the PRC, delay or
restrict the repatriation of the proceeds of subsequent offerings into the PRC,
or take other actions that could have a material adverse effect on our business,
financial condition, results of operations, reputation and prospects, as well as
the trading price of our Common Stock. The CSRC or other PRC regulatory agencies
also may take actions requiring us, or making it advisable for us, to halt
future offerings before settlement and delivery of the Common Stock offered in
such future offerings.  Consequently, if you engage in market trading
or other activities in anticipation of and prior to settlement and delivery, you
do so at the risk that settlement and delivery may not occur.




Also, if
the CSRC later requires that we obtain its approval, we may be unable to obtain
a waiver of the CSRC approval requirements, if and when procedures are
established to obtain such a waiver. Any uncertainties and/or negative publicity
regarding this CSRC approval requirement could have a material adverse effect on
the trading price of our Common Stock. Furthermore, published news reports in
China recently indicated that the CSRC may have curtailed or suspended overseas
listings for Chinese private companies. These news reports have created further
uncertainty regarding the approach that the CSRC and other PRC regulators may
take with respect to us.




These new
rules may significantly affect the means by which offshore-onshore
restructurings are undertaken in China in connection with offshore private
equity and venture capital financings, mergers and acquisitions. It is expected
that such transactional activity in China in the near future will require
significant case-by-case guidance from MOFCOM and other government authorities
as appropriate. It is anticipated that application of the new rules will be
subject to significant administrative interpretation, and we will need to
closely monitor how MOFCOM and other ministries apply the rules to ensure its
domestic and offshore activities continue to comply with PRC law. Given the
uncertainties regarding interpretation and application of the new rules, we may
need to expend significant time and resources to maintain
compliance.




25




It is
uncertain how our business operations or future strategy will be affected by the
interpretations and implementation of the SAFE notices and new rules. Our
business operations or future strategy could be adversely affected by the SAFE
notices and the new rules. For example, we may be subject to more stringent
review and approval process with respect to our foreign exchange
activities.




Failure
To Comply With The United States Foreign Corrupt Practices Act Could Subject Us
To Penalties And Other Adverse Consequences.




We are
subject to the United States Foreign Corrupt Practices Act, which generally
prohibits United States companies from engaging in bribery or other prohibited
payments to foreign officials for the purpose of obtaining or retaining
business. Foreign companies, including some that may compete with us, are not
subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft
and other fraudulent practices occur from time-to-time in the PRC. We can make
no assurance, however, that our employees or other agents will not engage in
such conduct for which we might be held responsible. If our employees or other
agents are found to have engaged in such practices, we could suffer severe
penalties and other consequences that may have a material adverse effect on our
business, financial condition and results of operations.




Any
Recurrence Of Severe Acute Respiratory Syndrome, Avian Flu, Or Another
Widespread Public Health Problem, In The PRC Could Adversely Affect Our
Operations.




A renewed
outbreak of severe acute respiratory syndrome, avian flu or another widespread
public health problem in China, where all of our manufacturing facilities are
located and where all of our sales occur, could have a negative effect on our
operations. Such an outbreak could have an impact on our operations as a result
of:




·
            quarantines
      or closures of some of our manufacturing facilities, which would severely
      disrupt our operations,




·
            the
      sickness or death of our key officers and employees,
  and




·
            a
      general slowdown in the Chinese
economy.




Any of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect our operations.




A
Downturn In The Economy Of The PRC May Slow Our Growth And
Profitability.




The
growth of the Chinese economy has been uneven across geographic regions and
economic sectors. There can be no assurance that growth of the Chinese economy
will be steady or that any downturn will not have a negative effect on our
business, especially if it results in either a decreased use of our products or
in pressure on us to lower our prices. The downturn in the Chinese economy and
worldwide in 2008 has had an adverse impact on the financial condition of
patients and hospitals, which in turn affects our pharmaceutical sales and
collection of trade receivables.




26




If
We Make Equity Compensation Grants To Persons Who Are PRC Citizens, They May Be
Required To Register With The State Administration Of Foreign Exchange Of The
PRC, Or SAFE. We May Also Face Regulatory Uncertainties That Could Restrict Our
Ability To Adopt An Equity Compensation Plan For Our Directors And Employees And
Other Parties Under PRC Law.




On April
6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic
Individuals Participating in the Employee Stock Ownership Plan or Stock Option
Plan of An Overseas Listed Company,” also know as “Circular 78.” It is not clear
whether Circular 78 covers all forms of equity compensation plans or only those
which provide for the granting of stock options. For any plans which are so
covered and are adopted by a non-PRC listed company after April 6, 2007,
Circular 78 requires all participants who are PRC citizens to register with and
obtain approvals from SAFE prior to their participation in the plan. In
addition, Circular 78 also requires PRC citizens to register with SAFE and make
the necessary applications and filings if they participated in an overseas
listed company’s covered equity compensation plan prior to April 6, 2007. We
intend to adopt an equity compensation plan in the future and make option grants
to our officers and directors, most of whom are PRC citizens. Circular 78 may
require our officers and directors who receive option grants and are PRC
citizens to register with SAFE. We believe that the registration and approval
requirements contemplated in Circular 78 will be burdensome and time consuming.
If it is determined that any of our equity compensation plans are subject to
Circular 78, failure to comply with such provisions may subject us and
participants of our equity incentive plan who are PRC citizens to fines and
legal sanctions and prevent us from being able to grant equity compensation to
our PRC employees. In that case, our ability to compensate our employees and
directors through equity compensation would be hindered and our business
operations may be adversely affected.




You
May Experience Difficulties In Effecting Service Of Legal Process, Enforcing
Foreign Judgments Or Bringing Original Actions In China Based Upon U.S. laws,
Including The Federal Securities Laws Or Other Foreign Laws Against Us Or Our
Management.




All of
our current operations are conducted in China. Moreover, all of our directors
and officers are nationals and residents of China. All or substantially all of
the assets of these persons are located outside the United States and in the
PRC. As a result, it may not be possible to effect service of process within the
United States or elsewhere outside China upon these persons. In addition,
uncertainty exists as to whether the courts of China would recognize or enforce
judgments of U.S. courts obtained against us or such officers and/or directors
predicated upon the civil liability provisions of the securities law of the
United States or any state thereof, or be competent to hear original actions
brought in China against us or such persons predicated upon the securities laws
of the United States or any state thereof.




RISKS
RELATED TO OUR CAPITAL STRUCTURE




The
Price Of Our Common Stock May Be Volatile, And If An Active Trading Market For
Our Common Stock Does Not Develop, The Price Of Our Common Stock May Suffer And
Decline.




Prior to
our initial public offering and listing of our common stock on the NYSE Amex
Equities on June 14, 2007, there has been no public market for our securities in
the United States. Accordingly, we cannot assure you that an active trading
market will develop or be sustained or that the market price of our common stock
will not decline. The price of our common stock is highly volatile and may
fluctuate substantially due to many factors, some of which are outside of our
control.




Due
To Its Current Price, Our Common Stock Could Be At Risk Of Being Delisted
By The NYSE Amex Equities.




Our
common stock currently trades on NYSE Amex Equities (the “Exchange”). The
Exchange, as a matter of policy, will consider the suspension of trading in, or
removal from listing of any stock if it has been selling for a substantial
period of time at a low price per share and the issuer fails to effect a reverse
split of such shares within a reasonable time after being notified that the
Exchange deems such action to be appropriate. In its review, the Exchange will
consider all pertinent factors including, market conditions in general, the
number of shares outstanding, plans which may have been formulated by
management, applicable regulations of the state or country of incorporation or
of any governmental agency having jurisdiction over the issuer, the relationship
to other Exchange policies regarding continued listing, and, in respect of
securities of foreign issuers, the general practice in the country of origin of
trading in low-selling price issues.  The delisting of our common
stock by the Exchange would adversely affect the price and liquidity of our
common stock.




27




Shares
Eligible For Future Sale May Adversely Affect The Market Price Of Our Common
Stock, As The Future Sale Of A Substantial Amount Of Outstanding Stock In The
Public Marketplace Could Reduce The Price Of Our Common Stock.




In June
2007, we completed a public offering and sale of 460,000 shares of common stock.
In addition, we registered 2,000,000 shares of common stock issued in a Private
Placement, and all lock up restrictions regarding these shares have expired. We
also registered 4,006,400 additional shares of common stock, effective September
19, 2007 (Registration No. 333-144959).




Additionally,
the former stockholders of Shenghuo China may be eligible to sell all or some of
our shares of common stock by means of ordinary brokerage transactions in the
open market pursuant to Rule 144, promulgated under the Securities Act (“Rule
144”), subject to certain limitations.  In general, pursuant to Rule
144, a non-affiliate stockholder who has satisfied a six month holding period
may, under certain circumstances, sell shares under Rule 144 without any volume
limitation. Any substantial sale of common stock pursuant to any resale
prospectus or Rule 144 may have an adverse effect on the market price of our
common stock by creating an excessive supply.





After
March 31, 2009, no open market sales of securities covered by these
registrations will be permitted (other than sales pursuant to Rule 144) until a
new registration statement on Form S-1 is filed and becomes
effective.





Our
Failure To Timely File Certain Periodic Reports With The SEC Could Pose Risks To
Our Business.





We did
not timely file with the SEC our annual report on Form 10-K for fiscal year 2007
or our interim report on Form 10-Q for the first fiscal quarter of 2008.
Consequently, we were not compliant with the reporting requirements under the
Exchange Act or the requirements of the Exchange.  As a result of our
failure to timely file these periodic reports with the SEC, we are ineligible to
utilize Form S-3 and Form S-8 registration statements until such time as we have
timely filed all required reports (including annual reports on Form 10-K,
quarterly reports on Form 10-Q and certain current reports on Form 8-K) under
the Exchange Act during the twelve calendar months and any portion of a month
immediately before the filing of the registration statement. Until filings with
the SEC have been timely made for a full year, we would be required to use Form
S-1 for any potential registration statement, which is likely to be more costly
and time-consuming.





Our
Principal Stockholder Has Significant Influence Over Us.




Our
largest shareholder, Lan’s Int’l Medicine Investment Co., Limited, or LIMI,
beneficially owns or controls approximately 77.3% of our outstanding shares. Gui
Hua Lan, our Chief Executive Officer, Feng Lan, our President, and Zheng Yi
Wang, our Executive Director of Exports, are directors of LIMI and have voting
and investment control over the shares owned by LIMI. In addition, Gui Hua Lan,
Feng Lan and Zheng Yi Wang own 62.42%, 5.15% and 1.45%, respectively, of LIMI’s
issued and outstanding shares, and Lei Lan, our Executive Director of Sales,
owns 9.37% of LIMI. We have other officers and directors who also hold equity
interests in LIMI. LIMI has controlling influence in determining the outcome of
any corporate transaction or other matters submitted to our shareholders for
approval, including mergers, consolidations and the sale of all or substantially
all of our assets, election of directors, and other significant corporate
actions. LIMI also has the power to prevent or cause a change in control. In
addition, without the consent of LIMI, we could be prevented from entering into
transactions that could be beneficial to it. The interests of LIMI may differ
from the interests of our other shareholders.




The
Interests Of The Existing Minority Shareholder In Shenghuo China May Diverge
From Our Own Interests And This May Adversely Affect Our Ability To Manage
Shenghuo China.




Shenghuo
China, our principal operating subsidiary, is an equity joint venture in which
we directly own a 94.95% interest and Kunming Dian Jiao Investment Consulting
Co., Ltd., or Dian Jiao, owns the remaining 5.05% interest. Dian Jiao’s interest
may not be aligned with our interest at all times. If our interests diverge,
Dian Jiao may exercise its right under PRC laws and its consent rights to
protect its own interest, which may be adverse to us and our investors. Further,
should we wish to transfer our equity interest in Shenghuo China, in whole or in
part, to a third-party, Dian Jiao has a right of first refusal under China’s
joint venture regulations.




28




In
addition to its statutory rights as a minority shareholder, Dian Jiao has
additional rights under the joint venture contract and under the articles of
association of Shenghuo China. The joint venture contract and articles of
association require the consent of each of Shenghuo China’s shareholders and/or
unanimous board approval on matters such as a major change in the business line
of the company and expansion or amendment of the business scope of the
company.




Dian Jiao
has thus far been cooperative with us in handling matters with respect to the
business of Shenghuo China. There is no assurance, however, that Dian Jiao will
continue to act in a cooperative manner in the future.




The
Ability Of Our Chinese Operating Subsidiaries To Pay Dividends May Be Restricted
Due To Our Corporate Structure.




Substantially
all of our operations are conducted in China and substantially all of our
revenues are generated in China. As an equity joint venture, Shenghuo China is
required to establish reserve funds and staff and workers’ bonus and welfare
funds, each of which is appropriated from net profit after taxation but before
dividend distributions in accordance with Chinese law. Shenghuo China is
required to allocate at least 10% of our net profits to the reserve fund until
the balance of this fund has reached 50% of Shenghuo China’s registered
capital.




In
addition, the profit available for distribution from our Chinese subsidiaries is
determined in accordance with generally accepted accounting principles in China.
This calculation may differ from the one performed under generally accepted
accounting principles in the United States, or GAAP. As a result, we may not
receive sufficient distributions from our Chinese subsidiaries to enable us to
make dividend distributions to our stockholders in the future and limitations on
distributions of the profits of Shenghuo China could negatively affect our
financial condition and assets, even if our GAAP financial statements indicate
that our operations have been profitable.




If
We Fail To Maintain Effective Internal Controls Over Financial Reporting Or
Effective Disclosure Controls and Procedures, The Price Of Our Common Stock May
Be Adversely Affected.




Our
internal control over financial reporting or disclosure controls and procedures
currently have weaknesses and conditions that need to be addressed, the
disclosure of which may have an adverse impact on the price of our common stock.
We are required to establish and maintain appropriate internal controls over
financial reporting and disclosure controls and procedures. Failure to establish
those controls, or any failure of those controls once established, could
adversely impact our public disclosures regarding our business, financial
condition or results of operations. In addition, management’s assessment of
internal controls over financial reporting or disclosure controls and procedures
may identify weaknesses and conditions that need to be addressed in our internal
controls over financial reporting, disclosure controls and procedures or other
matters that may raise concerns for investors, as occurred in 2007 and 2008. Any
actual or perceived weaknesses and conditions that need to be addressed in our
internal control over financial reporting or disclosure controls and procedures
may have an adverse impact on the price of our common stock.




As of
December 31, 2008, our Chief Executive Officer (CEO) and our Chief Financial
Officer (CFO) performed an evaluation of our disclosure controls and procedures
and concluded that our disclosure controls and procedures had significant
deficiencies that resulted in material weaknesses in our controls and
procedures, resulting in them being ineffective. These deficiencies consisted
of: material adjustments related to the prior year audits were not recorded in
the company’s accounting records that were necessary to reconcile the retained
earnings to the prior year balances in accordance with U.S. GAAP; multiple material adjustments were made as a result of
audit procedures performed by the external auditors, policies related to
handling returned goods were not followed, formal board approvals were not
obtained for capital expenditures and the duties of cashiers were not properly
segregated. We expect to expend a significant amount of funds to
address these deficiencies and there is no guarantee that we will be able to
resolve these deficiencies, which may result in an adverse impact on the price
of our common stock.




29




Standards
For Compliance With Section 404 Of The Sarbanes-Oxley Act Of 2002 Are Uncertain,
And If We Fail To Comply In A Timely Manner, Our Business Could Be Harmed And
Our Stock Price Could Decline.




Rules
adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002
require annual assessment of our internal control over financial reporting, and
attestation of this assessment by our company’s independent registered public
accountants.  We are currently required to conduct an annual
assessment of our internal controls, and the attestation requirement of
management’s assessment by our company’s independent registered public
accountants will first apply to our annual report for the 2009 fiscal year. The
standards that must be met for management to assess the internal control over
financial reporting as effective are new and complex, and require significant
documentation, testing and possible remediation to meet the detailed standards.
We may encounter problems or delays in completing activities necessary to make
an assessment of our internal control over financial reporting. In addition, the
attestation process by our independent registered public accountants is new and
it may encounter problems or delays in completing the implementation of any
requested improvements and receiving an attestation of our assessment by our
independent registered public accountants. If we cannot assess our internal
control over financial reporting as effective, or our independent registered
public accountants are unable to provide an unqualified attestation report on
such assessment once they are required to do so, investor confidence and share
value may be negatively impacted.




Our
Common Stock May Be Considered A “Penny Stock,” And Thereby Be Subject To
Additional Sale And Trading Regulations That May Make It More Difficult To
Sell.




Our
common stock may be considered to be a “penny stock” if it does not qualify for
one of the exemptions from the definition of “penny stock” under Section 3a51-1
of the Securities Exchange Act for 1934, as amended (the “Exchange Act”). Our
common stock may be a “penny stock” if it meets one or more of the following
conditions (i) the stock trades at a price less than $5.00 per share; (ii) it is
not traded on a “recognized” national exchange; (iii) it is not quoted on the
Nasdaq Capital Market, or even if so, has a price less than $5.00 per share; or
(iv) is issued by a company that has been in business less than three years with
net tangible assets less than $5 million.




The
principal result or effect of being designated a “penny stock” is that
securities broker-dealers participating in sales of our common stock will be
subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9
promulgated under the Exchange Act. For example, Rule 15g-2 requires
broker-dealers dealing in penny stocks to provide potential investors with a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document at least two business days before
effecting any transaction in a penny stock for the investor’s account. Moreover,
Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any
investor for transactions in such stocks before selling any penny stock to that
investor. This procedure requires the broker-dealer to (i) obtain from the
investor information concerning his or her financial situation, investment
experience and investment objectives; (ii) reasonably determine, based on that
information, that transactions in penny stocks are suitable for the investor and
that the investor has sufficient knowledge and experience as to be reasonably
capable of evaluating the risks of penny stock transactions; (iii) provide the
investor with a written statement setting forth the basis on which the
broker-dealer made the determination in (ii) above; and (iv) receive a signed
and dated copy of such statement from the investor, confirming that it
accurately reflects the investor’s financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult and time consuming for holders of our common stock to resell their
shares to third parties or to otherwise dispose of them in the market or
otherwise.




We
Do Not Foresee Paying Cash Dividends In The Foreseeable Future.




We
currently intend to retain any future earnings for funding growth. We do not
anticipate paying any dividends in the foreseeable future. As a result, you
should not rely on an investment in our securities if you require dividend
income. Capital appreciation, if any, of our shares may be your sole source of
gain for the foreseeable future. Moreover, you may not be able to resell your
shares in our company at or above the price you paid for them.




30




ITEM
1B. UNRESOLVED STAFF COMMENTS.




Smaller
reporting companies are not required to provide the information required by this
item.





ITEM
2. PROPERTIES.




We have
land use rights to two parcels of land with a total area of approximately 66.7
acres and own a 161,460 square foot factory. The land use rights for both
parcels have terms of 50 years and end in 2048 and 2050. Our principal executive
offices are located at No. 2, Jing You Road, Kunming National Economy &
Technology Developing District, People’s Republic of China 650217.




ITEM
3. LEGAL PROCEEDINGS.




Class Action
Lawsuit – In 2008, putative class action lawsuits were asserted against
the Company and certain other parties in the United States District Court for
the Southern District of New York (the “Court”). On February 12, 2009, an
amended complaint was served on the Company by new lead counsel for the class,
consolidating the putative class actions and bearing the caption Beni Varghese,
Individually and on Behalf of All Other Similarly Situated v. China Shenghuo
Pharmaceutical Holdings, Inc., et al., Index No. 1:08 CIV. 7422.  The
defendants include the Company, the Company’s controlling shareholders, Lan’s
International Medicine Investment Co., Limited, the Company’s chief executive
officer, Gui Hua Lan, the Company’s former chief financial officer, Qiong Hua
Gao, and the Company’s independent registered public accounting firm, Hansen,
Barnett & Maxwell, P.C.  By stipulation, the defendants currently
have until April 12, 2009to
respond to the amended consolidated complaint.





The amended consolidatedcomplaint alleges that the Company failed to take adequate steps
to ensure its financial reporting comported with U.S. Generally Accepted
Accounting Principles (“GAAP”) and, as a result, the Company was required to
restate what are alleged to be materially false and misleading financials for
accounting periods during the alleged class period from August 2007 through
August 20, 2008. The amended consolidated complaintfurther alleges, among other things, that
certain of the Company’s SEC filings and other public statements contained false
and misleading statements which resulted in damages to the plaintiffs and the
members of the purported class when they purchased the Company’s securities. On
the basis of those allegations, plaintiffs in each of the actions seek an
unspecified amount of damages under Sections 10(b) and 20(a) of the Exchange
Act, and Rule 10b-5 promulgated thereunder.
 
 The
Company believes the allegations in theamended
consolidated complaint are without merit, and intends to vigorously
defend the class action lawsuits. The Company does not believe the outcome of
this suit will have a material adverse effect on the Company. However, the
Company is unable at this time to predict the outcome of this litigation or
whether the Company will incur any liability associated with the litigation, or
to estimate the effect such outcome would have on the financial condition,
results of operations, or cash flows of the Company.





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.




None.




PART
II




ITEM
      5.
              MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY
SECURITIES.




Commencing
on June 14, 2007, our shares of common stock have been listed for trading on the
Exchange under the ticker symbol “KUN.” As of March 15, 2009, we had 49
registered shareholders.




31




For the
year ended December 31, 2008, the high and low sales prices for our common stock
are as set forth below. The closing sales price of our common stock on March 27,
2009 was $0.37per share.




2008High
              
              
              Low4th
      Quarter
              
              $
              1.89
              
              
              $
              0.373rd
      Quarter
              
              
              2.72
              
              
              
              1.892nd
      Quarter
              
              
              5.49
              
              
              
              3.211st
      Quarter
              
              
              7.45
              
              
              
              3.12




The price
of our common stock will likely fluctuate in the future. The stock market in
general has experienced extreme stock price fluctuations in the past few years.
In some cases, these fluctuations have been unrelated to the operating
performance of the affected companies. Many companies have experienced dramatic
volatility in the market prices of their common stock. We believe that a number
of factors, both within and outside our control, could cause the price of our
common stock to fluctuate, perhaps substantially. Factors such as the following
could have a significant adverse impact on the market price of our common
stock:




·
            Our
      ability to obtain additional financing and, if available, the terms and
      conditions of the financing;




·
            Our
      financial position and results of
operations;




·
            Concern
      as to, or other evidence of, the reliability and efficiency of our
      products and services or our competitors’ products and
      services;




·
            Announcements
      of innovations or new products or services by us or our
      competitors;




·
            U.S.
      federal and state governmental regulatory actions and the impact of such
      requirements on our business;




·
            The
      development of litigation against
us;




·
            Period-to-period
      fluctuations in our operating
results;




·
            Changes
      in estimates of our performance by any securities
  analysts;




·
            The
      issuance of new equity securities pursuant to a future offering or
      acquisition;




·
            Changes
      in interest rates;




·
            Competitive
      developments, including announcements by competitors of new products or
      services or significant contracts, acquisitions, strategic partnerships,
      joint ventures or capital
commitments;




·
            Investor
      perceptions of us; and




·
            General
      economic and other worldwide or national
  conditions.




Dividend
Policy




We have
not declared or paid any cash dividends on our common stock and we currently
intend to retain future earnings, if any, to finance the expansion of our
business.  We do not expect to pay any cash dividends in the
foreseeable future. The decision whether to pay cash dividends on our common
stock will be made by our board of directors, at their discretion, and will
depend on our financial condition, operating results, capital requirements and
other factors that the board of directors considers significant. We currently
intend to retain our earnings for funding growth and, therefore, do not expect
to pay any dividends in the foreseeable future.




32




Equity
Compensation Plan




As of
December 31, 2008, we did not have an equity compensation plan for employees,
but we did award warrants to non-employee directors in 2007.




#
      of securities to be
                                issued
      upon exercise
                                of
      outstanding
                                options,
      warrants
                                and
      rights
                              
                              
                              Weighted-average
                                exercise
      price of
                                outstanding
                                options,
      warrants
                                and
      rights
                              
                              
                              #
      of securities
                                remaining
      available
                                for
      future issuance
                                under
      equity
                                compensation
      plans
                                (excluding
      securities
                                reflected
      in column
                                (a))Equity
      compensation plans approved by security holders
                              
                              
                              40,000
                              
                              
                              
                              4.20
                              
                              
                              
                              -Equity
      compensation plans not approved by securities holders
                              
                              
                              6,000
                              (1)
                              
                              
                              3.50
                              
                              
                              
                              -Total
                              
                              
                              46,000
                              
                              
                              
                              -
                              
                              
                              
                              -







(1) A
total of 6,000 warrants were granted to two of our non-employee directors in
2007.




Recent
sales of unregistered securities




None.




ITEM
6. SELECTED FINANCIAL DATA.




Smaller
reporting companies are not required to provide the information required by this
item.





ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.




Forward-Looking
Statements




The
following discussion of our financial condition and results of operations should
be read in conjunction with our financial statements and the related notes, and
the other financial information included in this report.




This
filing contains forward-looking statements. The words “anticipated,” “believe,”
“expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and
similar expressions are intended to identify forward-looking statements. These
statements include, among others, information regarding future operations,
future capital expenditures, and future net cash flow. Such statements reflect
our management’s current views with respect to future events and financial
performance and involve risks and uncertainties, including, without limitation,
our ability to repay certain bank loans due in 2009, general economic and
business conditions; changes in foreign, political, social, and economic
conditions; our expansion into the retail distribution of our cosmetic products;
regulatory initiatives and compliance with governmental regulations; the ability
to achieve further market penetration and additional customers; and various
other matters, many of which are beyond our control. Should one or more of these
risks or uncertainties occur, or should underlying assumptions prove to be
incorrect, actual results may vary materially and adversely from those
anticipated, believed, estimated or otherwise indicated. Consequently, all of
the forward-looking statements made in this report are qualified by these
cautionary statements and there can be no assurance of the actual results or
developments. Refer to the sections entitled “Risk Factors” and “Special Note
Regarding Forward-Looking Statements” contained in this report.




33




Overview




We are
primarily engaged in the research, development, manufacture, and marketing of
pharmaceutical, nutritional supplement and cosmetic products. Almost all of our
products are derived from the medicinal herb Panax notoginseng, also known as
Sanqi, Sanchi or Tienchi. Panax notoginseng is the root of the greyish-brown or
greyish-yellow plant that only grows in a few geographic locations, among which
is the Yunnan Province in southwest China, where we are located; this province
accounts for 90% of the total global production. The main root of Panax
notoginseng are cylindrical shaped and are most commonly one to six centimeters
long and one to four centimeters in diameter. Panax notoginseng saponins (PNS),
the active ingredients in Panax notoginseng, are extracted from the plant using
high-tech equipment and in accord with Good Manufacturing Practice (GMP)
standards. Our main product, Xuesaitong Soft Capsules, accounted for more than
87% of our sales for the year ended December 31, 2008 as compared to more than
90% of our sales for the year ended December 31, 2007.




We earn
revenues mainly from the production and sale of our products and external
processing. We hope to increase profits as a result of making new products and
increasing sales, since the sale of products is our main source for generating
cash. Our business involves a significant degree of risk as a result of the
opportunities and challenges we face in selling our products. We have
traditionally focused on research and development of products serving
cardiovascular and cerebrovascular disease, peptic ulcer disease and health
products markets.  However, we intend to devote additional resources
to research and development and to continue to evaluate and develop additional
high-tech product candidates to expand our pipeline where we perceive an unmet
need and commercial potential and to improve existing products to enhance their
efficacy.




With
intense price competition among many similar or identical products in the
industry, we believe that building brand equity is the primary means to generate
and sustain profitable growth in the future. Our brand strategy is centered on
“Lixuwang”—the brand under which most of our products are sold. We believe that
our relationships within the Chinese pharmaceutical industry are key to building
brand equity, and we believe we can benefit from developing and maintaining
relationships with professionals within the industry, especially physicians and
hospitals.




Xuesaitong
Soft Capsules, which has been listed in the National Insurance Catalogue and is
subject to wholesale and retail price controls by the Chinese government, are
primarily sold in China, but the product is also sold in various developing
countries, including Malaysia, Indonesia and Kyrgyzstan. Sales of the product in
China are regulated by the SFDA as a prescription drug and therefore must be
sold to consumers through hospital pharmacies and cannot be advertised, thus
limiting the ability of the company to market the brand. Our three largest
distributors are Guangzhou Pharmaceutical, Ltd.; Yunnan Province Pharmaceutical,
LTD.; and Beijing Ai’xin Weiye Medicine, LTD, all of which accounted for 8.1%,
6.1% and 5.2% of our sales for the year ended December 31, 2008.




As of
December 31, 2008, our medicine marketing team maintains sales offices or agents
in approximately 31 provinces throughout China. The sales network covers
approximately 210 cities and is staffed by approximately 600 sales
representatives. We intend to grow our internal marketing and sales function and
increase our relationships with other national distributors to expand the
distribution and presence of our non-prescription brands and
cosmetics.




We hope
to further expand sales beyond China into other countries where our products
could be affordable treatment options. We intend to focus on the expansion of
our cosmetics product line and devote additional marketing and sales resources
to that end with the aim that our cosmetics products will account for a larger
percentage of our revenue in the future.




Our
business is capital intensive, and these research and development, marketing,
sales network expansion and cosmetic product expansion initiatives will require
us to expend significant cash resources, which could adversely affect our
profitability and liquidity. We do face certain challenges and risks, including
our relatively high debt ratio, which is one of our main risks. We have
encountered a shortage of working capital and are exploring possible ways to
address our short and long term cash needs.




We
believe that among the most important economic or industry-wide factors relevant
to our growth in the short term is the reform of the medical system in China and
the adjustment of medicine prices, which will affect the sale of our main
product, Xuesaitong Soft Capsules, in hospitals. In order to increase long-term
growth, we have applied for the designation of Xuesaitong Soft Capsules as a
medicine with “good quality worthy of high price,” which we received in February
2007. Currently, the Chinese government supports the medical system in urban and
rural communities.




34




According
to data from the Southern Medicine Economy Research Institute, the
pharmaceutical industry in China grew about 27% on a year-over-year basis in
2008. This growth was driven by a number of favorable factors including
improving standards of living from an increase in disposable income, an aging
population, the improving access and higher participation in the State Basic
Medical Insurance System, and the increase in government spending on public
health care.




In
January 21, 2009, the Chinese government announced a healthcare reform plan
proposing the government spend upward of RMB850 billion over the next three
years to make medical services and products more affordable and accessible to
the entire population. We believe the successful implementation of the policies
outlined in the plan will have a significant impact on the domestic
pharmaceutical sector. There are five key tasks the healthcare reforms are
aiming to address: 1) to expand medical insurance coverage and increase
participation rate, 2) set up a national basic drug system, 3) establishment of
an extensive public health system, 4) increasing the efficiency and improve the
quality of basic medical services, especially in the rural areas, and 5) reform
state-owned hospitals.




TCM,
including prescription and over-the-counter pharmaceuticals, have been widely
used in China for many years and are an important part of the overall Chinese
culture. The recently announced healthcare reform plan contains measures and
policies that we believe will help support and promote the growth and
development of the domestic TCM market. TCM drug manufacturers are likely to
benefit from this reform as we believe the government will add more TCM-related
drugs to the national medicine catalog. In addition, we expect the government
will focus on disease prevention as it rolls out the nationwide medical
insurance coverage. The TCM market is a vibrant and growing industry despite the
challenging economic environment and it will remain a part of mainstream
medicine in China.




We hope
to stabilize the sales channel into hospitals and widen the reach of sales in
urban and rural communities at the same time. Large increases in medicine sales
at an average lower price will ensure the growth of general medicinal sales over
the next few years.




In 2008,
we expanded the geographic region in which our 12 Ways cosmetic products were
sold to a number of cities and provinces outside our local region. We have
opened a number of retail specialty counters to offer our cosmetic products at
pharmacies throughout Eastern China, eventually expanding our retail presence
across China. As of December 31, 2008, we have opened about 550 retail specialty
counters in more than 30 cities. In addition, we opened a 12 Ways Chinese Herbal
Beauty Salon in Kunming that will feature approximately ten traditional Chinese
medicine practitioners and beauticians that provide a variety of services,
including acupuncture, body massage, foot massage and other services. All
products used in the salon will be supplied by us. Management hopes that the
opening of this salon and the opening of retail counters will allow us to
increase our brand recognition and strengthen marketing. Our ability to
effectively open and operate new retail locations depends on several factors,
including, among others, our ability to identify suitable counter locations, the
availability of which is outside our control; our ability to prepare counters
for opening within budget; our ability to hire, train and retain personnel; our
ability to secure required governmental permits and approvals; our ability to
contain payroll costs; and our ability to generate sufficient operating cash
flows or secure adequate capital on commercially reasonable terms to fund short
term cash needs and our expansion plans.




35




There is
pot ential
for growth in production and sales due to the growth of new products and
expansion of new channels into urban and rural communities. However, it will be uncertain which
of our new products will pass the applicable tests and get clinical approval
without difficulty because of the uncertainty of test results and clinical
approvals.Over the last three years, the price of the main raw
material we use - sanchi - has stabilized and is rising slightly, which will
likely increase our cost of product sold.  In addition, our expected
increased expenses for research and development, marketing and sales may have an
adverse affect on future profit levels and available cash
resources.




Company
History




We were
incorporated in the State of Delaware on May 24, 2005. We were originally
organized as a “blank check” shell company to investigate and acquire a target
company or business seeking the perceived advantages of being a publicly held
corporation. Our principal business operations from inception to August 31,
2006, to closing of the Share Exchange, was to achieve long-term growth
potential through a combination with a business rather than immediate,
short-term earnings. On June 30, 2006, we entered into a Share Exchange
Agreement (the “Exchange Agreement”) with Kunming Shenghuo Pharmaceutical
(Group) Co., Ltd. (“Shenghuo China”) and Lan’s Int’l Medicine Investment Co.,
Limited, a Hong Kong corporation and shareholder holding 93.75% of the equity
interest of Shenghuo China (“LIMI”). On August 11, and 28, 2006, the parties
entered into Amendment No. 1 and 2 to the Exchange Agreement, respectively.
Pursuant to the Exchange Agreement, as amended, we agreed to issue an aggregate
of 16,255,400 shares of our common stock to LIMI and its designees in exchange
for 93.75% of the equity interest of Shenghuo China (the “Share Exchange”). The
Share Exchange closed on August 31, 2006. Upon the closing of the Share
Exchange, we (i) became the 93.75% parent of Shenghuo China, (ii) assumed the
operations of Shenghuo China and its subsidiaries and (iii) changed our name
from SRKP 8, Inc. to China Shenghuo Pharmaceutical Holdings, Inc.




On June
18, 2007, the Board of Shenghuo China resolved to increase the registered
capital of Shenghuo China by $734,348.09 from $9,665,017 to
$10,399,800.  As a result, we own approximately 94.95% of the equity
interests of Shenghuo China, and Kunming Dian Jiao Investment
Consulting Co., Ltd. or Dian Jiao owns approximately 5.05% of the
equity interests of Shenghuo China.




36




Recent
Events




Restatement
of Financial Statements for the Fiscal Year 2007 and the First Fiscal Quarter of
2008




During
the third quarter of 2008, the Audit Committee of the Board of Directors of the
Company (the “Audit Committee”) conducted an internal investigation based on
preliminary information received from Hansen, Barnett & Maxwell, P.C.
(“HBM”), the independent registered public accounting firm of the Company,
regarding errors in the accounting for certain sales representative commission
advances and trade receivables, the Company’s internal controls, the Company’s
personnel involved and related matters. These errors resulted in the
understatement of general and administrative expenses (the line item that
includes bad debt allowance) and the resultant overstatement of net income and
earnings per share. The errors also resulted in an overstatement of the deferred
tax asset, which could adversely affect future operations and profit levels on a
continuing basis.  The Audit Committee found no evidence to suggest
that the accounting errors were made at the direction of, or with the knowledge
or involvement of, the Company’s executive officers and management, and the
Audit Committee determined that the actions of the two supervisors responsible
for the errors were not intended to manipulate the Company’s reported results or
financial statements.  The Company restated its financial statements
for the fiscal year ended December 31, 2007 and the fiscal quarter ended March
31, 2008 (the only periods found to have been impacted by the accounting errors)
to correct the accounting errors. See Note 1 of Notes to the Financial
Statements for information regarding the effect of the Restatement on the
Company’s financial statements for the affected periods.




Based on the Audit Committee’s recommendations, the
Company implemented the following remedial measures in order to prevent similar
accounting errors from occurring in the future: (1) dismissed the two
supervisors in the Company’s financial department who were responsible for the
erroneous journal entries; (2) provided additional training in compliance with
Section 404 of the Sarbanes-Oxley Act of 2002 and financial document production
and record retention to the Company’s finance personnel and other personnel who
provide financial data that is incorporated into the Company’s financial
statements; (3) accelerated the process of improving its disclosure controls and
procedures and internal controls over financial reporting (which included
documentation of policies and procedures by the end of 2008 and will include
implementation in January 2009 in compliance with Section 404 of the
Sarbanes-Oxley Act of 2002 following the COSO framework); and (4) replaced Qiong
Hua Gao, the Company’s former Chief Financial Officer, with Wendy Fu as the new
Chief Financial Officer, who is more experienced in the application of generally
accepted accounting principles in the United States.





As previously reported in the Company’s Form 10KSB/A,
filed on November 14, 2008, the effects of the Restatement of the financial
statements for the fiscal year 2007 were as follows:




As Previously
              
              
              Effect ofReported
              
              
              Restatement
              
              
              As RestatedConsolidated Balance SheetAs of December 31, 2007Accounts and notes receivable,
      net
              
              $
              9,651,304
              
              
              $
              916,368
              
              
              $
              10,567,672Employee advances, net
              
              
              10,147,415
              
              
              
              (1,897,609
              )
              
              
              8,249,806Total Current Assets
              
              
              27,581,623
              
              
              
              (981,241
              )
              
              
              26,600,382Deferred Income Taxes
              
              
              1,593,159
              
              
              
              (1,593,159
              )
              
              
              -TOTAL ASSETS
              
              
              37,910,118
              
              
              
              (2,574,400
              )
              
              
              35,335,718Minority Interest in Net Assets of
      Subsidiaries
              
              
              655,962
              
              
              
              (176,644
              )
              
              
              479,318Stockholders' Equity:Retained earnings
              
              
              6,335,590
              
              
              
              (2,296,253
              )
              
              
              4,039,337Accumulated other comprehensive income, foreign
      currency translation
              
              
              1,031,146
              
              
              
              (101,503
              )
              
              
              929,643Total Stockholders' Equity
              
              
              13,709,654
              
              
              
              (2,397,756
              )
              
              
              11,311,898TOTAL LIABILITIES AND STOCKHOLDERS'
      EQUITY
              
              
              37,910,118
              
              
              
              (2,574,400
              )
              
              
              35,335,718Consolidated Statement of
      OperationsFor the year ended December 31,
      2007General and administrative
      expense
              
              
              4,935,754
              
              
              
              942,194
              
              
              
              5,877,948Total Operating Expenses
              
              
              12,048,873
              
              
              
              942,194
              
              
              
              12,991,067Income from Operations
              
              
              2,886,755
              
              
              
              (942,194
              )
              
              
              1,944,561Income Before Income Taxes
              
              
              2,332,820
              
              
              
              (942,194
              )
              
              
              1,390,626Benefit from (provision for) income
      taxes
              
              
              1,978,963
              
              
              
              (1,529,765
              )
              
              
              449,198Minority interest in income of
      subsidiaries
              
              
              (295,143
              )
              
              
              175,706
              
              
              
              (119,437
              )Net Income
              
              
              4,016,640
              
              
              
              (2,296,253
              )
              
              
              1,720,387Foreign currency translation
      adjustment
              
              
              810,273
              
              
              
              (101,503
              )
              
              
              708,770Comprehensive Income
              
              
              4,826,913
              
              
              
              (2,397,756
              )
              
              
              2,429,157Earnings Per ShareBasic
              
              
              0.21
              
              
              
              (0.12
              )
              
              
              0.09Diluted
              
              
              0.21
              
              
              
              (0.12
              )
              
              
              0.09Consolidated Statement of Cash
      FlowsFor the year ended December 31,
      2007Cash Flows from Operating
      Activities:Net income
              
              
              4,016,640
              
              
              
              (2,296,253
              )
              
              
              1,720,387Deferred income taxes
              
              
              (1,002,915
              )
              
              
              1,529,764
              
              
              
              526,849Minority interest in income of
      subsidiaries
              
              
              295,143
              
              
              
              (175,706
              )
              
              
              119,437Change in current assets and
      liabilities:Accounts and notes
    receivable
              
              
              900,437
              
              
              
              (879,905
              )
              
              
              20,532Employee advances
              
              
              (7,024,869
              )
              
              
              1,822,100
              
              
              
              (5,202,769
              )Net Cash Used in Operating
      Activities
              
              
              (5,036,769
              )
              
              
              -
              
              
              
              (5,036,769
              )





Critical
Accounting Policies and Estimates




The
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles in the United States.
We believe the following are the critical accounting policies that impact the
financial statements, some of which are based on management’s best estimates
available at the time of preparation. Actual experience may differ from these
estimates.




Basis of
Presentation and Translating Financial Statements - The consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America. The functional currency of
the operating subsidiaries in the PRC is the Chinese Yuan Renminbi (“CNY”);
however, the consolidated financial statements have been expressed in United
States Dollars (“USD”). The accompanying consolidated balance sheets have been
translated into USD at the exchange rates prevailing at each balance sheet date.
The consolidated statements of operations have been translated using the average
exchange rates prevailing during the operating periods of each
statement.




37




Principles of
Consolidation - The accompanying consolidated financial statements
present the operations of the Company and its majority owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.




Accounting
Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosures of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.




Fair Value of
Financial Instruments - The carrying amounts reported in the consolidated
balance sheets for accounts and notes receivables, sales representative
advances, advances to suppliers, accounts payable, accrued liabilities, and
advances from customers approximate fair value because of the immediate or
short-term maturity of these financial instruments. Management believes the
interest rates on short-term notes payable and long-term debt reflect rates
currently available in the PRC. Thus, the carrying value of these loans
approximates fair value.




Cash and Cash
Equivalents - Our cash and cash equivalents are maintained in bank
deposit accounts. We have not experienced any losses with respect to these
deposits. Cash and cash equivalents include interest bearing and non-interest
bearing bank deposits, money market accounts, and short-term certificates of
deposit with original maturities of three months or less. We did not enter into
any hedge contracts during any of the periods presented.




Accounts
Receivable and Notes Receivable and Allowance for Doubtful Accounts -
Trade receivables are carried at original invoiced amounts less an allowance for
doubtful accounts. An allowance for uncollectible accounts receivable is
established by charges to operations for amounts required to maintain an
adequate allowance, in management’s judgment, to cover anticipated losses from
customer accounts and sales returns. Such accounts are charged to the allowance
when collection appears doubtful. Any subsequent recoveries are credited to the
allowance account. The Company believes that the allowance for doubtful accounts
is consistent with industry standards in the PRC based on the products that are
being sold.




Notes
receivable were $750,877 and $1,165,535 as of December 31, 2008 and 2007,
respectively. The notes represent bank drafts that have been arranged with
third-party financial institutions by certain customers to settle their
purchases from us. These bank drafts are non-interest bearing and due within six
months. Such sales and purchasing agreements are consistent with industry
practices in the PRC.




Sales
Representative Advances - Sales representative advances are presented net
of an estimated allowance for doubtful advances. Sales representative advances
consist of business advances to sales representatives for travel and related
expenses and various prepaid expenses mainly for market development. As time
passes from when advances are made to sales representatives for travel and
related expenses, the Company will create an allowance for these older
receivables as the likelihood of collection from each particular sales
representative decreases as their respective advances age. Long-term sales
representative advances are not expected to be realized in the current operating
period.




Credit
Risk - The carrying amounts of accounts receivable and sales
representative advances included in the balance sheets represent the Company’s
major exposure to credit risk in relation to its financial assets. No other
financial assets carry a significant exposure to credit risk. The Company
performs ongoing credit evaluations of each customer’s financial condition. It
maintains allowances for doubtful accounts and such allowances in the aggregate
have not exceeded management’s estimations. The Company has its cash in bank
deposits and money market funds primarily in the PRC. Historically, deposits in
Chinese banks have been secure due to the state policy on protecting depositors’
interests. China promulgated a new Bankruptcy Law in August 2006, which came
into effect on June 1, 2007, which, together with specific, complementary
regulation to be issued in future regulations shall provide the implementation
of measures for the bankruptcy of Chinese banks. In the event that these
bankruptcy laws are enacted for banks in the PRC, the Company’s deposits may be
at a higher risk of loss.




38




Inventory
- Inventories consist principally of pharmaceutical products and are stated at
weighted average cost. When market value of the inventory products is lower than
the weighted average cost, inventory is reduced to its net realizable value. The
Company also holds inventory on consignment.




Property and
Equipment - Property and equipment are stated at cost. Maintenance and
depreciation are charged to expense as incurred and major improvements are
capitalized. Gains or losses on sales or retirements are included in the
statements of operations in the period of disposition, determined by reference
to their carrying amounts. The Company reviews its property and equipment
periodically for changes in circumstances that would indicate its recoverable
carrying value is less than its net book value. If such circumstances occur,
impairment is charged to such items.




Intangible
Assets - Acquisition costs of land use rights are capitalized at their
acquisition costs and amortized using the straight-line method over their
estimated useful lives. For those intangible assets with legal protection over a
specific period, their useful life is the protected period. Assets that do not
have legal protection periods are amortized over their estimated useful life.
Research and development costs are expensed during the period
incurred.




Impairment of
Long-Lived Asset - The Company reviews its long-lived assets, including
intangibles, for impairment when events or changes in circumstances indicate
that the carrying value of an asset may not be recoverable. The Company
evaluates, at each balance sheet date, whether events and circumstances have
occurred that indicate possible impairment. The Company uses an estimate of
future undiscounted net cash flows from the related asset or group of assets
over their remaining life in measuring whether the assets are recoverable. As of
December 31, 2008, the Company does not consider any of its long-lived assets to
be impaired.




Deposits and
Accrued Expenses - Accrued expenses consists of accrued commission
expense, accrued payroll expense, and accrued welfare expense. Deposits consist
of funds paid by the selling representatives held by the Company until the
selling representatives no longer provide services to the Company, at which time
the deposit is returned to the selling representatives. The Company records
deposits from selling representatives when payments are received.




Advances to
Suppliers and Advances from Customers - As is customary in the PRC, we
will often make advanced payments to suppliers for materials, which may include
provisions that set the purchase price and delivery date of raw materials, or
receive advance payments from customers.




Revenue
Recognition - The Company recognizes revenue when it is realized and
earned. The Company considers revenue realized or realizable and earned when (1)
it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the
sales price is fixed or determinable, and (4) collectability is reasonably
assured. Delivery does not occur until products have been shipped to the client,
risk of loss has transferred to the client and client acceptance has been
obtained, client acceptance provisions have lapsed, or the Company has objective
evidence that the criteria specified in client acceptance provisions have been
satisfied. The sales price is not considered to be fixed or determinable until
all contingencies related to the sale have been resolved. The Company recognizes
revenue for its consignment sales only after the customer has checked the
quality of the goods and the Company has received a written confirmation from
the customer that they have accepted the goods.




Revenue
is recognized net of value added tax (“VAT”) payable to the Chinese tax
authorities as part of the PRC government’s policy. Sales of products in the PRC
are subject to a 17% VAT.




Cost of
Revenues - The cost of revenues are the direct expenses incurred in
producing the pharmaceuticals and cosmetics, which include materials, wages,
handling charges, and a portion of overhead expenses associated with the
manufacture and delivery of products.




Shipping and
Handling Costs - Shipping and handling costs are included in selling
expenses.




Research and
Development Expense - We expense research and development expenses as
incurred.  Revenue from research and development activities is
recognized in accordance with revenue recognition policy as stated above.
Because in many cases we cannot be assured that the terms of specific contracts
can be fulfilled, we recognizes revenue only after all terms of a contract are
complete.




39




Advertising
Expense - We expense advertising costs as incurred.




Basic and Diluted
Earnings per Share - Basic and diluted earnings per share are calculated
by dividing net earnings attributable to common stockholders by the
weighted-average number of shares of common stock outstanding during the year.
Diluted earnings per share are calculated to give effect to potentially issuable
dilutive common shares. Potentially dilutive securities for the year ended
December 31, 2008 include 46,000 warrants which were antidilutive due to losses
of the Company. Using the treasury stock method, dilutive securities for the
year ended December 31, 2008 include the effects of warrants for the respective
periods outstanding during the year. The following table is a reconciliation of
the numerators and denominators used in the calculation of basic and diluted
earnings per share and the weighted-average common shares outstanding,
respectively:




For
      the Years Ended
                                  December
      31,2008
                                
                                
                                2007Net
      (loss) income
                                
                                $
                                (4,642,909
                                )
                                
                                $
                                1,720,387Basic
      weighted-average common shares outstanding
                                
                                
                                19,679,400
                                
                                
                                
                                19,387,619Effect
      of dilutive securities:Warrants
                                
                                
                                -
                                
                                
                                
                                51,458Diluted
      weighted-average common shares outstanding
                                
                                
                                19,679,400
                                
                                
                                
                                19,439,077(Loss)
      earnings per share:Basic
                                
                                $
                                (0.24
                                )
                                
                                $
                                0.09Diluted
                                
                                $
                                (0.24
                                )
                                
                                $
                                0.09





Retirement
Benefit Plans - The Company makes monthly contributions to various
employee retirement benefit plans organized by provincial governments in the PRC
in accordance with rates prescribed by them. The provincial governments
undertake to assume the retirement benefit obligations of all existing and
future retired employees of the Company. Contributions to these plans are
charged to expense as incurred.




Comprehensive
Income - Other comprehensive income presented in the consolidated
financial statements consists of cumulative foreign currency translation
adjustments.




Recently Enacted
Accounting Standards - In September 2006, the Financial Accounting
Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements, which
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS No. 157 was effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. In February
2008, the FASB issued FASB Staff Position (FSP FIN) No. 157-2 which extended the
effective date for certain nonfinancial assets and nonfinancial liabilities to
fiscal years beginning after November 15, 2008. The adoption of the portions of
SFAS No. 157 that were not postponed by (FSP FIN) No. 157-2 did not have an
effect on our consolidated financial statements. The Company does not expect the
adoption of the postponed portions of SFAS No. 157 to have a material impact on
our consolidated financial statements.




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations, and SFAS
No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No.
141(R) requires an acquirer to measure the identifiable assets acquired, the
liabilities assumed and any non-controlling interest in the acquiree at their
fair values on the acquisition date, with goodwill being the excess value over
the net identifiable assets acquired. SFAS No. 160 clarifies that a
non-controlling interest in a subsidiary should be reported as equity in the
consolidated financial statements, consolidated net income shall be adjusted to
include the net income attributed to the non-controlling interest and
consolidated comprehensive income shall be adjusted to include the comprehensive
income attributed to the non-controlling interest. The calculation of earnings
per share will continue to be based on income amounts attributable to the
parent. SFAS No. 141(R) and SFAS No. 160 are effective for financial statements
issued for fiscal years beginning after December 15, 2008. Early adoption is
prohibited. SFAS No. 141(R) and SFAS No. 160 are not expected to have a material
impact on our results of operations or financial position.




40




In April
2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of
Intangible Assets (FSB FAS 142-3). FSP FAS 142-3 amends the factors that should
be considered in developing renewal or extension assumptions used to determine
the useful life of a recognized intangible asset under SFAS No. 142, Goodwill
and Other Intangible Assets. The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under FAS
142 and the period of expected cash flows used to measure the fair value of the
asset under SFAS No. 141(R) and other generally accepted accounting principles.
FSP FAS 142-3 is effective for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2008. The Company does not expect the
adoption of FSP FAS 142-3 to have a material impact on our consolidated
financial statements.




Results
of Operations




The
following table sets forth our results of operations in dollars and as a
percentage of revenues for the years ended December 31, 2008 and
2007.




Years
      Ended December 31,2008
                          
                          
                          2007In
      Dollars
                          
                          
                          Percent
      ofRevenues
                          
                          
                          In
      Dollars
                          
                          
                          Percent
      ofRevenues(dollar amounts in thousands,
      except for share
                            and
      earnings per share data)Sale
      of Products
                          
                          $
                          28,691
                          
                          
                          
                          100.0%
                          
                          
                          $
                          19,974
                          
                          
                          
                          100.0%Cost
      of Products Sold
                          
                          
                          7,694
                          
                          
                          
                          26.8%
                          
                          
                          
                          5,038
                          
                          
                          
                          25.2%Gross
      Profit
                          
                          
                          20,997
                          
                          
                          
                          73.2%
                          
                          
                          
                          14,936
                          
                          
                          
                          74.8%Operating
      Expenses:Selling
      expense
                          
                          
                          13,275
                          
                          
                          
                          46.3%
                          
                          
                          
                          6,841
                          
                          
                          
                          34.2%General
      and administrative expense
                          
                          
                          10,856
                          
                          
                          
                          37.8%
                          
                          
                          
                          5,878
                          
                          
                          
                          29.4%Research
      and development expense
                          
                          
                          339
                          
                          
                          
                          1.2%
                          
                          
                          
                          272
                          
                          
                          
                          1.4%Total
      Operating Expenses
                          
                          
                          24,470
                          
                          
                          
                          85.3%
                          
                          
                          
                          12,991
                          
                          
                          
                          65.0%Income(loss)
      from Operations
                          
                          
                          (3,473
                          )
                          
                          
                          -12.1%
                          
                          
                          
                          1,945
                          
                          
                          
                          9.7%Other
      Income (Expense):Interest
      income
                          
                          
                          7
                          
                          
                          
                          0.0%
                          
                          
                          
                          22
                          
                          
                          
                          0.1%Income
      from research and development activities
                          
                          
                          409
                          
                          
                          
                          1.4%
                          
                          
                          
                          448
                          
                          
                          
                          2.2%Interest
      expense
                          
                          
                          (1,310
                          )
                          
                          
                          -4.6%
                          
                          
                          
                          (946
                          )
                          
                          
                          -4.7%Non-operating
      expenses
                          
                          
                          (73
                          )
                          
                          
                          -0.3%
                          
                          
                          
                          (78
                          )
                          
                          
                          -0.4%Net
      Other Expense
                          
                          
                          (967
                          )
                          
                          
                          -3.4%
                          
                          
                          
                          (554
                          )
                          
                          
                          -2.8%Income
      (loss) Before Income Taxes
                          
                          
                          (4,440
                          )
                          
                          
                          -15.5%
                          
                          
                          
                          1,391
                          
                          
                          
                          7.0%Benefit
      from (provision for) income taxes
                          
                          
                          (438
                          )
                          
                          
                          -1.5%
                          
                          
                          
                          449
                          
                          
                          
                          2.2%Minority
      interest in income of subsidiaries
                          
                          
                          235
                          
                          
                          
                          0.8%
                          
                          
                          
                          (120
                          )
                          
                          
                          -0.6%Net
      Income (loss)
                          
                          $
                          (4,643
                          )
                          
                          
                          -16.2%
                          
                          
                          $
                          1,720
                          
                          
                          
                          8.6%Foreign
      currency translation adjustment
                          
                          
                          727
                          
                          
                          
                          2.5%
                          
                          
                          
                          709
                          
                          
                          
                          3.5%Comprehensive
      Income (loss)
                          
                          $
                          (3,916
                          )
                          
                          
                          -13.7%
                          
                          
                          $
                          2,429
                          
                          
                          
                          12.1%Earnings
      Per ShareBasic
                          
                          $
                          (0.24
                          )
                          
                          
                          
                          
                          
                          $
                          0.09Diluted
                          
                          $
                          (0.24
                          )
                          
                          
                          
                          
                          
                          $
                          0.09Weighted-Average
      Shares OutstandingBasic
                          
                          
                          19,679,400
                          
                          
                          
                          
                          
                          
                          
                          19,387,619Diluted
                          
                          
                          19,679,400
                          
                          
                          
                          
                          
                          
                          
                          19,439,077




41





Fiscal
Years Ended December 31, 2008 and 2007




Sale of
products:  Sale of products for the year ended December 31,
2008 was approximately $28.69 million, which is $8.72 million more than our sale
of products of approximately $19.97 million for the year ended December 31,
2007, reflecting a 44% increase. We achieved the increase by expanding business
to more cities and provinces. Specifically, the increase is due to (i) an
increase of $6.5 million in revenue from our main product, Xuesaitong Soft
Capsules and two other prescription drugs; (ii) an increase of $0.68 million in
revenue from other pharmaceuticals and export to other countries; (iii) an
increase of $0.95 million in revenue from our 12 Ways cosmetic products; (iv)
fluctuations in foreign exchange rates; and (v) other retail sales of $0.5
million.




Cost of products
sold:  Our costs of products sold for the year ended December
31, 2008 was approximately $7.69 million, an increase of approximately $2.65
million from approximately $5.04 million for the year ended December 31, 2007.
The increase in the cost of products sold is due to the increase in sales of our
products and a slight increase in production costs per unit in 2008 compared to
2007, because of the increase in the price of our main raw material and other
ingredients.




Gross
profit:  Our gross profit for the year ended December 31, 2008
was approximately $21 million as compared to approximately $14.94 million for
the year ended December 31, 2007. Gross profit as a percentage of revenues was
approximately 73.18% for the year ended December 31, 2008, which is a decrease
as compared to 74.78% for the year ended December 31, 2007. The lower margin in
2008 was due to higher production costs.




Selling
expense:  Selling expenses were approximately $13.27 million
for the year ended December 31, 2008, an increase of $6.4 million, or 94%, from
approximately $6.84 million for the year ended December 31, 2007. As a
percentage of total revenue, selling expense was 46.27% for the year ended
December 31, 2008, as compared to 34.24% for the year ended December 31, 2007.
The primary reasons for the increase are (i) an increase of $4.2 million of
commissions that we paid to sales representatives and sales offices in an effort
to stimulate the sales in existing and new markets; (ii) an increase of $1.8
million in advertising of new products, particularly in our cosmetics line; and
(iii) the impact of the fluctuation in foreign exchange rate and other expenses
of $0.4 million.




General and
administrative expense:  General and administrative expenses
were $10.85 million for the year ended December 31, 2008, an increase of
approximately $4.98 million, or 8.4% as a percentage of sale of products, from
approximately $5.88 million for the year ended December 31, 2007. The increase
was primarily a result of an increase in legal, auditing and other expenses
related to being a public company and an increase in management expenses due to
the expansion of business. In 2008, we incurred one-time, additional auditing
and legal fees because of the internal investigation conducted by the Audit
Committee of the Company regarding the accounting errors identified by our
independent auditor, resulting in the restatement of our financial statements
for fiscal year 2007 and the first fiscal quarter of 2008. In 2008 we accrued
additional bad debt allowance as a result of worsening economic conditions and
customers’ diminishing ability to pay.




Research and
development expense:  Research and development expense for the
year ended December 31, 2008 was approximately $338,546 as compared to
approximately $272,295 for the year ended December 31, 2007. The increase was
primarily due to our efforts to enhance our product development, which we expect
to continue over the next few years. Our goal is to develop innovative and
competitive pharmaceuticals and cosmetic products by applying traditional
Chinese medicine theory and modern technology.




Net other
expense:  Net other expense, which includes interest income,
income from research and development activities, interest expense and
non-operating expenses, was $967,150 for the year ended December 31, 2008 as
compared to $553,935 for the year ended December 31, 2007, an increase of
$413,215. The increase in net other expense was primarily due to an increase in
interest expense for outstanding bank loans.




42




Benefits from
(Provision for) income taxes:  Provision for income taxes was
approximately $438,279 for the year ended December 31, 2008 as compared to a
benefit from income tax of approximately $449,198 for the year ended December
31, 2007. The provision for income taxes was related to the effect of reduction
in statutory rates from 33% to 25% and other changes in valuation
allowance.




Net income
(loss):Net loss was $4.6 million for the year ended December 31, 2008 as
compared to approximately $1.7 million of net income for the year ended December
31, 2007. Considering the foreign currency translation adjustments of
approximately $727,169 and $708,770 for the years ended December 31, 2008 and
2007, respectively, comprehensive loss of $3.9 million and comprehensive income
of $2.4 million was realized for the years ended December 31, 2008 and 2007,
respectively.




Liquidity
and Capital Resources




General -
As of December 31, 2008, we had cash and cash equivalents of $ 1.6 million. We
have historically financed our business operations through bank loans, in
addition to equity offerings. As of December 31, 2008, we had borrowed from
banks and other institutions and had amounts of approximately $9.85 million in
short-term notes payable, $3.6 million of which is due in April 2009 and $5.8
million of which is due in August 2009. As of December 31, 2008, we had also
borrowed $ 3.24 million in our current portion of long-term debt. All loans are
secured by land, buildings and machinery as collateral except the loan from the
Agricultural Bank of China mentioned below which is secured by a pledge by Lan’s
International Medicine Investment Co Ltd. (“LIMI”) of its shareholding in China
Shenghuo (KUN).




The
following schedule summarizes our short-term obligations and respective balances
at December 31, 2008 and 2007:




December
31,2008
                        
                        
                        2007Short-term note payable to a
      municipality, interest at 1.8%,due on demand,
      unsecured
                        
                        $
                        72,948
                        
                        
                        $
                        68,360Short-term note payable to a
      finance bureau, interest at4.5%, due on demand,
      unsecured
                        
                        
                        75,182
                        
                        
                        
                        70,455Short-term note payable to a bank,
      interest at 7.47%, maturesApril 2009, secured by
      property
                        
                        
                        3,647,399
                        
                        
                        
                        -Short-term note payable to a bank,settled during
      2008
                        
                        
                        -
                        
                        
                        
                        1,367,222Short-term note payable to a bank,settled during
      2008
                        
                        
                        -
                        
                        
                        
                        3,418,056Short-term note payable to a
      government development zone, interest at 2.43%, due on demand,
      secured by property
                        
                        
                        218,844
                        
                        
                        
                        410,167Short-term note payable to a bank,
      interest at 7.72%, maturesAugust 2009, secured by
      shareholder
                        
                        
                        5,835,838
                        
                        
                        
                        -Total short-term notes
      payable
                        
                        $
                        9,850,211
                        
                        
                        $
                        5,334,260




43




For the
year ended December 31, 2008, the net decrease in cash and cash equivalents was
approximately $1.2 million. The decrease was mainly due to the use of funds forfinancing in the amount of $3.0million offset
by cash provided by operations of $1.9 million. The following table
provides summary information about net cash flow for the years ended December
31, 2008 and 2007:




Years
      ended December 31,2008
              
              
              2007(in
      thousands)Net
      cash provided by (used in) operating activities
              
              $
              1,947
              
              
              $
              (5,037
              )Net
      cash (used in) provided by  investing activities
              
              
              (304
              )
              
              
              378Net
      cash (used in) provided by financing activities
              
              
              (3,009
              )
              
              
              3,563Cash
      and Cash Equivalents at End of Period
              
              $
              1,612
              
              
              $
              2,801




Operating
Activities:  Net cash provided by operating activities for the
year ended December 31, 2008 was approximately $1.9 million, as compared to cash
used by operating activities of $5 million for the year ended December 31, 2007.
The increase in cash provided was primarily due to the improved management of
working capital. There was a decrease in cash used for accounts and notes
receivable, other current assets, advances to suppliers, sales representative
advances and inventory.  There was also an increase in cash provided
in accounts payable, accrued expenses, advances and deposits from customers and
tax and related payables.




Investing Activities:Net cash
used by investing activities was $304,426 for the year ended December 31, 2008,
as compared to net cash provided in the amount of $377,621 for the year ended
December 31, 2007. The net cash used by investing activities in 2008 was due to
capital expenditures.




Financing
Activities:  Net cash used by financing activities was
approximately $3.0 million for the year ended December 31, 2008 compared to $3.6
million provided from financing activities for the year ended December 31, 2007.
The cash used by financing activities was primarily due to the repayment of
short and long-term bank loans, which was partially offset by proceeds from
short and long-term bank loans. The cash provided by financing activity in 2007
was from sale of stock in June 2007 and net proceeds from short and long-term
bank loans.




Working
Capital




Although the Company has had a history of positive
income, working capital and retained earnings, the Company incurred a net loss
for the year ended December 31, 2008 of $4.6 million and net cash provided by
operating activities of $1.9 million and used funds in financing activities of
$3.0 million. As a result, during the year ended December 31, 2008, the cash and
cash equivalent decreased $1.2 million. The Company has $9.5 million in short
term loans that mature in 2009.


As of
December 31, 2008, our accounts receivable and notes receivable (less allowance
for doubtful accounts of $4.8 million) were $9.1 million, a decrease of $1.4
million, or 14%, as compared to our accounts receivable of $10.6 million (net of
allowance for doubtful accounts of $3.2 million) as of December 31, 2007. In
2008, because of the worsening economic condition in China due to the financial
crisis worldwide, we wrote off accounts receivable aging over two years that
were fully accrued for bad debt allowance. We also accrued additional bad debt
allowance as a result of worsening economic conditions and customers’
diminishing ability to pay. Any recovery of the debts written off in the future
will be recorded as income. The collection period of our accounts receivable
typically runs from nine months to one year, consistent with the relatively long
collection period in our industry.




Our
company normally requires one to two months to deliver products once an order is
placed. Inventory increased during the year ended December 31, 2008 slightly by
$162,269 over inventory as of December 31, 2007. The increase was primarily due
to currency exchange fluctuations offset somewhat by a decrease in inventory. We
purchased a significant amount of Sanchi, which is our main raw material for
products. In order to avoid a risk of spoilage by storing the Sanchi in our
warehouse, our production department purified the Sanchi into powder for
storage. As a result, inventory increased. Moreover, our payment cycle is
considerably shorter than our receivable cycle, since we typically pay our
suppliers all or a portion of the purchase price in advance, and for some
suppliers we must maintain a deposit for future orders. As of December 31, 2008,
our advance payments to our suppliers totaled approximately $446,168. We require
our customers to pay a certain percentage of the sales price as deposit before
we ship products to them. The percentage varies from customer to customer.
During the course of business, we reduce the deposit requirement for some
customers with good credit.




44




To the
extent that we cannot satisfy our cash needs, whether from operations or from a
financing source, our business would be impaired in that it may be difficult for
us to obtain products which could, in turn, impair our ability to generate
sales. We have implemented new policies aimed at improving collection of
accounts receivable in the future, including more detailed reporting from and
increased control over provincial sales offices and representatives, incentives
for sales representatives more closely tied to timely collection and more
stringent enforcement of payment terms with distributors.




One
of our bank loans of $3.65 million from China Construction Bank is due
in April 2009 and another bank loan of $5.84 million from China Agriculture is
due in August 2009. We expect to rollover these loans, and expect funds from
existing and rolled over bank loans and cash generated from operations to
provide us with sufficient capital for a sustainable operation; we may also
require additional capital for acquisitions or for the operation of the combined
companies. There can be no assurance that such funding will be available. There
can be no assurance that the bank loans due in April and August 2009 will be
rolled over by the lenders. As of the date of this report, we have no material
commitments for capital expenditures.




We make
significant cash advances to our sales representatives to assist and encourage
them to expand the marketing and sales of our products into new markets and gain
new customers. We believe the sales representatives are able to expand into new
markets and obtain new customers if they have advanced funds for their travel,
meals, and other incidental expenses that arise over the time they perform their
functions as sales representatives. There are some sales representative advances
that have aged significantly and, based on prior experience, we do not expect to
collect on every outstanding advance and have estimated the uncollectible
balance based on the age of the advances. When we make advances to sales
representatives, we require that our selling offices sign advance agreements
with sales representatives to arrange the specific purpose of the advance, the
amount of the advance, and the term of the advance. Our finance department
records the detail of advances and checks the remaining balance with sales
representatives every month. We also supervise the repayment of the advances.
For sales representatives who refuse to pay off the advances, we attempt to
collect on the advances and decrease the risk of bad debt as much as possible by
withholding sales commissions, warning delinquent sales representatives, and by
other valid means of collection. We also added punitive measures for overdue
advances to the advance agreement.




Current
and long-term sales representative advances were approximately $9.3 million at
December 31, 2008 and $8.8 million as of December 31, 2007, an increase of $0.5
million, or 6%. The increase was due to us advancing more money to sales
representatives to encourage them to expand their markets and increase sales. As
of December 31, 2008, the gross amount of sales representative advances was
$12.9 million, and as of December 31, 2007 it was $11.2 million, an increase of
$1.7 million. We employed more sales representatives, and, as a result, we made
more advances to sales representatives in an attempt to encourage and assist
sales representatives to expand into new selling markets and gain new customers.
Because of the increase in the balance of sales representative advances, we, in
compliance with our established policy to reserve an allowance for specific
percentages of our aged receivables, accrued a larger allowance for the
increased sales representative advances in order to consistently apply our
established allowance policy.




The table
below sets forth the outstanding gross and net amount of outstanding balances of
sales representative advances for the years ended December 31, 2008 and
2007.




For
      the year ended
                    December
      31, 2008
                
                
                For
      the year ended
                    December
      31, 2007Gross
      amount of sales representative advances
                
                $
                12,921,134
                
                
                $
                11,210,881Allowance
      for doubtful accounts
                
                
                3,620,048
                
                
                
                2,447,033Net
      amount
                
                $
                9,301,086
                
                
                $
                8,763,848




45




As of
December 31, 2008, we had accrued taxes and related payables of $1.2 million
that included Value Added Taxes, or VAT taxes. The newly issued Enterprise
Income Tax law unifies income tax rates for all types of enterprises in China.
From 2009, the same tax rate applies to all enterprises. However, a transition
period is allowed for enterprises that had been granted favorable tax rates
before the law became effective. One of our majority owned subsidiaries had been
granted tax exemption period and favorable tax treatment for three years after
the exemption period. 2008 was the last year of tax break period for this
subsidiary. We believe that we will have sufficient cash flows from operations
to meet the accrued tax liabilities.




Off-Balance
Sheet Arrangements




None.




Foreign
Currency Risk




Since all
of our operations are conducted in the PRC, we are subject to special
considerations and significant risks not typically associated with companies
operating in the United States of America. These risks include, among others,
the political, economic and legal environments and foreign currency exchange
rate fluctuations. Our operational results may be adversely affected by changes
in the political and social conditions in the PRC, and by changes in
governmental policies with respect to medical reforms and other laws and
regulations, anti-inflationary measures, currency conversion and remittance
abroad, and rates and methods of taxation, among other things. Exchange rate
fluctuations may adversely affect the value, in U.S. dollar terms, of our net
assets and income derived from its operations in the PRC. In addition, all of
our revenue is denominated in the Chinese Yuan Renminbi (“CNY”), which must be
converted into other currencies before remittance out of the PRC. Both the
conversion of CNY into foreign currencies and the remittance of foreign
currencies abroad require approval of the PRC government. The effect of the
fluctuations of exchange rates is not considered to be material to our business
operations.




Interest
Rate Risk




We do not
have significant interest rate risk, as our debt obligations are primarily fixed
interest rates.




ITEM
      7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.




Smaller
reporting companies are not required to provide the information required by this
item.





ITEM
      8.
              FINANCIAL
      STATEMENTS AND SUPPLEMENTARY
DATA.




The
information required by this Item 8 is incorporated by reference to the
Consolidated Financial Statements beginning at page F-1 at the end of this Form
10-K.




ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.




None.




ITEM
      9A.
            CONTROLS
      AND PROCEDURES.




Disclosure
Controls and Procedures




As
required by Rule 13a-15 under the Exchange Act, our management, including Lan
Gui Hua our Principal Executive Officer, and Wendy Fu, our Principal Financial
Officer, evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2008.




46




Disclosure
controls and procedures refer to controls and other procedures designed to
ensure that information required to be disclosed in the reports we file or
submit under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required disclosure. In
designing and evaluating our disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in evaluating and
implementing possible controls and procedures.




Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our principal executive officer and our principal financial
officer. Based on that evaluation, management concluded that because of the
material weaknesses in internal control over financial reporting described
below, our disclosure controls and procedures were not effective as of December
31, 2008.




Management’s
Report on Internal Control over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act.  Our management is also required to
assess and report on the effectiveness of our internal control over financial
reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002
(“Section 404”).  Management assessed the effectiveness of our
internal control over financial reporting as of December 31, 2008.  In
making this assessment, we used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -
Integrated Framework.  In the course of its audit work for 2008, our accountants identified significant
deficiencies, resulting in material weaknesses in our financial reporting process
described belowand management identified
additional significant deficiencies. These matters were reported to our
Board of Directors and Audit Committee by management in March 2009:


§
            Material
      adjustments related to the prior year audits were not recorded in the
      company's accounting records that were necessary to reconcile the retained
      earnings to the prior year balances, which is a material weakness.




§
            Multiple
      material adjustments were made as a result of audit procedures performed,
      which is a material weakness.




§
            Sales
      department and warehouse department failed to follow the policy of
      returned goods to timely handle the returned goods from customers, which
      is a material weakness.




§
            Capital
      expenditures were discussed and approved at management meetings at which
      some directors of the board of directors attended but no formal board
      approval procedure were followed, which is a significant
      deficiency.




In
addition, the duties of the cashiers in our financial department were not
properly segregated, which is a significant deficiency in our internal
controls.




In order
to correct the foregoing material weaknesses, we have taken the following
remediation measures during and after the fourth quarter of 2008:




§
            We
      maintained a separate, independent set of accounting records to record all
      U.S. GAAP audit adjustments from 2008 along with the local GAAP accounting
      records so as to reconcile our records according to US
    GAAP.




§
            We
      enhanced our book closing procedure to including a review of all account
      balances for material adjustment.




§
            We
      have started to implement adequate segregation of duties in financial
      function which will separate duties of accessing to property and assets
      from preparing or recording
accounts.




§
            We
      have recently established an internal audit function to strengthen the
      overall internal control environment and to monitor compliance with the
      Company’s policies and procedures by all departments. The current skill
      and experience mix of the internal audit staff. However, this may not
      ensure an effective internal audit function. The Company has restructured
      the internal audit team to oversee the implementation of our internal
      controls over financial reporting. The internal audit department is
      independent and reports directly to the audit
  committee.




§
            We
      have developed a policy to require board of directors’ written resolutions
      to approve all important capital
expenditures.




47




In
addition, we have allocated significant financial and human resources to
strengthen the internal control structure.




We
believe that the foregoing steps help us remediate the material weakness
identified above and we will continue to monitor the effectiveness of these
steps and make any changes that our management deems appropriate.




A
material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a
deficiency, or a combination of deficiencies, in internal control over financial
reporting such that there is a reasonable possibility that a material
misstatement of our annual or interim financial statements will not be prevented
or detected on a timely basis. A significant deficiency is a deficiency, or a
combination of deficiencies, in internal control over financial reporting that
is less severe than a material weakness, yet important enough to merit attention
by those responsible for oversight of the company’s financial
reporting.




Our
management is not aware of any material weakness in our internal control over
financial reporting that causes them to believe that any material inaccuracies
or errors existed in our financial statements as of December 31, 2008. Nor are
we aware of any instance where such reportable conditions or other identified
areas of weakness have resulted in a material misstatement of omission in any
report we have filed with or submitted to the Commission, other than those that
were corrected in connection with the Restatement to address the accounting
errors in the financial statements for the fiscal year ended December 31, 2007
and the fiscal quarter ended March 31, 2008.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies and procedures may deteriorate.




Auditor
Attestation




This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by our
registered public accounting firm pursuant to rules of the Securities and
Exchange Commission that permit us to provide only management’s report in this
annual report.




Changes
in Internal Controls over Financial Reporting




Except as
described above, there were no changes in our internal controls over financial
reporting during the fourth quarter of fiscal year 2008 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.




ITEM
9B. OTHER INFORMATION.




None.




PART
III




ITEM
      10.
              DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.




The
information required by this Item is incorporated by reference to the applicable
information in our Proxy Statement related to the 2009 Annual Meeting of
Stockholders (the “2009 Proxy Statement”).




48




ITEM
      11.
              EXECUTIVE
      COMPENSATION.




The
information required by this Item is incorporated by reference to the applicable
information in the 2009 Proxy Statement.




ITEM
      12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS.




The
information required by this Item is incorporated by reference to the applicable
information in the 2009 Proxy Statement.




ITEM
      13.
              CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE.




The
information required by this Item is incorporated by reference to the applicable
information in the 2009 Proxy Statement.




ITEM
      14.
              PRINCIPAL
      ACCOUNTING FEES AND SERVICES.




The
information required by this Item is incorporated by reference to the applicable
information in the 2009 Proxy Statement.




PART
IV




ITEM15.
              EXHIBITS,
      FINANCIAL STATEMENT
SCHEDULES.







Exhibit
                      Number
                    
                    Description
      of Exhibit2.1
                    
                    Share
      Exchange Agreement, dated as of June 30, 2006, by and among the Company,
      Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and Lan’s International
      Medicine Investment Co., Limited (incorporated by referenced from Exhibit
      2.1 to the Quarterly Report on Form 10-QSB filed with the Securities and
      Exchange Commission on July 28, 2006).2.1(a)
                    
                    Amendment
      No. 1 to the Share Exchange Agreement, dated as of August 11, 2006, by and
      among the Company, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and
      Lan’s International Medicine Investment Co., Limited (incorporated by
      reference from Exhibit 2.1(a) to the Registration Statement on Form SB-2
      filed with the Securities and Exchange Commission on December 21,
      2006).2.1(b)
                    
                    Amendment
      No. 2 to the Share Exchange Agreement, dated as of August 28, 2006, by and
      among the Company, Kunming Shenghuo Pharmaceutical (Group) Co., Ltd., and
      Lan’s International Medicine Investment Co., Limited (incorporated by
      reference from Exhibit 2.1(b) to Current Report on Form 8-K filed with the
      Securities and Exchange Commission on September 1,
  2006).3.1
                    
                    Certificate
      of Incorporation of the Company (incorporated by reference from Exhibit
      3.1 to Registration Statement on Form 10-SB filed with the Securities and
      Exchange Commission on August 3, 2005).3.2
                    
                    Bylaws
      of the Company (incorporated by reference from Exhibit 3.2 to Registration
      Statement on Form 10-SB filed with the Securities and Exchange Commission
      on August 3, 2005, and incorporated herein by
  reference).3.3
                    
                    Articles
      of Merger Effecting Name Change (incorporated by reference from Exhibit
      3.3 to Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).
  49
  10.1
                      
                      Form
      of Subscription Agreement dated August 31, 2006 (incorporated by reference
      from Exhibit 10.1 to Current Report on Form 8-K filed with the Securities
      and Exchange Commission on September 1, 2006).10.2*
                      
                      Employment
      Agreement dated December 3, 2004 by and between Gui Hua Lan and the
      Company (translated to English) (incorporated by reference from Exhibit
      10.2 to Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).10.3*
                      
                      Employment
      Agreement dated December 3, 2004 by and between Feng Lan and the Company
      (translated to English) (incorporated by reference from Exhibit 10.3 to
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).10.4*
                      
                      Employment
      Agreement dated December 3, 2004 by and between Lei Lan and the Company
      (translated to English) (incorporated by reference from Exhibit 10.4 to
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).10.5*
                      
                      Employment
      Agreement dated December 3, 2004 by and between Qiong Hua Gao and the
      Company (translated to English) (incorporated by reference from Exhibit
      10.5 to Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).10.6*
                      
                      Employment
      Agreement dated December 3, 2004 by and between Peng Chen and the Company
      (translated to English) (incorporated by reference from Exhibit 10.6 to
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).10.7*
                      
                      Employment
      Agreement dated December 3, 2004 by and between Zheng Yi Wang and the
      Company (translated to English) (incorporated by reference from Exhibit
      10.7 to Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 1, 2006).10.8
                      
                      Joint
      Establishment Agreement of Kunming Beisheng Science & Technology
      Development Co., Ltd. dated January 1, 2006 entered into by and between
      the Company and Beijing University Shijia Research Center (translated to
      English) (incorporated by reference from Exhibit 10.8 to the Registration
      Statement on Form SB-2 filed with the Securities and Exchange Commission
      on December 21, 2006).10.9
                      
                      Joint
      Venture Agreement for Kunming Shenghuo Pharmaceutical Group Co., Ltd.
      dated May 22, 2006 entered into by and between Lan’s International
      Medicine Investment Co., Limited and SDIC Venture Capital Investment, Co.,
      Ltd. (translated to English) (incorporated by reference from Exhibit 10.9
      to the Registration Statement on Form SB-2 filed with the Securities and
      Exchange Commission on December 21, 2006).10.10
                      
                      Form
      of Lock Up Agreement for Investors in the August 2006 Private Placement
      (incorporated by reference from Exhibit 10.10 to the Registration
      Statement on Form SB-2 filed with the Securities and Exchange Commission
      on December 21, 2006).10.11
                      
                      Loan
      Agreement, by and between the Company and Shuang Long Branch of
      Agricultural Bank of China (incorporated by reference from Exhibit 10.1 to
      the Quarterly Report on Form 10-QSB filed with the Securities and Exchange
      Commission on November 15, 2007).10.12*
                      
                      Form
      of Independent Director’s Agreement, entered into by the Company with each
      of Gene Michael Bennett, Mingyang Liao, Yunhong Guan, Jason Zhang and
      Xiaobo Sun (incorporated by reference from Exhibit 10.1 to the
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 26, 2007).10.13*
                      
                      Form
      of Warrant Agreement, entered into by the Company with each of Gene
      Michael Bennett and Yunhong Guan (incorporated by reference from Exhibit
      10.2 to the Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 26,
2007).                                            50
  10.14
                            
                            Form
      of Warrant to be issued to be issued to the Underwriter, entered into by
      the Company and Westpark Capital Inc. (incorporated by reference from
      Exhibit 4.1 to the Registration Statement on Form SB-2 filed with the
      Securities and Exchange Commission on June 11, 2007).14.1**
                            
                            China
      Shenghuo Pharmaceutical Holdings, Inc. Code of Business Conduct and Ethics
      (incorporated by reference from Exhibit 99.1 to the Current Report on Form
      8-K filed with the Securities and Exchange Commission on June 12,
      2007).21.1
                            
                            List
      of Subsidiaries (incorporated by reference from Exhibit 21.1 to the
      Registration Statement on Form SB-2 on Form S-3 filed with the Securities
      and Exchange Commission on September 18, 2007).31.1
                            
                            Rule
      13a-14(a) Certification of the Chief Executive Officer of China Shenghuo
      Pharmaceutical Holdings, Inc. in accordance with Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                            
                            Rule
      13a-14(a) Certification of the Chief Financial Officer of China Shenghuo
      Pharmaceutical Holdings, Inc. in accordance with Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1*
      *
                            
                            Section
      1350 Certification of the Chief Executive Officer and Chief Financial
      Officer of China Shenghuo Pharmaceutical Holdings, Inc. in accordance with
      Section 906 of the Sarbanes-Oxley Act of
2002.


*
              
              Indicates
      management contract or compensatory plan or
arrangement.**
              
              This
      exhibit shall not be deemed “filed” for purposes of Section 18 of the
      Securities Exchange Act of 1934, as amended, or otherwise subject to the
      liabilities of that Section, nor shall it be deemed incorporated by
      reference in any filing under the Securities Act of 1933, as amended, or
      the Securities Exchange Act of 1934, as amended, whether made before or
      after the date hereof and irrespective of any general incorporation
      language in any filings.




51





SIGNATURES




In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.




CHINA SHENGHUO
      PHARMACEUTICAL HOLDINGS,
      INC.
                (Company)March
      31, 2009
              By:
              /s/
      Gui Hua LanGui
      Hua LanChief
      Executive Officer and Chairman of the
  Board




In
accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.




/s/
      Gui Hua LanDate: March
      31, 2009
                                                                  
                                                                  Gui
      Hua Lan, Chief Executive Officer and
                                                                    Chairman
      of the Board
                                                                    (Principal Executive Officer)/s/
      Wendy FuDate: March
      31, 2009
                                                                  
                                                                  Wendy
      Fu, Chief Financial Officer
                                                                    (Principal
      Financial and Accounting Officer)/s/
      Feng LanDate: March
      31, 2009
                                                                  
                                                                  Feng
      Lan, President and Director/s/
      Zheng Yi WangDate: March
      31, 2009
                                                                  
                                                                  Zheng Yi Wang, Executive Director
      of Exports, Corporate Secretary and
      Director/s/
      Yunhong GuanDate: March
      31, 2009
                                                                  
                                                                  Yunhong
      Guan, DirectorDate: March
      31, 2009
                                                                  
                                                                  Mingyang
      Liao, Director/s/
      Jason Yuanxin ZhangDate: March
      31, 2009
                                                                  
                                                                  Jason
      Yuanxin Zhang, Director/s/
      Xiaobo SunDate:
      March
      31, 2009
                                                                  
                                                                  Xiaobo
      Sun,
Director





52


CHINA SHENGHUO PHARMACEUTICAL HOLDINGS,
INC.
 AND
SUBSIDIARIES
  
 TABLE
OF CONTENTS
 
 Report
      of Independent Registered Public Accounting Firm
                F-1Consolidated
      Balance Sheets as of December 31, 2008 and 2007
                F-2Consolidated
      Statements of Operations and Comprehensive (Loss) Income for the Years
      Ended December 31, 2008 and 2007
                F-3Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31, 2007
      and 2008
                F-4Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2008 and
      2007
                F-5Notes
      to the Consolidated Financial Statements
                F-6
  
  HANSEN, BARNETT& MAXWELL,
      P.C.
                  A
      Professional Corporation
                  CERTIFIED
      PUBLIC ACCOUNTANTS
                  5
      Triad Center, Suite 750
                  Salt
      Lake City, UT 84180-1128
                  Phone:
      (801) 532-2200
                  Fax:
      (801) 532-7944
                  www.hbmcpas.com
                Registered with the Public
      Company
                  Accounting
      Oversight Board
                  
                  
                  
                  A Member of the
      Forum of Firms
  REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 To the
Board of Directors and Stockholders
 China
Shenghuo Pharmaceutical Holdings, Inc.
 
 We have
audited the accompanying consolidated balance sheets of China Shenghuo
Pharmaceutical Holdings, Inc. and subsidiaries as of December 31, 2008 and 2007,
and the related consolidated statements of operations and comprehensive (loss)
income, stockholders’ equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Shenghuo
Pharmaceutical Holdings, Inc. and subsidiaries as of December 31, 2008 and 2007
and the results of its operations and its cash flows for the years then ended,
in conformity with accounting principles generally accepted in the United States
of America.
  /s/ HANSEN, BARNETT &
      MAXWELL, P.C.Salt
      Lake City, Utah
                  March
      31, 2009
 F-1
 CHINA SHENGHUO PHARMACEUTICAL
      HOLDINGS, INC.CONSOLIDATED BALANCE
      SHEETS
  December
31,2008
                                            
                                            
                                            2007ASSETS:Current
    Assets:Cash and cash
      equivalents
                                            
                                            $
                                            1,612,054
                                            
                                            
                                            $
                                            2,800,641Accounts and notes receivable,
      less allowance for doubtful accounts of $4,834,745 and $3,218,661,
      respectively
                                            
                                            
                                            9,108,703
                                            
                                            
                                            
                                            10,567,672Sales representative advances,
      less allowance for doubtful accoutns of $2,955,516 and $729,955,
      respectively
                                            
                                            
                                            8,637,653
                                            
                                            
                                            
                                            8,249,806Advances to
      suppliers
                                            
                                            
                                            446,168
                                            
                                            
                                            
                                            669,858Inventory, net of reserve for
      obsolescence of $147,978 and $136,359, respectively
                                            
                                            
                                            4,287,462
                                            
                                            
                                            
                                            4,125,193Receivable from related
      parties
                                            
                                            
                                            -
                                            
                                            
                                            
                                            27,555Other current
      assets
                                            
                                            
                                            41,177
                                            
                                            
                                            
                                            159,657Total Current
      Assets
                                            
                                            
                                            24,133,217
                                            
                                            
                                            
                                            26,600,382Property, plant and equipment, net
      of accumulated depreciation of $5,341,933 and $4,247,993,
      respectively
                                            
                                            
                                            7,581,664
                                            
                                            
                                            
                                            7,573,204Intangible assets, net of
      accumulated amortization of $71,456 and $42,957,
      respectively
                                            
                                            
                                            665,959
                                            
                                            
                                            
                                            648,090Long-term sales representative
      advances, less allowance for doubtful accoutns of $664,532 and $1,717,078,
      respectively
                                            
                                            
                                            663,433
                                            
                                            
                                            
                                            514,042TOTAL
ASSETS
                                            
                                            $
                                            33,044,273
                                            
                                            
                                            $
                                            35,335,718LIABILITIES AND STOCKHOLDERS'
      EQUITY:Current
      Liabilities:Accounts
      payable
                                            
                                            $
                                            1,293,460
                                            
                                            
                                            $
                                            745,514Accrued
      expenses
                                            
                                            
                                            2,721,082
                                            
                                            
                                            
                                            2,017,748Deposits
                                            
                                            
                                            5,550,502
                                            
                                            
                                            
                                            3,439,892Payable to related
      parties
                                            
                                            
                                            148,575
                                            
                                            
                                            
                                            94,939Short-term notes
      payable
                                            
                                            
                                            9,850,211
                                            
                                            
                                            
                                            5,334,260Advances from
      customers
                                            
                                            
                                            222,609
                                            
                                            
                                            
                                            119,287Taxes and related
      payables
                                            
                                            
                                            1,236,574
                                            
                                            
                                            
                                            855,084Current portion of long-term
      debt
                                            
                                            
                                            3,245,685
                                            
                                            
                                            
                                            4,101,667Total Current
      Liabilities
                                            
                                            
                                            24,268,698
                                            
                                            
                                            
                                            16,708,391Long-Term
    Debt
                                            
                                            
                                            1,131,193
                                            
                                            
                                            
                                            6,836,111Total
      Liabilities
                                            
                                            
                                            25,399,891
                                            
                                            
                                            
                                            23,544,502Minority Interest in Net Assets of
      Subsidiaries
                                            
                                            
                                            248,224
                                            
                                            
                                            
                                            479,318Stockholders'
      Equity:Common stock, $0.0001 par value,
      100,000,000 shares authorized, 19,679,400 and 19,679,400 outstanding,
      respectively
                                            
                                            
                                            1,968
                                            
                                            
                                            
                                            1,968Additional paid-in
      capital
                                            
                                            
                                            6,193,927
                                            
                                            
                                            
                                            6,193,927Statutory
      reserves
                                            
                                            
                                            147,023
                                            
                                            
                                            
                                            147,023Retained (deficit)
      earnings
                                            
                                            
                                            (603,572
                                            )
                                            
                                            
                                            4,039,337Accumulated other comprehensive
      income, foreign currency translation
                                            
                                            
                                            1,656,812
                                            
                                            
                                            
                                            929,643Total Stockholders'
      Equity
                                            
                                            
                                            7,396,158
                                            
                                            
                                            
                                            11,311,898TOTAL LIABILITIES AND
      STOCKHOLDERS' EQUITY
                                            
                                            $
                                            33,044,273
                                            
                                            
                                            $
                                            35,335,718
    F-2
 CHINA SHENGHUO PHARMACEUTICAL
      HOLDINGS, INC.CONSOLIDATED STATEMENTS OF
      OPERATIONSAND COMPREHENSIVE (LOSS)
      INCOME
  Years EndedDecember
31,2008
                                  
                                  
                                  2007Sale of
      Products
                                  
                                  $
                                  28,690,509
                                  
                                  
                                  $
                                  19,973,918Cost of Products
      Sold
                                  
                                  
                                  7,693,635
                                  
                                  
                                  
                                  5,038,290Gross
Profit
                                  
                                  
                                  20,996,874
                                  
                                  
                                  
                                  14,935,628Operating
      Expenses:Selling
    expense
                                  
                                  
                                  13,274,942
                                  
                                  
                                  
                                  6,840,824General and administrative
      expense
                                  
                                  
                                  10,856,184
                                  
                                  
                                  
                                  5,877,948Research and development
      expense
                                  
                                  
                                  338,546
                                  
                                  
                                  
                                  272,295Total Operating
      Expenses
                                  
                                  
                                  24,469,672
                                  
                                  
                                  
                                  12,991,067(Loss) Income  from
      Operations
                                  
                                  
                                  (3,472,798
                                  )
                                  
                                  
                                  1,944,561Other Income
      (Expense):Interest
    income
                                  
                                  
                                  7,755
                                  
                                  
                                  
                                  22,431Income from research and
      development activities
                                  
                                  
                                  408,500
                                  
                                  
                                  
                                  448,254Interest
      expense
                                  
                                  
                                  (1,309,984
                                  )
                                  
                                  
                                  (946,456
                                  )Non-operating
      expenses
                                  
                                  
                                  (73,421
                                  )
                                  
                                  
                                  (78,164
                                  )Net Other
      (Expense)
                                  
                                  
                                  (967,150
                                  )
                                  
                                  
                                  (553,935
                                  )(Loss) Income Before Income
      Taxes
                                  
                                  
                                  (4,439,948
                                  )
                                  
                                  
                                  1,390,626Income tax (expense)
      benefit
                                  
                                  
                                  (438,279
                                  )
                                  
                                  
                                  449,198Minority interest in loss (income)
      of subsidiaries
                                  
                                  
                                  235,318
                                  
                                  
                                  
                                  (119,437
                                  )Net (Loss)
      Income
                                  
                                  $
                                  (4,642,909
                                  )
                                  
                                  $
                                  1,720,387Foreign currency translation
      adjustment
                                  
                                  
                                  727,169
                                  
                                  
                                  
                                  708,770Comprehensive
      (Loss)  Income
                                  
                                  $
                                  (3,915,740
                                  )
                                  
                                  $
                                  2,429,157(Loss) Earnings Per
      ShareBasic
                                  
                                  $
                                  (0.24
                                  )
                                  
                                  $
                                  0.09Diluted
                                  
                                  $
                                  (0.24
                                  )
                                  
                                  $
                                  0.09Weighted-Average Shares
      OutstandingBasic
                                  
                                  
                                  19,679,400
                                  
                                  
                                  
                                  19,387,619Diluted
                                  
                                  
                                  19,679,400
                                  
                                  
                                  
                                  19,439,077
    F-3
 CHINA SHENGHUO PHARMACEUTICAL
      HOLDINGS, INC.CONSOLIDATED STATEMENTS OF
      STOCKHOLDERS'
EQUITY
  AccumulatedAdditional
                              
                              
                              
                              
                              
                              Retained
                              
                              
                              Other
                              
                              
                              TotalCommon
Stock
                              
                              
                              Paid-in
                              
                              
                              Statutory
                              
                              
                              Earnings
                              
                              
                              Comprehensive
                              
                              
                              Stockholders'Shares
                              
                              
                              Amount
                              
                              
                              Capital
                              
                              
                              Reserves
                              
                              
                              (Deficit)
                              
                              
                              Income
                              
                              
                              EquityBalance, December 31,
      2006
                              
                              
                              19,119,400
                              
                              
                              $
                              1,912
                              
                              
                              $
                              4,829,633
                              
                              
                              $
                              147,023
                              
                              
                              $
                              2,318,950
                              
                              
                              $
                              220,873
                              
                              
                              $
                              7,518,391Shares issued in public offering ,
      net of costs
                              
                              
                              460,000
                              
                              
                              
                              46
                              
                              
                              
                              1,094,336
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              1,094,382Exercise of warrants for
      cash
                              
                              
                              100,000
                              
                              
                              
                              10
                              
                              
                              
                              249,990
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              250,000Issuance of warrants for
      services
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              19,968
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              19,968Net income for the
      year
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              1,720,387
                              
                              
                              
                              -
                              
                              
                              
                              1,720,387Foreign currency translation
      adjustment
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              708,770
                              
                              
                              
                              708,770Balance, December 31,
      2007
                              
                              
                              19,679,400
                              
                              
                              
                              1,968
                              
                              
                              
                              6,193,927
                              
                              
                              
                              147,023
                              
                              
                              
                              4,039,337
                              
                              
                              
                              929,643
                              
                              
                              
                              11,311,898Net loss for the
      year
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (4,642,909
                              )
                              
                              
                              -
                              
                              
                              
                              (4,642,909
                              )Foreign currency translation
      adjustment
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              727,169
                              
                              
                              
                              727,169Balance, December 31,
      2008
                              
                              
                              19,679,400
                              
                              
                              $
                              1,968
                              
                              
                              $
                              6,193,927
                              
                              
                              $
                              147,023
                              
                              
                              $
                              (603,572
                              )
                              
                              $
                              1,656,812
                              
                              
                              $
                              7,396,158
    F-4
 CHINA SHENGHUO PHARMACEUTICAL
      HOLDINGS, INC.CONSOLIDATED STATEMENTS OF CASH
      FLOWS
  For the Years
      EndedDecember
31,2008
                        
                        
                        2007Cash Flows from Operating
      Activities:Net (loss)
      income
                        
                        $
                        (4,642,909
                        )
                        
                        $
                        1,720,387Adjustments to reconcile net
      (loss) income to net cash provided by operating
      activities:Bad debt
      provision
                        
                        
                        2,371,559
                        
                        
                        
                        3,725,276Depreciation and
      amortization
                        
                        
                        821,574
                        
                        
                        
                        676,547Deferred income
      taxes
                        
                        
                        -
                        
                        
                        
                        526,849Minority interest in income of
      subsidiaries
                        
                        
                        (235,318
                        )
                        
                        
                        119,437Warrants issued for
      services
                        
                        
                        -
                        
                        
                        
                        19,968Change in current assets and
      liabilities:Accounts and notes
      receivable
                        
                        
                        755,997
                        
                        
                        
                        (2,052,913
                        )Sales representative
      advances
                        
                        
                        (943,163
                        )
                        
                        
                        (6,854,600
                        )Advances to
      suppliers
                        
                        
                        264,467
                        
                        
                        
                        (595,358
                        )Inventory
                        
                        
                        112,744
                        
                        
                        
                        (1,311,644
                        )Other current
      assets
                        
                        
                        120,381
                        
                        
                        
                        (140,750
                        )Accounts
      payable
                        
                        
                        490,195
                        
                        
                        
                        (68,893
                        )Accrued expenses and
      deposits
                        
                        
                        2,418,749
                        
                        
                        
                        1,607,130Advances from
      customers
                        
                        
                        93,839
                        
                        
                        
                        (236,998
                        )Taxes and related
      payables
                        
                        
                        319,086
                        
                        
                        
                        (2,171,207
                        )Net Cash Provided by (Used
      in)  Operating Activities
                        
                        
                        1,947,201
                        
                        
                        
                        (5,036,769
                        )Cash Flows from Investing
      Activities:Capital
      expenditures
                        
                        
                        (304,426
                        )
                        
                        
                        (176,453
                        )Receivable from related
      parties
                        
                        
                        -
                        
                        
                        
                        67,018Restricted
    cash
                        
                        
                        -
                        
                        
                        
                        487,056Net Cash (Used in) Provided by
      Investing Activities
                        
                        
                        (304,426
                        )
                        
                        
                        377,621Cash Flows from Financing
      Activities:Payable to related
      parties
                        
                        
                        78,588
                        
                        
                        
                        (312,391
                        )Proceeds from short and long-term
      loans
                        
                        
                        5,745,269
                        
                        
                        
                        15,491,257Payments on short and long-term
      loans
                        
                        
                        (8,833,351
                        )
                        
                        
                        (12,960,626
                        )Issuance of common stock for
      cash
                        
                        
                        -
                        
                        
                        
                        1,094,382Proceeds from exercise of
      warrants
                        
                        
                        -
                        
                        
                        
                        250,000Net Cash (Used in) Provided by
      Financing Activities
                        
                        
                        (3,009,494
                        )
                        
                        
                        3,562,622Effect of exchange rate changes on
      cash
                        
                        
                        178,132
                        
                        
                        
                        205,729Net Decrease in Cash and Cash
      Equivalents
                        
                        
                        (1,188,587
                        )
                        
                        
                        (890,797
                        )Cash and Cash Equivalents at
      Beginning of Period
                        
                        
                        2,800,641
                        
                        
                        
                        3,691,438Cash and Cash Equivalents at End
      of Period
                        
                        $
                        1,612,054
                        
                        
                        $
                        2,800,641Supplemental
      InformationCash paid for
      interest
                        
                        $
                        1,232,257
                        
                        
                        $
                        781,030Cash paid for income
      taxes
                        
                        
                        -
                        
                        
                        
                        98,357
    F-5
  CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
  NOTE
1 – ORGANIZATION AND NATURE OF OPERATIONS
 
 Nature of
Business – China Shenghuo Pharmaceutical Holdings, Inc. (the “Company” or
“the Parent” or “the Group”) and its subsidiaries designs, develops, markets,
exports and sells pharmaceutical, nutritional supplements and cosmetic products
throughout the People’s Republic of China (PRC) and abroad. The Company also
conducts research and development for third parties as well as for itself using
the medicinal herb Panax notoginseng, also known as Sanqi, Sanchi, or Tienchi
and sells pharmaceutical, nutritional supplements and cosmetic products that
contain this herb, which is grown in two provinces in the PRC. Sales from the
cosmetic products represent less than 10% of total Company sales and revenue.
The Company does not maintain accounting records by line of business as the
Company’s subsidiaries sell products from multiple lines of business and
management evaluates each subsidiary as a separate entity.
 
 Organization– The Company owns a
93.75% equity interest of Kunming Shenghuo Pharmaceuticals Co., Ltd.
(“Shenghuo”). Shenghuo owns a 99% equity interest in Kunming Shenghuo Medicine
Co., Ltd. (“Medicine”) and Kunming Pharmaceutical Importation and Exportation
Co., Ltd. (“Import/Export”), a 98.18% interest in Kunming Shenghuo Cosmetics
Co., Ltd. (“Cosmetic”). All of these entities are formed in and operate within
the PRC. In August 2007, Shenghuo established a wholly owned subsidiary in the
PRC named Pingbian Shenghuo Nanyao Development Co., LTD. (“Pingbian Shenghuo”).
In November 2008, the Company obtained approval from the government to dissolve
Pingbian Shenghuo.  There were no material operations for Pingbian
Shenghuo for the years ended December 31, 2008 or 2007.
 
 NOTE
2 – SIGNIFICANT ACCOUNTING POLICIES
 
 Basis
of Presentation and Translating Financial Statements–The consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America and pursuant to the rules and
regulations of the United States Securities and Exchange Commission. The
functional currency of the operating subsidiaries in the PRC is the Chinese Yuan
Renminbi (“CNY”); however, the consolidated financial statements have been
expressed in United States Dollars (“USD”). The accompanying consolidated
balance sheets have been translated into USD at the exchange rates prevailing at
each balance sheet date. The consolidated statements of operations have been
translated using the average exchange rates prevailing during the operating
periods of each statement.
 
 Principles of
Consolidation – The accompanying consolidated financial statements
present the operations of the Company and its majority owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
 
 Accounting
Estimates – The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosures of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
 
 Fair Value of
Financial Instruments — The carrying amounts reported in the consolidated
balance sheets for accounts and notes receivables, employee advances, advances
to suppliers, accounts payable, accrued liabilities, and advances from customers
approximate fair value because of the immediate or short-term maturity of these
financial instruments. Management believes the interest rates on short-term
notes payable and long-term debt reflect rates currently available in the PRC.
Thus, the carrying value of these loans approximates fair value.
  F-6
  CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 Cash and Cash
Equivalents – The Company’s cash and cash equivalents are maintained in
bank deposit accounts.  The Company has not experienced any losses
with respect to these deposits.  Cash and cash equivalents include
interest bearing and non-interest bearing bank deposits, money market accounts,
and short-term certificates of deposit with original maturities of three months
or less. The Company did not enter into any hedge contracts during any of the
periods presented.
 
 Accounts and
Notes Receivable and Allowance for Doubtful Accounts – Trade receivables
are carried at original invoiced amounts less an allowance for doubtful
accounts. An allowance for uncollectible accounts receivable is established by
charges to operations for amounts required to maintain an adequate allowance, in
management’s judgment, to cover anticipated losses from customer accounts and
sales returns. Such accounts are charged to the allowance when collection
appears doubtful. Any subsequent recoveries are credited to the allowance
account. The Company believes that the allowance for doubtful accounts is
consistent with industry standards in the PRC based on the products that are
being sold.
 
 Notes receivable were $750,877 and $1,165,535 as of December 31,
2008 and 2007, respectively. The notes represent bank drafts that have been
arranged with third-party financial institutions by certain customers to settle
their purchases from us. These bank drafts are non-interest bearing and are due
within six months.  Such sales and purchasing arrangements are
consistent with industry practices in the PRC.
 
 Sales
Representative Advances – Sales representative advances are presented net
of an estimated allowance for doubtful advances. As time passes from when
advances are made to sales representatives for travel and related expenses, the
Company will create an allowance for these older receivables as the likelihood
of collection from each particular sales representative decreases as their
respective advances age.  Long-term sales representative advances are
not expected to be realized in the current operating period.
 
 Inventory
– Inventories consist principally of pharmaceutical products and are stated at
weighted average cost. When market value of the inventory products is lower than
the weighted average cost, inventory is reduced to its net realizable
value.  The Company also holds inventory on consignment.
 
 Property and
Equipment – Property and equipment are stated at cost. Maintenance and
depreciation are charged to expense as incurred and major improvements are
capitalized. Gains or losses on sales or retirements are included in the
statements of operations in the period of disposition, determined by reference
to their carrying amounts. The Company reviews its property and equipment
periodically for changes in circumstances that would indicate its recoverable
carrying value is less than its net book value. If such circumstances occur,
impairment is charged to such items.
 
 Intangible
Assets – Acquisition costs of land use rights are capitalized at their
acquisition cost and amortized using the straight-line method over their
estimated useful lives. For those intangible assets with legal protection over a
specific period, their useful life is the protected period. Assets that do not
have legal protection periods are amortized over their estimated useful life.
Research and development costs are expensed during the period
incurred.
 
 Impairment of
Long-Lived Asset -The Company reviews its long-lived assets, including
intangibles, for impairment at least annually or when events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. The Company evaluates, at each balance sheet date, whether events
and circumstances have occurred that indicate possible impairment. The Company
uses an estimate of future undiscounted net cash flows from the related asset or
group of assets over their remaining life in measuring whether the assets are
recoverable. As of December 31, 2008, the Company does not consider any of its
long-lived assets to be impaired.
  F-7
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 Deposits and
Accrued Expenses –Accrued expenses consists of accrued commission
expense, accrued payroll expense, and accrued welfare expense. Deposits consist
of funds paid by the sales representatives to obtain the Company’s products to
sell.  The Company retains these deposits during the time the sales
representatives provide services to the Company.  When the sales
representatives terminate sales services, the deposits are returned to the sales
representatives. The Company records deposits from sales representatives when
payments are received.
 
 Advances to
Suppliers and Advances from Customers – The Company will often make
advanced payments to suppliers for materials, or receive advance payments from
customers in the normal course of business. Advances to suppliers were $446,168
and $669,858 as of December 31, 2008 and 2007, respectively. Advances to
suppliers are recorded when payment is made by the Company and relieved against
inventory when goods are received. The advance payments to suppliers may include
provisions that set the purchase price and delivery date of raw materials.
Advances from customers were $222,609 and $119,287 as of December 31, 2008 and
2007, respectively and are recognized in revenue when delivery has
occurred.
 
 Revenue
Recognition – The Company recognizes revenue when it is realized and
earned. The Company considers revenue realized or realizable and earned when (1)
it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the
sales price is fixed or determinable, and (4) collectability is reasonably
assured. Delivery does not occur until products have been shipped to the client,
risk of loss has transferred to the client and client acceptance has been
obtained, client acceptance provisions have lapsed, or the Company has objective
evidence that the criteria specified in client acceptance provisions have been
satisfied. The sales price is not considered to be fixed or determinable until
all contingencies related to the sale have been resolved.
 
 The
Company recognizes revenue for its consignment sales only after the customer has
checked the quality of the goods and the Company has received a written
confirmation from the customer that they have accepted the goods.
 
 Cost of
Revenues – The cost of revenues are the direct expenses incurred in
producing the pharmaceuticals and cosmetics, which include materials, wages,
handling charges, and a portion of overhead expenses associated with the
manufacture and delivery of products.
 
 Shipping and
Handling Costs– Shipping and handling costs are paid by customers for
goods shipped out and are recorded as selling expenses.
 
 Research and
Development–The
Company charges research and development costs to operations in the period
incurred.  The Company recognizes revenue from research and
development activities in accordance with the revenue recognition policy as
stated above. Because in many cases the Company cannot be assured that the terms
of specific contracts can be fulfilled, the Company recognizes revenue only
after all terms of a contract are complete.
 
 Advertising
–Advertising expense was $2,135,558 and $330,937 for the years ended December
31, 2008 and 2007, respectively.
  F-8
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
  Basic and Diluted
Earnings per Share–The computation of basic and
diluted earning per share is based on the weighted-average number of shares
outstanding during the periods presented. Potentially dilutive securities for
the year ended December 31, 2008 include 46,000 warrants which were antidilutive
due to losses of the Company.  Using the treasury stock method,
dilutive securities for the year ended December 31, 2007 include the effects of
warrants for the respective periods outstanding during the year.  The
following table is a reconciliation of the numerators and denominators used in
the calculation of basic and diluted earnings per share and the weighted-average
common shares outstanding, respectively:
 
 For the Years Ended December
      31,2008
                            
                            
                            2007Net (loss)
      income
                            
                            $
                            (4,642,909
                            )
                            
                            $
                            1,720,387Basic weighted-average common
      shares outstanding
                            
                            
                            19,679,400
                            
                            
                            
                            19,387,619Effect of dilutive
      securities:Warrants
                            
                            
                            -
                            
                            
                            
                            51,458Diluted weighted-average common
      shares outstanding
                            
                            
                            19,679,400
                            
                            
                            
                            19,439,077(Loss) earnings per
      share:Basic
                            
                            $
                            (0.24
                            )
                            
                            $
                            0.09Diluted
                            
                            $
                            (0.24
                            )
                            
                            $
                            0.09
 
 Retirement
Benefit Plans – The Company makes monthly contributions to various
employee retirement benefit plans organized by provincial governments in the PRC
in accordance with rates prescribed by them. The provincial governments
undertake to assume the retirement benefit obligations of all existing and
future retired employees of the Company. Contributions to these plans are
charged to expense as incurred.
  Comprehensive
Income – Other comprehensive income presented in the consolidated
financial statements consists of cumulative foreign currency translation
adjustments.
 
 Credit
Risk – The carrying amounts of accounts receivable and sales
representative advances included in the balance sheets represent the Company’s
major exposure to credit risk in relation to its financial assets. No other
financial assets carry a significant exposure to credit risk. The Company
performs ongoing credit evaluations of each customer’s financial condition. It
maintains allowances for doubtful accounts and believes its current reserves are
adequate.
 
 The
Company has its cash in bank deposits and money market funds primarily in the
PRC. Historically, deposits in Chinese banks have been secure due to the state
policy on protecting depositors’ interests. China promulgated a new Bankruptcy
Law in August 2006, which came into effect on June 1, 2007, which, together with more specific,
complementary regulations to be issued in the future, shall provide the
implementation for the bankruptcy of Chinese banks.In the event that
bankruptcy laws are enacted for banks in the PRC, the Company’s deposits may be
at a higher risk of loss.
  F-9
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
  Business
Conditionand
Liquidity–Although
theCompany
has had a history of positive income, working capital and retained earnings, the
Company has incurred a net loss for the year ended December 31, 2008 of $4.6
million and net cash provided by operating activities of $1.9 million and used
funds in financing activities of $3.0 million.  As a result, during
the year ended December 31, 2008, the cash and cash equivalents have decreased
$1.2 million. As shown in Note 6, the Company has $9.5million
in short term loans that mature in 2009. Additionally, as discussed in Note
10, putative class action lawsuits have been asserted against the Company, and
the Company is responding to a voluntary document request from the
SEC.
  The
Company has expended significant efforts to expand its revenues by assisting its
sales representatives and increasing its marketing in fiscal 2008. The net loss
recognized in 2008 was primarily caused by increased legal, auditing, expenses
related to assisting sales representatives and marketing expenses.  In
addition, the Company has been forced to give significant attention to the
internalinvestigationconducted
by the Audit Committee and has to address class action lawsuits noted
above.  The Company believes that it will remedy these matters and
will be able to return to its normal operations in the near future, but the
Company cannot give any assurance that this will be the
case.
 
 Recently Enacted
Accounting Standards – In
September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157,Fair
Value Measurements, which
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS No. 157 was effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. In
February 2008, the FASB issued FASB Staff Position (FSP FIN) No. 157-2 which
extended the effective date for certain nonfinancial assets and nonfinancial
liabilities to fiscal years beginning after
November 15, 2008.  The adoption of the portions of SFAS No. 157 that
were not postponed by (FSP FIN) No. 157-2 did not have an effect on our
consolidated financial statements. The Company does not expect the
adoptionof the postponed portions of SFAS
No. 157 to have a material impact onitsconsolidated financial
statements.
 
 In December 2007, the FASB issued SFAS
No. 141(R),Business
Combinations, and SFAS
No. 160,Noncontrolling
Interests in Consolidated Financial Statements.SFAS No. 141(R) requires an
acquirer to measure the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree at their fair values on the
acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS
No. 160 clarifies that a non-controlling interest in a subsidiary should be
reported as equity in the consolidated financial statements, consolidated net
income shall be adjusted to include the net income attributedto the non-controlling interest and
consolidated comprehensive income shall be adjusted to include the comprehensive
income attributed to the non-controlling interest. The calculation of earnings
per share will continue to be based on income amounts attributable to the parent. SFAS
No. 141(R) and SFAS No. 160 are effective for financial
statements issued for fiscal years beginning after December 15, 2008. Early
adoption is prohibited. SFAS No. 141(R) and SFAS No. 160 are not expected to
have a material impact on our results of operations or
financial position.
 
 In April 2008, the FASB issued FSP FAS
142-3,Determination of the
Useful Life of Intangible Assets(FSB FAS 142-3). FSP FAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS No. 142,Goodwill and Other
Intangible Assets. The
intent of this FSP is to improve the consistency between the useful life of a
recognized intangible asset
under FAS 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141(R) and other generally accepted accounting
principles. FSP FAS 142-3 is effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15,
2008. The Company does not expect the adoption of FSP FAS 142-3 to have a
material impact on our consolidated financial statements.
  F-10
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 
 In October 2008, the FASB issued FSP FAS
157-3Determining Fair
Value of a FinancialAsset in a Market
That Is Not Active(FSP FAS
157-3). FSP FAS 157-3 clarified the application of SFAS No.157 inan inactive market. It demonstrated how
the fair value of a financial asset is determined when the market for that
financial asset is inactive. FSP FAS 157-3 was effective upon
issuance, including prior periods for which financial statements had not been
issued. The adoption of FSP FAS 157-3 is not expected to have a material impact
on the Company’s financial
statements.
 
 In December 2008, the FASB issued FASB Staff Position FAS 140-4
and FIN 46(R)-8,Disclosures by
Public Entities (Enterprises) about Transfers of Financial Assets and Interests
in Variable Interest Entities("FSP FAS 140-4 and FIN 46(R)-8"). FSP
FAS 140-4 and FIN 46(R)-8 amends SFAS 140,Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilitiesand FIN 46(R),FASB
Interpretation No. 46 (R), Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51, torequire public entities to provide
additional disclosures about transfers of financial assets and their involvement
with variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is effective for
the first interim or annual reporting period ending after December 15, 2008. The adoption of FSP FAS
140-4 and FIN 46(R)-8 is not expected to have a material impact on the
Company’s financial
statements.
 
 NOTE
3 – INVENTORY
 
 Inventory
consisted of the following:
  December
31,2008
                              
                              
                              2007Raw
    materials
                              
                              $
                              1,061,465
                              
                              
                              $
                              871,425Work-in-process
                              
                              
                              2,003,825
                              
                              
                              
                              1,797,379Finished
    goods
                              
                              
                              648,074
                              
                              
                              
                              786,235Product on
      consignment
                              
                              
                              722,076
                              
                              
                              
                              806,513Total
    Inventory
                              
                              $
                              4,435,440
                              
                              
                              $
                              4,261,552Less: Provision for
      obsolescence
                              
                              
                              (147,978
                              )
                              
                              
                              (136,359
                              )Net
    Inventory
                              
                              $
                              4,287,462
                              
                              
                              $
                              4,125,193
  F-11
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 NOTE
4 – PROPERTY, PLANT AND EQUIPMENT
 
 Property
and equipment consisted of the following:
  December
31,2008
                            
                            
                            2007Buildings and land use
      rights
                            
                            $
                            6,130,852
                            
                            
                            $
                            5,745,353Machinery
                            
                            
                            5,724,217
                            
                            
                            
                            5,234,388Other
    equipment
                            
                            
                            477,315
                            
                            
                            
                            429,985Vehicles
                            
                            
                            445,166
                            
                            
                            
                            411,471Construction in
      process
                            
                            
                            146,047
                            
                            
                            
                            -Total
                            
                            
                            12,923,597
                            
                            
                            
                            11,821,197Less accumulated
      depreciation
                            
                            
                            (5,341,933
                            )
                            
                            
                            (4,247,993
                            )Net property, plant and
      equipment
                            
                            $
                            7,581,664
                            
                            
                            $
                            7,573,204
 
 Depreciation is computed on a
straight-line basis over the estimated useful lives of the assets, which were as
follows:
  LifeAsset
                    
                    (years)Buildings and land use
      rights
                    
                    30 - 50Machinery
                    
                    3 - 20Other
    equipment
                    
                    3 - 10Vehicles
                    
                    3 -
  10
 
 Depreciation
and amortization expense was $821,574 and $676,547 for the years ended December
31, 2008 and 2007, respectively.
 
 NOTE
5 – INTANGIBLE ASSETS
 
 At
December 31, 2008 the Company’s intangible assets consist of land use rights
that were not currently being utilized but were held for future use as building
sites. When utilized in the construction of buildings, the land use rights are
reclassified as property, plant and equipment and are depreciated using the
straight-line method over the remainder of their 50-year life. Estimated
aggregate future amortization expense for the succeeding five years and
thereafter as of December 31, 2008 is as follows:
  2009
                      
                      $
                      25,2192010
                      
                      
                      25,2192011
                      
                      
                      25,2192012
                      
                      
                      25,2192013
                      
                      
                      25,219Thereafter
                      
                      
                      539,864
 F-12
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 NOTE
6 – NOTES PAYABLE
 
 The
Company’s notes payable consist of short and long-term debt that is payable to
banks, governmental financial bureaus, municipalities and a company. The
following schedule summarizes the Company’s debt obligations and respective
balances at December 31, 2008 and 2007:
 
 December
31,2008
                                                            
                                                            
                                                            2007Short-term note payable to a
      municipality, interest at 1.8%, due on demand,
      unsecured
                                                            
                                                            $
                                                            72,948
                                                            
                                                            
                                                            $
                                                            68,360Short-term note payable to a
      finance bureau, interest at 4.5%, due on demand,
      unsecured
                                                            
                                                            
                                                            75,182
                                                            
                                                            
                                                            
                                                            70,455Short-term note payable to a bank,
      interest at 7.47%, matures April 2009, secured by
      property
                                                            
                                                            
                                                            3,647,399
                                                            
                                                            
                                                            
                                                            -Short-term note payable to a bank,
      settled during 2008
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            1,367,222Short-term note payable to a bank,
      settled during 2008
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            3,418,056Short-term note payable to a
      government development zone, interest at 2.43%, due on demand, secured by
      property
                                                            
                                                            
                                                            218,844
                                                            
                                                            
                                                            
                                                            410,167Short-term note payable to a bank,
      interest at 7.72%, matures August 2009, secured
      by shareholder
                                                            
                                                            
                                                            5,835,838
                                                            
                                                            
                                                            
                                                            -Total short-term notes
      payable
                                                            
                                                            $
                                                            9,850,211
                                                            
                                                            
                                                            $
                                                            5,334,260December
31,2008
                                                            
                                                            
                                                            2007Long-term note payable to a bank,
      settled in 2008, secured by shareholder
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            6,836,111Long-term note payable to a bank,
      interest at 8.316%, matures April 2010
                                                            
                                                            
                                                            1,458,959
                                                            
                                                            
                                                            
                                                            -Long term note payable to a 
      bank, interest at 6.57%, matures March 2010, secured by
      property
                                                            
                                                            
                                                            2,917,919
                                                            
                                                            
                                                            
                                                            4,101,667Total long-term
      debt
                                                            
                                                            
                                                            4,376,878
                                                            
                                                            
                                                            
                                                            10,937,778Less current maturities of
      long-term debt
                                                            
                                                            
                                                            3,245,685
                                                            
                                                            
                                                            
                                                            4,101,667Long-term notes payable, net of
      current portion
                                                            
                                                            $
                                                            1,131,193
                                                            
                                                            
                                                            $
                                                            6,836,111Past due notes
      payable
                                                            
                                                            $
                                                            294,026
                                                            
                                                            
                                                            $
                                                            480,622
  F-13
  CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
  The
Company’s short and long-term debt obligations and respective balances at
December 31, 2008 are payable as follows:
 
 2009
                                  
                                  
                                  12,935,2582010
                                  
                                  
                                  1,291,831$
                                  14,227,089
 
 On August
17, 2007, the Company received a loan for $6,651,094 from Shuang Long Branch of
Agricultural Bank of China with a term of two years. The loan bears interest at
a rate of 7.72% which is due quarterly. The loan was for working capital and is
guaranteed by Lan's International Medicine Investment Co Ltd. (“LIMI”). Gui Hua
Lan, our Chief Executive Officer; Feng Lan, our President; and Zheng Yi Wang,
our Executive Director of Exports, are directors and have voting and investment
control over the shares owned by LIMI, which beneficially owns or controls
approximately 78% of our outstanding shares. In addition, Gui Hua Lan, Feng Lan
and Zheng Yi Wang owns 62.42%, 5.15% and 1.45%, respectively, of LIMI’s issued
and outstanding shares. LIMI is not receiving any compensation for the guarantee
of the Company’s loan.
 
 NOTE
7 – STOCKHOLDERS’ EQUITY
 
 Statutory
Reserves -According to the
Articles of Association, the Company is required to transfer a certain portion
of its net profits to Statutory Reserves, as determined under PRC accounting
regulations, from net income to both the surplus reserve fund and the public
welfare fund.  Accordingly, the Company has recorded an aggregate of
$147,023 in the Statutory Reserves account in the equity section of the
accompanying balance sheet as of December 31, 2008 and 2007.
 
 Initial Public
Offering - In June 2007, the Company completed an initial public offering
(“IPO”) consisting of 460,000 shares of common stock.  The Company’s
sale of common stock, which was sold indirectly by the Company at a price to the
public of $3.50 per share, resulted in net proceeds of
$1,094,382.  These proceeds were net of underwriting discounts and
commissions and offering costs payable by the Company totaling approximately
$0.6 million.  Upon the closing of the offering the Company sold the
underwriter warrants to purchase 40,000 shares of common stock for
$400.  The warrants are exercisable at a per share price of $4.20 and
expire if unexercised after five years.  The shares underlying the
warrants have been registered.
 
 American Stock
Exchange Non-compliance - On August 21, 2008 the Company received a
deficiency letter from the American Stock Exchange (“AMEX”) stating that the
Company was no longer in compliance with their listing standards and suspended
trading the Company’s stock. As a result of an investigation authorized by the
Audit Committee of the Board of Directors of the errors in the accounting for
accounts receivable and sales representative advances in 2007, the Company
failed to timely file its Quarterly report on Form 10-Q for the quarter ended
June 30, 2008 with the Securities and Exchange Commission.  In order
to maintain its AMEX listing, the Company had to submit a plan  by
September 4, 2008, outlining actions the Company had taken, or will take, to
regain compliance with the continued listing standards of AMEX, including
submission of all required Securities and Exchange Commission filings, by no
later than November 19, 2008.
 
 Pursuant
to the Deficiency Letter, if AMEX were to determine that the Company made a
reasonable demonstration in the Plan of an ability to regain compliance with all
applicable continued listing standards by November 19, 2008, AMEX would accept
the Plan. As of December 31, 2008, the Plan had been timely submitted by the
Company and accepted by AMEX at which time trading of the Company’s stock
recommenced.
  F-14
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 
 Issuance of
Warrants - On September 25, 2007, pursuant to agreements with the two of
the Company’s independent directors, the Company issued each independent
director 3,000 five-year warrants at an exercise price of $3.50 per
share.  The Warrants were valued using the Black Scholes Option
Pricing Model with the following assumptions: dividend yield of 0%, estimated
life of 5 years, closing market price of $4.84, volatility of 72.4% and a
risk-free interest rate of 4.26%. This resulted in a fair value of $3.328 per
warrant for a total value of $19,968 for the 6,000 warrants. The warrants vested
immediately upon issuance.
 
 Exercise of
Warrants - During 2007, the Company received proceeds of $250,000 upon
the exercise of the warrant to purchase 100,000 shares of common stock at $2.50
per share.
 
 The
following summarizes the outstanding warrants as of December 31,
2008:
  Weighted-AverageExercise
                        
                        Warrants
                        
                        Remaining
      Contractual
                        
                        NumberPrice
                        
                        Outstanding
                        
                        Life
(Years)
                        
                        Exercisable$3.50
                        
                        6,000
                        
                        3.7
                        
                        6,000$4.20
                        
                        40,000
                        
                        3.5
                        
                        40,00046,000
                        
                        
                        
                        46,000
  NOTE
8 – RELATED PARTY TRANSACTIONS
 
 As of
December 31, 2008 and 2007, the Company had receivables due from officers in the
amount of $0 and $27,555, respectively.
 
 At
December 31, 2008 and 2007 the amounts payable to officers were $148,575 and
$94,939, respectively.  These amounts are due on demand and do not
accrue interest.
 
 During
2007 the Company entered into a loan agreement with a bank which is secured by
shares of the Company owned by the Company’s principal
shareholder.  See Note 6.
 
 NOTE
9 – INCOME AND OTHER TAXES
 
 The
Company accounts for its income taxes in accordance with SFAS No. 109, which
requires recognition of deferred tax assets and liabilities and their respective
tax bases and any tax credit carry forwards available. 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. 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 is not subject to any income taxes in the United States, but was subject
to corporate income tax in the PRC at a combined rate of 25% for 2008 and 30%
and a local income tax rate of 3% for 2007. However, because the Parent is
located in a special region, it has a 15% corporate income tax rate and has been
granted a “tax holiday” during which it will pay no income taxes through
December 31, 2008. On March 16, 2007, the National People’s Congress of China
passed the new Enterprise Income Tax Law, (“EIT Law”), and on December 6, 2007,
the State Council of China issued the Implementation Regulations for the EIT Law
which took effect on January 1, 2008. The EIT Law and Implementation
Regulations Rules impose a unified EIT of 25% on all domestic-invested
enterprises and Foreign Invested Entities, or FIEs, unless they qualify under
certain limited exceptions.
 F-15
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 As a
result of the above change in the income tax laws, the Parent had a 15% rate
with a tax holiday for 2008 and will have a favorable rate of 50% of the tax
rates in effect during fiscal 2009 through 2011 as determined by the PRC
government and the regional tax authorities. The phase-in income tax rate is 18%
for 2009, 20% for 2010, 22% for 2011, 24% for 2012, and 25% for 2013 and after.
Medicine, Import/Export, Cosmetics, Beisheng and Pingbian Shenghuo are taxed at
the new 25% rate effective January 1, 2008.
 
 The
Company recognizes deferred tax assets and liabilities for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax bases
and any tax credit carry forwards available. 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. 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 has established a valuation allowance for all deferred income tax
assets due to the uncertainty of their realization. Income taxes payable are
included in taxes and related payables on the accompanying balance sheets.
Income taxes are not required to be paid to the PRC until after the end of the
Company’s fiscal year.
 
 Undistributed
earnings of the Company’s foreign subsidiaries since acquisition amounted to
approximately $1.77 million at December 31, 2008. Those earnings, as well
as the investment in the subsidiaries of approximately $8.73 million are
considered to be indefinitely reinvested and, accordingly, no U.S. federal and
state income taxes have been provided thereon. Upon distribution of those
earnings in the form of dividends or otherwise, the Company would be subject to
both U.S. income taxes (subject to an adjustment for foreign tax credits) and
withholding taxes payable to the PRC. The Company has U.S. net operating loss
carryforwards of approximately $2.86 million that, if unused begin to expire in
2026. Determination of the amount of unrecognized deferred U.S. income tax
liability is not practical because of the complexities associated with its
hypothetical calculation; however, unrecognized foreign tax credits may be
available to reduce a portion of the U.S. tax liability.
 
 The
Company is also subject to Value Added Tax (“VAT”) and other miscellaneous taxes
including city construction tax, turnover tax and consumption tax. All
enterprises that sell commodities, engage in repair and maintenance or import
and export business in the PRC are subject to VAT tax. The standard rate for VAT
tax is 17%. Once declared, VAT taxes are due on a monthly basis. Taxes and
related payables are composed of the following:
  December
31,2008
                                    
                                    
                                    2007VAT taxes
                                    
                                    $
                                    533,533
                                    
                                    
                                    $
                                    740,403Income
taxes
                                    
                                    
                                    655,476
                                    
                                    
                                    
                                    58,562Other taxes
                                    
                                    
                                    47,565
                                    
                                    
                                    
                                    56,119Total taxes and related
      payables
                                    
                                    $
                                    1,236,574
                                    
                                    
                                    $
                                    855,084
 F-16
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 On March
15, 2007, the Company’s majority owned subsidiary, Medicine was granted an
approval of their application by the government of the PRC for relief of income
taxes for the years ended December 31, 2006 and 2005.  As a result,
Medicine recognized an aggregate of $976,048 in income taxes that are no longer
payable as of March 15, 2007. The amount has been recognized under the caption
“Benefit from (provision for) income taxes” in the accompanying Consolidated
Statement of Operations and Comprehensive Income for the year ended December 31,
2007.
 
 The
temporary differences and carryforwards which give rise to the deferred income
tax asset are as follows:
  December
31,2008
                          
                          
                          2007Net operating loss
      carryforwards
                          
                          $
                          3,256,071
                          
                          
                          $
                          893,720Allowance for doubtful trade
      receivables
                          
                          
                          562,976
                          
                          
                          
                          934,521Allowance for doubtful other
      receivables
                          
                          
                          405,149
                          
                          
                          
                          672,481Inventory obsolescence
      reserve
                          
                          
                          13,881
                          
                          
                          
                          5,096Total deferred income tax
      assets
                          
                          
                          4,238,077
                          
                          
                          
                          2,505,818Valuation
      allowance
                          
                          
                          (4,238,077
                          )
                          
                          
                          (2,505,818
                          )Net deferred income tax
      asset
                          
                          $
                          -
                          
                          
                          $
                          -
 
 Following
is a reconciliation of income taxes calculated at the federal and local
statutory rates to actual income tax expense:
  For the
    YearsEnded December
      31,2008
                          
                          
                          2007Tax at statutory rate of 25% and
      33%
                          
                          $
                          (929,079
                          )
                          
                          $
                          411,842Effect of favorable
      rate
                          
                          
                          86,240
                          
                          
                          
                          (1,732,456
                          )Effect of reduction in statutory
      rates
                          
                          
                          (293,479
                          )Tax refund from
      government
                          
                          
                          -
                          
                          
                          
                          (976,048
                          )Other change in valuation
      allowance
                          
                          
                          1,574,597
                          
                          
                          
                          1,847,464Provision for (benefit from)
      income taxes
                          
                          $
                          438,279
                          
                          
                          $
                          (449,198
                          )
 The
provision for income taxes consisted of the following:
  For the
    YearsEnded December
      31,2008
                                  
                                  
                                  2007Current
                                  
                                  $
                                  438,279
                                  
                                  
                                  $
                                  (976,048
                                  )Deferred
                                  
                                  
                                  -
                                  
                                  
                                  
                                  526,850Provision for (benefit from)
      income taxes
                                  
                                  $
                                  438,279
                                  
                                  
                                  $
                                  (449,198
                                  )
 F-17
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 
 The
Company has $9,139,890 of net operating loss carryforwards available in the PRC
that, if unused, begin to expire in 2011.
 
 NOTE
10– COMMITMENTS AND CONTINGENCIES
 
 Class Action
Lawsuits –In 2008,
putative class action lawsuits were asserted against the Company and certain
other parties in the United States District Court for the Southern District of
New York (the “Court”). On February 12, 2009, an amended complaint was served on
the Company by new lead counsel for the class, consolidating the putative class
actions and bearing the caption Beni Varghese, Individually and on Behalf of All
Other Similarly Situated v. China Shenghuo Pharmaceutical Holdings, Inc., et
al., Index No. 1:08 CIV. 7422.  The defendants include the Company,
the Company’s controlling shareholders, Lan’s International Medicine Investment
Co., Limited, the Company’s chief executive officer, Gui Hua Lan, the Company’s
former chief financial officer, Qiong Hua Gao, and the Company’s independent
registered public accounting firm, Hansen, Barnett & Maxwell,
P.C.  By stipulation, the defendants currently have until April 12,
2009 to respond to the amended consolidated complaint.
 
 The amended consolidated complaint
alleges that the Company failed to take adequate steps to ensure its financial
reporting comported with U.S. Generally Accepted Accounting Principles
("GAAP") and, as a result, the Company was required to restate what are alleged
to be materially false and misleading financials for accounting periods during
the alleged class period from August 2007 through August 20, 2008.
The amended consolidated complaint further alleges, among other
things, that certain of the Company’s SEC filings and other public statements
contained false and misleading statements which resulted in damages to the
plaintiffs and the members of the purported class when they purchased the
Company’s securities. On the basis of those allegations, plaintiffs in each of
the actions seek an unspecified amount of damages under Sections 10(b) and 20(a)
of the Exchange Act, and Rule 10b-5 promulgated thereunder.
 
 The Company believes the allegations in
the amended consolidated complaint are without merit, and intends to vigorously
defend the class action lawsuits. The Company does not believe the outcome of
this suit will have a material adverse effect on the Company.However, the Company is unable at this
time to predict the outcome ofthis litigation or whether the Company
willincurany liability associated with the
litigation, or to estimate the effect such outcome would have onthefinancial condition, results of
operations, or cash flows of the Company.
  Economic
environment– Since all of
the Company’s operations are conducted in the PRC, the Company is subject to
special considerations and significant risks not typically associated with
companies operating in theUnited States of America. These risks include, among others, the
political, economic and legal environments and foreign currency exchange rate
fluctuations. The Company’s operational results may be adversely affected by
changes in the political and social conditions in the PRC, and by changes in
governmental policies with respect to medical reforms and other laws and
regulations, anti-inflationary measures, currency conversion and remittance
abroad, and rates and methods of taxation, among other things. In addition, all
of the Company’s revenue is denominated in the PRC’s currency CNY, which must be
converted into other currencies before remittance out of the PRC. Both the
conversion of CNY into foreign currencies and the remittance of foreign
currencies abroad require approval of the PRC government.
 
 Due to changes in current worldwide
economic conditions, the Company’s ability to raise capital or borrow funds may
be limited andmay also
adversely affect the Company’s operations.
 F-18
 CHINA
SHENGHUO PHARMACEUTICAL HOLDINGS, INC.
 Notes
to Consolidated Financial Statements
 For
the Years Ended December 31, 2008 and 2007
 Dependence
on a single raw material–
The primary ingredient in all of the Company’s products is Sanchi, an herb grown
in two provinces of the PRC. The Company relies on its in-house purchasing
department to acquire sufficient Sanchi at reasonable prices and may on occasion
make advance payments to suppliers that include provisions for setting the
purchase price and delivery date. However, the Company is not reliant on a
single source or supplier in order to obtain the Sanchi.
 
 Advertising
agreement -The Company has entered into an
agreement for certain advertising services to be performed during fiscal
2009.  The total commitment under
the contract is approximately $86,000of which a deposit of approximately
$26,000 has beenmade to the service provider which
isreflected inadvances to suppliersinthe accompanyingconsolidatedbalance sheet as of December 31,
2008.
 
 NOTE
11 - GEOGRAPHIC INFORMATION
 
 The
Company derives its sales from China and from other various
countries.  Operations in China make up the majority of the Company’s
sales, with a very small portion from other various countries.  No
revenues from external customers attributed to any individual foreign country
are material. The following table summarizes sales by geographic location for
the years ended December 31, 2008 and 2007:
  Years Ended December
      31,2008
                      
                      
                      2007Sales from
      China
                      
                      $
                      28,162,119
                      
                      
                      $
                      19,655,934Sales from other
      countries
                      
                      
                      528,390
                      
                      
                      
                      317,984Total Sales
                      
                      $
                      28,690,509
                      
                      
                      $
                      19,973,918
 
 NOTE
12 – CONCENTRATIONS
 
 During
the year ended December 31, 2008, the Company had concentrations of purchases
from one vendor accounting for 27 % of total purchases.
 
 NOTE
13 – SUBSEQUENT EVENTS
 
 On February 10, 2009, the Company received a
deficiency letter (the “Deficiency Letter”) from the NYSE Alternext US LLC (the
“Exchange”) stating that, as a result of the Company’s failure to hold an annual
meeting of its stockholders during 2008, the Company is no longer in compliance
with the listing requirements of the Exchange.  The Deficiency Letter
states that, in order to maintain its Exchange listing, the Company must submit
a plan of compliance (the “Plan”), by March 10, 2009, advising the Exchange of
actions the Company has taken, or will take, to regain compliance by no later
than August 11, 2009.  The Company submitted its Plan on March 2, 2009
indicating that it anticipates holding its annual meeting of stockholders on or
about May 20, 2009, and is awaiting a response from the
Exchange.
 
 Pursuant
to the Deficiency Letter, if the Exchange determines that the Company has made a
reasonable demonstration in the Plan of an ability to regain compliance with the
continued listing standards by August 11, 2009, the Exchange will accept the
Plan.  If the Exchange does not accept the Plan, or the Company does
not make adequate progress and complete the actions outlined in the Plan by
August 11, 2009, the Exchange will initiate delisting proceedings against the
Company.  The Company can provide no assurances that it will regain
compliance with the Exchange’s continued listing standards, and its failure to
do so could result in the delisting of the Company’s common stock from the
Exchange.  Until the Company achieves compliance with the Exchange’s
requirements, the Company’s stock trading symbol will be appended with the “.BC”
extension.