UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, DC 20549





FORM 10-Q





x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the quarterly period ended March 31, 2011





oro
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the transition period from ______ to ______.





Commission File Number 001-34394











SKYSTAR BIO-PHARMACEUTICAL COMPANY


(Exact name of small business issuer as specified in its charter)





Nevada
33-0901534(State or other jurisdiction of
(I.R.S. employerincorporation or organization)
identification number)





4/F Building B, Chuangye Square, No. 48 Keji Road,


Gaoxin District, Xi’an Province, P.R. China


(Address of principal executive offices and zip code)





(8629) 8819-3188


(Registrant’s telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x      No o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o    No o





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





Large Accelerated Filer o
Accelerated Filer oNon-accelerated filer o
Smaller Reporting Company x





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





APPLICABLE ONLY TO CORPORATE ISSUERS:





As of May 16, 2011, the Registrant had 7,161,919 shares of common stock outstanding.











SKYSTAR BIO-PHARMACEUTICAL COMPANY





FORM 10-Q





INDEX





Page No.SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

3PART I.  FINANCIAL INFORMATION

4Item 1.
Condensed Consolidated Financial Statements

4Condensed Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010

4Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss) for the Three Months Ended March 31, 2011 and 2010 (unaudited)

5Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (unaudited)

6Condensed Consolidated Statements of Shareholders’ Equity (unaudited)

7Notes to the Condensed Consolidated Financial Statements (unaudited)

8Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

26Item 4.
Controls and Procedures

32PART II.  OTHER INFORMATION

33Item 6.
Exhibits

33SIGNATURES

34





2





SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS





This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words “estimate,” “anticipate,” “believe,” “expect,” or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this Report, including the matters set forth under the captions “Risk Factors” and in our other SEC filings. These risks and uncertainties could cause our actual results to differ materially from those indicated in the forward-looking statements. We undertake no obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments.





Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the heading “Risks Relating to Our Business” below, as well as those discussed elsewhere in this Quarterly Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We file reports with the SEC. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.





We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.





3


PART I.  FINANCIAL INFORMATION





ITEM 1. FINANCIAL STATEMENTS





SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS  March 31,


December 31,2011

(Unaudited)


2010ASSETSCURRENT ASSETS:Cash

$
7,403,389


$
5,887,831Accounts receivable, net of allowance for doubtful accounts of $341,266 (Unaudited) and $339,031 as of March 31, 2011 and December 31, 2010, respectively


5,770,607



4,977,850Inventories


14,099,464



7,202,223Deposits and prepaid expenses


18,631,564



17,074,000Loans receivable


458,100



8,040,100Other receivables


2,735,617



1,558,775Total current assets


49,098,741



44,740,779PLANT AND EQUIPMENT, NET


22,450,965



22,613,113CONSTRUCTION-IN-PROGRESS


2,660,880



1,590,720OTHER ASSETS:Long-term prepayments


1,493,794



1,454,226Long-term prepayments for acquisitions


4,838,035



4,806,352Intangible assets, net


5,890,246



6,043,941Total other assets


12,222,075



12,304,519Total assets

$
86,432,661


$
81,249,131LIABILITIES AND SHAREHOLDERS’ EQUITYCURRENT LIABILITIES:Accounts payable

$
401,132


$
201,850Other payable and accrued expenses


2,189,747



1,845,051Short-term loans


4,307,133



3,025,884Deposits from customers


1,283,376



1,260,030Taxes payable


2,326,549



749,836Shares to be issued to related parties


79,575



53,050Due to related parties


281,200



217,912Total current liabilities


10,868,712



7,353,613OTHER LIABILITIES:Deferred government grant


992,550



986,050Warrant liability


684,145



1,419,639Total other liabilities


1,676,695



2,405,689Total liabilities


12,545,407



9,759,302COMMITMENTS AND CONTINGENCIESSHAREHOLDERS’ EQUITYPreferred stock, $0.001 par value, 50,000,000 shares authorized, No Series “A” shares authorized. 48,000,000 Series “B” shares authorized. No Series “B” shares issued and outstandingCommon stock, $0.001 par value, 40,000,000 shares authorized, 7,161,919 shares issued and outstanding as of March 31, 2011 (Unaudited) and December 31, 2010


7,162



7,162Paid-in capital


35,784,378



35,784,378Statutory reserves


5,695,236



5,695,236Retained earnings


26,779,122



24,847,290Accumulated other comprehensive income


5,621,356



5,155,763Total shareholders’ equity


73,887,254



71,489,829Total liabilities and shareholders’ equity

$
86,432,661


$
81,249,131




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




4




SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (LOSS)

(Unaudited)  For Three Months Ended

March 31,2011


2010REVENUE, net

$
7,086,954


$
4,869,243COST OF REVENUE


3,491,346



2,291,219GROSS PROFIT


3,595,608



2,578,024OPERATING EXPENSES:Research and development


287,472



43,995Selling expenses


369,404



171,134General and administrative


1,294,798



619,550Total operating expenses


1,951,674



834,679INCOME FROM OPERATIONS


1,643,934



1,743,345OTHER INCOME:Other income (expense), net


182



417Interest income (expense), net


29,672



(4,816
)Change in fair value of warrants


735,494



(317,380
)Total other expense, net


765,348



(321,779
)INCOME BEFORE PROVISION FOR INCOME TAXES


2,409,282



1,421,566PROVISION FOR INCOME TAXES


477,450



325,319NET INCOME


1,931,832



1,096,247OTHER COMPREHENSIVEINCOME (LOSS):Foreign currency translation adjustment


465,593



(40,816
)COMPREHENSIVE INCOME

$
2,397,425


$
1,055,431EARNINGS PER SHARE:Basic

$
0.27


$
0.16Diluted

$
0.27


$
0.15WEIGHTED AVERAGE NUMBER OF COMMON SHARES:Basic


7,166,919



7,061,530Diluted


7,179,309



7,140,140


The accompanying notes are an integral part of these condensed consolidated financial statements.
  5





SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(Unaudited)  Three months ended

March 31,2011


2010CASH FLOWS FROM OPERATING ACTIVITIES:Net income

$
1,931,832


$
1,096,247Adjustments to reconcile net income to net cashprovided by operating activities:Depreciation


332,428



123,484Amortization


230,922



91,370Common stock issued for services


-



16,245Common stock to be issued to related parties for compensation


-



27,025Change in fair value of warrant liability


(735,494
)


317,380Change in operating assets and liabilitiesAccounts receivable


(757,356
)


935,790Inventories


(6,826,437
)


(921,558
)Deposits and prepaid expenses


(1,440,749
)


(272,640
)Other receivables


(1,162,594
)


(81,901
)Accounts payable


197,277



123,423Accrued expenses


470,501



(223,979
)Deposits from customers


14,989



573,897Taxes payable


1,566,418



102,941Other payables


(110,052
)


1,233Net cash (used in) provided by operating activities


(6,288,315
)


1,908,957CASH FLOWS FROM INVESTING ACTIVITIES:Payments of long-term prepayments


(451,722
)


-Prepayment for asset acquisition


-



(5,499,375
)Collection of loans to third parties


7,609,000



-Purchases of intangible assets


(38,045
)


-Purchases of plant and equipment


(22,275
)


(1,451,016
)Payments on construction-in-progress


(634,222
)


(404,990
)Net cash provided by (used in)  investing activities


6,462,736



(7,355,381
)CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from short-term loans


1,257,007



-Repayment for short-term loans


-



(219,975
)Due (from) to related parties


62,834



(78,269
)Net cash provided by (used in) financing activities


1,319,841



(298,244
)EFFECT OF EXCHANGE RATE CHANGES ON CASH


21,296



(43,315
)INCREASE (DECREASE) IN CASH


1,515,558



(5,787,983
)CASH, beginning of period


5,887,831



11,699,398CASH, end of period

$
7,403,389


$
5,911,415SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid for interest

$
54,409


$
5,210Cash paid for income taxes

$
-


$
-Non-cash investing and financing activitiesLong-term prepayment transferred to construction-in-progress

$
421,843


$
-Long-term prepayment transferred to property, plant and equipment


-



439,777Construction-in-progress transferred to property, plant and equipment


-



52,463Cashless exercise of warrants

$
-



1,345,496





The accompanying notes are an integral part of these condensed consolidated financial statements.
  6
 
  SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)  AccumulatedRetained earnings

otherCommon stock

Paid-in

Statutory



comprehensiveShares

Amount

capital

reserves

Unrestricted

income


TotalBALANCE, December 31, 2010


7,161,919

$
7,162

$
35,784,378

$
5,695,236

$
24,847,290

$
5,155,763


$
71,489,829Foreign currency translation


-


-


-


-


-


465,593



465,593Net income


-


-


-


-


1,931,832


-



1,931,832BALANCE, March 31, 2011


7,161,919

$
7,162

$
35,784,378

$
5,695,236

$
26,779,122

$
5,621,356


$
73,887,254


The accompanying notes are an integral part of these condensed consolidated financial statements.
  7


SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
 MARCH 31, 2011
 (Unaudited)
  Note 1 - ORGANIZATION
 
 Organization and description of business
 
 Skystar Bio-Pharmaceutical Company (“Skystar” or the “Company”), was incorporated in Nevada on September 24, 1998. Since its acquisition on November 7, 2005 of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), a Cayman Islands company, the Company has been engaged in research, development, production, marketing, and sales of veterinary healthcare and medical care products. All current operations of the Company are in the People’s Republic of China (“China” or the “PRC”).
 
 All of the Company’s operations are carried out by Xian Tianxing Bio-Pharmaceutical Co., Limited (“Xian Tianxing”), a PRC joint stock company that the Company controls through contractual arrangements originally between Skystar Cayman and Xian Tianxing. On March 10, 2008, the Company entered into a series of agreements transferring all of the rights and obligations of Skystar Cayman under the contractual arrangements to Sida Biotechnology (Xian) Co., Ltd. (“Sida”), a PRC company. Sida is the wholly owned subsidiary of Fortunate Time International Limited (“Fortunate Time”), a Hong Kong company and wholly owned subsidiary of Skystar Cayman. Xian Tianxing also has a wholly owned subsidiary, Shanghai Siqiang Biotechnological Co., Ltd. (“Shanghai Siqiang”), a PRC company.
 
 As a result of these contractual arrangements, which obligates Sida to absorb all of the risk of loss from Xian Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xian Tianxing as a variable interest entity (“VIE”) under Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities.  Accordingly, the Company consolidates Xian Tianxing’s results, assets, and liabilities.
 
 Hereinafter, Skystar, Skystar California, Skystar Cayman, Fortunate Time, Sida, Xian Tianxing, Skystar Jingzhou and Shanghai Siqiang are sometimes collectively referred to as the “Company.”
 
 Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Principles of consolidation
 
 The accompanying condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The condensed consolidated financial statements include the financial statements of the Company, its wholly owned subsidiaries, and its VIEs. All significant inter-company transactions and balances between the Company, its subsidiaries, and VIEs have been eliminated in consolidation.
 
 Certain information and footnote disclosures normally present in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K. The results for the three months ended March 31, 2011, are not necessarily indicative of the results to be expected for the full year ending December 31, 2011.
 
 Use of estimates
 
 The preparation of consolidated 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. For example, the Company estimates its allowance for doubtful accounts and useful lives of plant and equipment. Because of the use of estimates inherent in the financial reporting process, actual results could materially differ from those estimates upon which the carrying values were based.
 
 8
 
 Foreign currency translation
 
 The Company uses the United States dollar (“U.S. dollar”) for financial reporting purposes and the Chinese Renminbi (“RMB”) as its functional currency. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency, being the primary currency of the economic environment in which their operations are conducted.
 
 The Company translates the subsidiaries’ and VIEs’ assets and liabilities into U.S. dollars using the applicable exchange rates prevailing at the balance sheet dates, and the statements of operations and cash flows are translated at average exchange rates during the reporting period. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the subsidiaries’ and VIEs’ financial statements are recorded as accumulated other comprehensive income.
 
 The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China. The rates of exchange quoted by the People’s Bank of China on March 31, 2011 and December 31, 2010 were US $1.00 to RMB 6.55 and RMB6.59, respectively. The average translation rates of US $1.00 to RMB 6.57 and RMB 6.82 was applied to the income statement accounts for the three months ended March 31, 2011 and 2010, respectively.
 
 Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents and signed contracts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
 
 Fair values of financial instruments
 
 The accounting standards regarding fair value of financial instruments and related fair value measurements defines financial instruments and requires fair value disclosures of those financial instruments.  This accounting standard defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosures requirements for fair value measures.  Current assets and current liabilities qualify as financial instruments and management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and if applicable, their current interest rates are equivalent to interest rates currently available.  The three levels of valuation hierarchy are defined as follows:
 
 •
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
 
 •
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
 
 •
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
  9
 
 The Company has stock purchase warrants which are treated as derivative liabilities.  These warrants do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants using the Black-Scholes Option Pricing Model (“Black-Scholes Model”) using the following assumptions:
 
 Warrants – (1)


Purchase Options – (2)March 31,2011(Unaudited)


December 31,2010


March 31,2011(Unaudited)


December 31,2010Stock price

$
5.75


$
9.73


$
5.75


$
9.73Exercise price

$
5.00


$
5.00


$
8.11


$
8.11Annual dividend yield


-



-




-


-Expected term (years)


0.92



1.16



3.25



3.50Risk-free interest rate


0.30
%


0.30
%


1.30
%


1.50
%Expected volatility


53
%


51
%


147
%


180
%
 
 (1)
As of December 31, 2010, 34,230 warrants with an exercise price of $5.00 were outstanding. As of March 31, 2011, 34,230 of these warrants were outstanding.
 
 (2)
As of December 31, 2010, 140,000 purchase options with an exercise price of $8.11 were outstanding. As of March 31, 2011, 140,000 of these options were outstanding.
 
 Expected volatility is based on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the term of the warrants. The Company believes this method produces an estimate that is representative of future volatility over the expected term of these warrants. The Company has no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the warrants.
 
 As required by the FASB’s accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Depending on the product and the terms of the transaction, the fair values warrant liability were modeled using a series of techniques, including closed-form analytic formula, such as the Black-Scholes Model, which does not entail material subjectivity because the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.
 
 The fair value of the 174,230 warrants and options outstanding as of March 31, 2011 was determined using the Black-Scholes Model, defined in the FASB’s accounting standard of fair value measurement as level 2 inputs, and recorded the change in earnings. As a result, the warrant liability is carried on the consolidated balance sheets at fair value. The Company recognized a gain of $735,494 and a loss of $317,380 from the change in fair value of the warrant liability for the three months ended March 31, 2011 and 2010, respectively.
  The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2011:
 
 Carrying Value at

March 31,


Fair Value Measurement at

March 31,20112011


Level 1


Level 2


Level 3Warrant liability (unaudited)

$
684,145


$
—


$
—


$
684,145
 
 In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company is required to record assets and liabilities at fair value on a non-recurring basis.  Generally, assets are recorded at fair value on a non-recurring basis as a result of impairment charges.  For the three months ended March 31, 2011, there were no impairment charges.
 
 Revenue recognition
 
 Revenue of the Company is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected on these consolidated financial statements as sales returns are de minimis based on historical experience.
 
 10
  There are two types of sales upon which revenue is recognized:
 
 a.
Credit sales: revenue is recognized when the products have been delivered to the customers.
 
 b.
Full payment before delivering: revenue is recognized when the products have been delivered to customers.
 
 Shipping and handling costs related to goods sold are included in selling expenses, which totaled $194,216 and $71,771 for the three months ended March 31, 2011 and 2010, respectively.
 
 The Company’s revenues and cost of revenues by product line were as follows:
 
 Three Months Ended

March 31,2011


2010RevenuesMicro-organism

$
1,596,094


$
1,206,578Veterinary Medications


4,865,047



3,196,259Feed Additives


326,407



236,040Vaccines


299,406



230,366Total Revenues

$
7,086,954


$
4,869,243Cost of RevenuesMicro-organism

$
494,182


$
343,018Veterinary Medications


2,821,906



1,822,258Feed Additives


140,866



100,046Vaccines


34,392



25,897Total Cost of Revenues


3,491,346



2,291,219Gross Profit

$
3,595,608


$
2,578,024
 
 Cash
 
 Cash includes cash on hand, demand deposits with banks and liquid investments with an original maturity of three months or less.
 
 Accounts receivable and other receivables
 
 Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, bad debt percentages determined by management based on historical experience, as well as current economic climate, are applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against allowance for doubtful accounts when identified.
 
 Inventories
 
 Inventories are stated at the lower of cost or market, as determined on a moving weighted-average basis. Inventories include purchases and related costs incurred in bringing the inventories to their present location and condition. Management reviews inventories for obsolescence and cost in excess of net realizable value at least annually and records a reserve against the inventory and additional cost of goods sold when the carrying value exceeds net realizable value.
  11
  Plant and equipment
 
 Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance and repairs which do not improve or extend the useful lives of the assets are charged to operations as incurred, while renewals and betterments are capitalized. Gains and losses on disposals are included in the results of operations. Estimated useful lives of the assets are as follows:
 
 Estimated Useful LifeBuildings

20-40 yearsMachinery and equipment

10 yearsComputer, office equipment and furniture

5 yearsVehicles

5-10 years
 
 Management assesses the carrying value of plant and equipment annually, more often when factors indicating impairment are present, and reduces the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management believes that, as of March 31, 2011 and December 31, 2010, there was no impairment for its plant and equipment.
 
 Construction-in-progress
 
 Construction-in-progress includes direct costs of construction of a factory building. Interest incurred during the period of construction, if significant, is capitalized. All other interest is expensed as incurred. Construction-in-progress is not depreciated until such time the assets are completed and put into service.
 
 Intangible assets
 
 Land Use Rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on a straight-line basis over its 50-year term.
 
 Technological Know-How — Purchased technological know-how includes confidential formulas, manufacturing processes, technical and procedural manuals, and is amortized using the straight-line method over the weighted average useful life of nine years, which reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.
 
 Impairment of Intangible Assets —The Company evaluates the carrying value of intangible assets annually, or more often when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of March 31, 2011, there was no impairment of its intangible assets.
 
 Comprehensive income
 
 Comprehensive income and loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income is comprised of the changes in foreign currency exchange rates.
 
 Research and development costs
 
 Research and development costs are charged to operations as incurred and include salaries, professional fees and technical support fees related to such efforts.
  12
  Advertising costs
 
 Advertising costs are charged to operations currently. Advertising costs for the three months ended March 31, 2011 and 2010 were $99 and $1,651, respectively.
 
 Income taxes
 
 The Company accounts for income taxes in accordance with the FASB’s accounting standard for income taxes.  Under the asset and liability method as required by this accounting standard,  deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized.
 
 Further, in accordance with this accounting standard, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. The adoption had no effect on the Company’s condensed consolidated financial statements.
 
 The Company’s operations are subject to income and transaction taxes in the United States and in the PRC jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.
 
 According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent.  The statute of limitations extends to five years under special circumstances. In the case of transfer pricing issues, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. Accordingly, the income tax returns of the Company’s PRC operating subsidiaries for the years ended December 31, 2006 through 2010 are open to examination by the PRC state and local tax authorities.
 
 The Company does not anticipate any events which could cause a change to these uncertainties.
 
 Stock-based compensation
 
 The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.
 
 Earnings per share
 
 The Company reports earnings per share and present both basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including convertible preferred shares, and stock options were converted or exercised. Further, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period, or retroactively if the stock dividends or stock splits occur after the end of the period but before the release of the financial statements, by considering it outstanding of the entirety of each period presented. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
 
 13
 
 Related parties
 
 Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of such principal owners and management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.
 
 Recently issued accounting pronouncements
  In January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair Value Measurements. This update provides amendments to Subtopic 820-10 that requires new disclosure to include transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements.  Further, this update clarifies existing disclosures on level of disaggregation and Disclosures about inputs and valuation techniques.  A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.    The adoption of this ASU did not have a material impact on its condensed consolidated financial statements.
  In April 2010, the FASB issued Accounting Standards Update 2010-13, “Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” or ASU 2010-13. ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The adoption of this ASU did not have a material impact on its condensed consolidated financial statements.
 
 In December 2010, the FASB issued Accounting Standards Update 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force). ASU No. 2010-28 addresses questions about entities that have reporting units with zero or negative carrying amounts. The amendments modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In addition, current GAAP will be improved by eliminating an entity’s ability to assert that a reporting unit is not required to perform Step 2 because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired. As a result, goodwill impairments may be reported sooner than under current practice. The provisions of ASC No. 2010-28 are effective for fiscal years, and interim periods within those years, beginning after Dec. 15, 2010. Early adoption is not permitted. The adoption of this ASU did not have a material impact on its condensed consolidated financial statements.
 
 14
  In December 2010, the FASB issued Accounting Standards Update 2010-29, Business Combinations (Topic 805) — Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU No. 2010-29 clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The amendments expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted.
  Note 3 - CONCENTRATIONS AND CREDIT RISK
 
 The Company’s operations are all carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
 
 For the three months ended March 31, 2011 and 2010, all of the Company’s sales occurred in the PRC. No major customers accounted for more than 10% of the Company’s total revenues. In addition, all accounts receivable at March 31, 2011 and December 31, 2010 also arose in the PRC.
 
 The Company’s six largest vendors accounted for approximately 73% and 60% of the Company’s total purchases, respectively, for the three months ended March 31, 2011 and 2010.
 
 The Company had one product that accounted for 15% of the Company’s total revenues for the three months ended March 31, 2011, while the Company had one product that accounted for 17% of the Company’s total revenues for the three months ended March 31, 2010.
 
 Note 4 - ACCOUNTS RECEIVABLE, NET
 
 Accounts receivable consisted of the following:
  March 31,

2011


December 31,

2010Account receivable

$
6,111,873


$
5,316,881Allowance for bad debts


(341,266
)


(339,031
)Account receivable, net

$
5,770,607


$
4,977,850
 
 The following table presents the movement of allowance for doubtful accounts:
 
 Allowance for bad debt, January 1, 2010

$
339,031Addition


—Recovery


—Translation adjustment


—Allowance for bad debt, December 31, 2010


339,031Addition


—Recovery


—Translation adjustment


2,235Allowance for bad debt, March 31, 2011 (unaudited)

$
341,266
  15
  Note 5 – INVENTORIES
 
 Inventories consist of the following:
  March 31,

2011


December 31,

2010Raw materials

$
12,117,157



5,466,902Packing materials


631,926



170,843Work-in-process


11,084



23,071Finished goods


1,523,067



1,721,943Other


23,848



25,723Total


14,307,082



7,408,482Less: Allowance for slow moving raw materials


(207,618)



(206,259
)Total

$
14,099,464



7,202,223
 
 The Company periodically reviews its reserves for slow-moving and obsolete inventories. As of March 31, 2011 and December 31, 2010, the Company recorded a slow-moving allowance for raw materials of $207,618, and $206,259, respectively.
 
 Note 6 - DEPOSITS AND PREPAID EXPENSES
 
 Deposits and prepaid expenses are comprised of the following:
 
 March 31,

2011


December 31,

2010Prepayment for raw materials purchasing

$
17,813,220


$
15,967,236Prepayment for packaging materials purchasing


638,687



767,623Other


179,657



339,141Total

$
18,631,564


$
17,074,000
 
 Note 7 - PLANT AND EQUIPMENT, NET
 
 Plant and equipment consist of the following:
 
 March 31,

2011


December 31,

2010Building and improvements

$
20,894,388


$
20,757,554Machinery and equipment


3,665,762



3,640,635Office equipment and furniture


279,193



256,690Vehicles


570,865



566,718Total


25,410,208



25,221,597Less: accumulated depreciation


(2,959,243
)


(2,608,484
)Plant and equipment, net

$
22,450,965


$
22,613,113
 
 Depreciation expense was $332,428 and $123,484 for the three months ended March 31, 2011 and 2010, respectively.
  16
  Note 8 - CONSTRUCTION-IN-PROGRESS
 
 Construction-in-progress (“CIP”) is related to a plant being built in accordance with the PRC’s Good Manufacturing Practices (“GMP”) Standard. Construction on this plant commenced in 2005. The veterinary medicine facility and the building that houses quality control, research and development and administration were completed during 2007.  Construction of the vaccine facility was completed in 2010.  The facility is currently waiting for the GMP certification from the Ministry of Agriculture.  The Company expects the GMP certification will be completed by the third quarter of 2011. During the three months ended March 31, 2011, the Company started a facility improvement project in the amount of $305,400 (RMB 2,000,000) for the Animal Laboratory.  The Company also started two projects in the vaccine facility to modify the air filtration, water treatment and other facility changes based on recommendations by the outside experts hired by the Company to advise on the GMP qualification process for the vaccine facility.  Total CIP balance increased by about $1 million compared to the ending balance at December 31, 2010 as results of the above projects.  During the three months ended March 31, 2011, no amount was transferred from CIP to property, plant and equipment.  During the three months ended March 31, 2010, some general facility improvements were completed and placed in service resulting in a transfer from CIP to property, plant and equipment of $72,249. No depreciation is provided for construction-in-progress until such time the assets are completed and placed into service.
 
 The construction projects the Company is in the progress of completing are:
 
 Project

Total in CIPas of

March 31, 2011


Estimate cost

toComplete


Estimated
Total Cost

EstimatedCompletion DateVaccine facility

$
2,258,131



-


$
2,258,131

July 2011Kunshan facility


97,349



-



97,349

December 2011Animal Laboratory


305,400



-



305,400

June 2011TOTAL CIP Balance

$
2,660,880






$
2,660,880
 As of March 31, 2011 and December 31, 2010, the Company had construction in progress amounting to $2,660,880 and $1,590,720, respectively. No interest expense had been capitalized for construction in progress for the three months ended March 31, 2011 and 2010, respectively.
 
 Note 9 - LONG-TERM PREPAYMENTS
 
 Long-term prepayments consist of the following:
 
 March 31,

2011


December 31,

2010R&D project

$
305,400


$
303,400Construction deposit


458,100



455,100Deposit for building and equipment purchase


730,294



695,726Deposit for potential acquisitions


4,838,035



4,806,352Total

$
6,331,829


$
6,260,578
 
 As of March 31, 2011, deposits for building and equipment purchase of $730,294 represented deposits made for equipments.
 
 As of March 31, 2011 and December 31, 2010, deposits for potential acquisitions of $4,838,035 and $4,806,352, respectively, represented deposits made to potential acquisition targets.
 
 17
  Note 10 – INTANGIBLE ASSETS
 
 Intangible assets consisted of the following:
  March 31,

2011


December 31,

2010Land use rights

$
4,719,351


$
4,650,521Technological know-how


2,137,800



2,123,800Patent


305,400



303,400Total


7,162,551



7,077,721Less: accumulated amortization


(1,272,305
)


(1,033,780
)Intangible assets, net

$
5,890,246


$
6,043,941
 
 In 2009, the Company paid $1,172,880 (RMB 8,000,000) for fish disease vaccine technology transfer for an eleven-year term from September 2009 through September 2020.
 
 For the three months ended March 31, 2011 and 2010, the amortization expense for intangibles amounted to $230,922 and $91,370, respectively.
 
 Amortization expense for the future five years and thereafter is as follows:
 
 Years ending December 31,

Amount2011

$
383,7782012


403,3032013


403,3032014


403,3032015


330,654Thereafter


3,965,905Total

$
5,890,246
 
 Note 11 – SHORT-TERM LOANS
 
 On August 24, 2010, the Company obtained a one year loan with Shaanxi Agricultural Yanta Credit Union for $763,500 (RMB 5,000,000) at an annual interest rate of 8.66%. This loan was secured by the Company’s office buildings located in Xi’an City.
 
 The Company entered into a line of credit agreement with Bank of East-Asia that allows the Company to borrow up to $3,000,000 (RMB 20,000,000). This line of credit agreement expires within two years starting with the first withdrawal. The Company withdrew $471,843 (RMB 3,090,000), $518,264 (RMB 3,394,000) and $1,292,224 (RMB 8,462,500) on September 7, 2010, September 9, 2010 and October 12, 2010, respectively, at an annual interest rate of 6.372% with interest due every three months starting on the date of the first withdrawal. This line of credit is secured by the Company’s land use right and manufacturing plant located in Huxian County.
 
 Interest expense incurred and associated with the short-term loans amounted to $54,409 for the three months ended March 31, 2011, none of which has been capitalized as part of construction-in-progress in 2011. Interest expense incurred and associated with the short-term loans amounted to $5,210 for the three months ended March 31, 2010, none of which has been capitalized as part of construction-in-progress in 2010.
  18
  Note 12 - DEFERRED GOVERNMENT GRANT
 
 Deferred government grant represents subsidies for Good Manufacturing Practice projects granted by various levels of the PRC government. To date, the Company received government subsidies totaling $992,550 (RMB 6,500,000) of which, RMB 5,000,000 were granted by the PRC Government, of which, RMB 1,000,000 was re-paid on December 7, 2010, with the remaining fund to be paid back in 2012. RMB 2,000,000 was granted by Shaanxi Provincial Government, and RMB 500,000 was granted by Xi’an Municipal Government. The Shaanxi Provincial Government grant and Xi’an Municipal Government Grant do not need to be repaid.
 
 Note 13 - CAPITAL TRANSACTIONS
  Stock-based compensation
 
 On March 30, 2010, the Company agreed to issue 2,500 shares of common stock to a non-executive director in exchange for services unrelated to directorship at the fair market value of $11.74 per share based on the closing price of March 30, 2010. On April 16, 2010, the Company entered into another agreement to grant 10,000 shares of common stock to that director for his one-year service from April 1, 2010. The closing price per share on the grant date was $10.61. The common stock compensation vests in four equal quarterly installments of 2,500 shares. Shares owed were accrued at end of each quarter at the fair market value of the grant date at $10.61 per share. A total of $26,525 and $27,000 was charged to general and administrative expense for the three months ended on March 31, 2011 and 2010 respectively. On October 25, 2010, 5,000 shares were issued to the director for the shares vested in the first two quarters of 2010. As of March 31, 2011, 7,500 shares were accrued at the closing price of the grant date of $10.61 per share and pending to be issued.
 
 On May 26, 2009, the Company renewed the one-year service agreement with the former CFO and agreed to issue 14,440 shares of common stock, which would vest in four equal installments of 3,610 shares every quarter starting August 5, 2009. Compensation expense is recognized on the straight-line method over the vesting period. On February 26, 2010, 10,830 shares were issued at the fair market value of $8.57. Effective April 16, 2010, the former CFO resigned from his position and the last installment of 3,610 shares was prorated to 2,880 shares. The Company issued the 2,880 common shares to the former CFO on October 25, 2010 at the fair market value of $7.81 per share. Total compensation expense of $0 and $16,245 were charged to general and administrative
 expenses for the three months ended March 31, 2011 and 2010, respectively.
 
 On May 26, 2009, the Company agreed to issue 5,556 shares of common stock to a director at the beginning of each term of his directorship. The trading value of the common stock on May 26, 2009 was $4.50 per share. The amount was charged to general and administrative expenses in 2009 and $0 and $16,245 were expensed for the three months ended March 31, 2011 and 2010, respectively. The Company issued 5,556 shares on February 26, 2010. In accordance with the agreement between the Company and this director, this director must continue to serve as a member of the Board until his successor is duly elected and qualified in order to receive the shares. This director has continued in his position and the Company is in the process of finalizing its agreement with this director and expects to complete this process shortly.
 
 Warrants and Purchase Options
 
 On February 28, 2007, the Company issued 195,000 warrants to four investors with an exercisable price of $6.00 per share for a term of three years.  On the same date, the Company also issued warrants to the private placement agent, exercisable for 114,100 shares of the Company’s common stock at a price of $5.00 per share for a five-year term. For the three months ended March 31, 2011, no warrants were exercised. For the three months ended March 31, 2010, 202,050 shares of warrants were exercised.
 
 In connection with the 2009 equity offering discussed below, the Company granted 140,000 common stock purchase options to five designees of the Underwriters with a vesting date of June 30, 2010. The options are exercisable from June 30, 2010 to June 30, 2014, and each option is exercisable for one share of the Company’s common stock at an exercise price at $8.11 per share. All options were provided for services performed. On June 30, 2010, the purchase options were reclassified from equity to warrant liabilities, and the Company reclassified $779,674 from additional paid in capital to derivative liability.
  19
  The fair value of each warrant and purchase option is estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Company’s stock, and reflect the assumption that the historical volatilities are indicative of future trends, which may not necessarily be the actual outcome. Expected term of each warrant and purchase option award represents the period of time that options granted are expected to be outstanding and is estimated based on the historical exercise behavior of separate groups of employees or officers. The risk-free rate reflects the interest rate for United States Treasury Notes with similar time-to-maturity to that of the options.
  March 31, 2011


March 31, 2010Expected term (year)


0.92 – 3.25



1.66- 4.25Expected volatility


53% - 147
%


34% - 178
%Weighted average volatility


53% - 147
%


34% - 178
%Expected dividend yield


0
%


0
%Risk-free rate


0.3% - 1.30
%


.04% - 1.14
%
 
 Following is an activity summary of the Company’s outstanding warrants and purchase options:
 
 Number of warrants/purchase options


Weighted –

average

exercise price


Weighted-

average

remaining

contractual term

(Year)Outstanding at January 1, 2010


392,254


$
5.57Granted


-


$Forfeited


-Exercised


(218,024
)


5.72Outstanding at December 31, 2010


174,230


$
7.50Granted


-



-Forfeited


-



-Exercised


-


$Outstanding at March 31, 2011


174,230


$
7.50



2.79Vested and expected to vest at March 31, 2011


174,230


$
7.50



2.79Exercisable at March 31, 2011


174,230


$
7.50



2.79
 
 Equity Compensation Plan
 
 On December 8, 2009, the Company’s board of directors approved a stock incentive plan for officers, directors, employees and consultants entitled the “Skystar Bio-Pharmaceutical Company 2010 Stock Incentive Plan” (the “2010 Plan”). The maximum number of shares that may be issued under the 2010 Plan is 700,000 shares of common stock. The 2010 Plan was approved by the Company’s stockholders on December 31, 2009, and awards may be granted thereunder until December 7, 2019. As of March 31, 2011, there are 690,000 shares of the Company’s common stock remaining available for future issuance under the Plan.
 
 Note 14 - STATUTORY RESERVES
 
 Statutory reserves represent restricted retained earnings. Based on the legal formation of the entities, all PRC entities are required to set aside 10% of its net income as reported in its statutory accounts on an annual basis to the statutory surplus reserve fund. Once the total statutory surplus reserve reaches 50% of the entity’s registered capital, further appropriations are discretionary. The statutory surplus reserve can be used to increase the entity’s registered capital (upon approval by relevant government authorities) and eliminate its future losses under PRC GAAP (upon a resolution by the board of directors). The statutory surplus reserve is not distributable to shareholders except in the event of liquidation. As of March 31, 2011, apart from Xian Tianxing met the statutory surplus reserve requirement, and approximately $10,418,518 still needs to be transferred to the respective statutory surplus reserve of other PRC subsidiaries.
 
 20
  Appropriations to the above statutory reserves are accounted for as a transfer from unrestricted earnings to statutory reserves. There are no legal requirements in the PRC to fund these statutory reserves by the transfer of cash to any restricted accounts, and as such, the Company has not transferred any cash to these accounts. These reserves are not distributable as cash dividends.
 
 Note 15 – TAXES
 
 Skystar is subject to United States federal income tax provisions. Skystar Cayman is a tax-exempt company incorporated in the Cayman Islands and conducts all of its business through its subsidiaries, Fortune Time, Sida, Fortune Time’s subsidiary Skystar Kunshan, Sida’s subsidiary Skystar Jingzhou, and Sida’s PRC VIEs, Xi’an Tianxing, Shanghai Siqiang and Sikeda.
 
 Sida, Skystar Jingzhou, Skystar Kunshan, Xi’an Tianxing, and Shanghai Siqiang are subject to the PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25%. Xi’an Tianxing has been approved as a new technology enterprise, and under PRC Income Tax Laws is entitled to a preferential tax rate of 15%.
 
 The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months ended March 31, 2011 and 2010:
 
 For the three months endedMarch 31,

2011


March 31,

2010U.S. Statutory rate


34.0
%


34.0
%Foreign income not recognized in the U.S.


(34.0
)


(34.0
)China income tax rate


25.0



25.0China income tax exemption


(10.0
)


(10.0
)Other item (1)


4.8



7.9Total provision for income taxes


19.8
%


22.9
%
 
 (1)
The other item is operating expenses incurred by Skystar that are not deductible in the PRC which resulted in an increase in effective tax rate of 4.8% and 7.9% for the three months ended March 31, 2011 and 2010, respectively.
 
 Taxes payable consisted of the following:
  March 31,

2011


December 31,

2010Income taxes payable

$
839,936


$
432,722Value added tax


1,369,358



203,684Other taxes


117,255



113,430Total

$
2,326,549


$
749,836
 
 The estimated tax savings due to the reduced tax rate for the three months ended March 31, 2011 and 2010 amounted to $151,049 and $216,880, respectively. If the statutory income tax had been applied, the Company would have decreased basic earnings per share and diluted per shares from $0.27 to $0.25 for the three months ended March 31, 2011. For the three months ended March 31 2010, the Company would have decreased basic earnings per share from $0.16 to $0.12 and diluted per shares from $0.15 to $0.12, if the statutory income tax had been applied.
  21
  Skystar is incorporated in the U.S. and has incurred a net operating loss for income tax purposes for the three months ended March 31, 2011. As of March 31, 2011, the estimated net operating loss carryforwards for U.S. income tax purposes amounted to $5,336,575 which may be available to reduce future years’ taxable income. These carryforwards will expire, if not utilized, beginning in 2026 and continue through 2010. Management believes that the realization of the benefits arising from this loss appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at March 31, 2011 and December 31, 2010. The valuation allowance at March 31, 2011 and December 31, 2010 was $1,814,436 and $1,781,954, respectively. The Company’s management reviews this valuation allowance periodically and makes adjustments as necessary.
 
 The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $42 million as of March 31, 2011, which are included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations.  Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.
 
 Note 16 - EARNINGS PER SHARE
 
 The following is the calculation of earnings per share:
  For the three months ended

March 31,2011


2010Net income

$
1,931,832


$
1,096,247Weighted average shares used in basic computation


7,166,919



7,061,530Diluted effect of stock warrants


12,390



78,610Weighted average shares used in diluted computation


7,179,309



7,140,140Earnings per share:Basic

$
0.27


$
0.16Diluted

$
0.27


$
0.15
 
 For the three months ended March 31, 2011, the average stock price was greater than the exercise prices of warrants which resulted in additional weighted-average common stock equivalents of 12,390. For the three months ended March 31, 2010, the average stock price was greater than the exercise prices of warrants which resulted in additional weighted-average common stock equivalents of 51,699.
 
 For the three months ended March 31, 2011, the outstanding 140,000 options were excluded from the diluted earnings per share calculation as they are anti-dilutive as the average stock price was less than the exercise prices of the options. For the three months ended March 31, 2010, the average stock price was greater than the exercise prices of 140,000 outstanding options which resulted in additional weighted-average common stock equivalents of 26,911.
 22





Note 17 - RELATED PARTY TRANSACTIONS AND ARRANGEMENTS





Amounts payable to related parties are summarized as follows:





March 31,

2011


December 31,

2010Shares to be issued to related partyScott Cramer – non-executive director (1)

$
79,575


$
53,050Amounts due to related partiesScott Cramer – non-executive director and shareholder


191,404



170,937Officer and shareholder (2)


89,796



46,975Total

$
281,200


$
217,912








(1) As of  March 31, 2011 and December 31, 2010, the Company had $79,575 (representing 7,500 common shares) and $53,050 (representing 5,000 common shares), respectively, under agreement to issue shares to Scott Cramer, as compensation for being a representative of the Company in the United States for the periods from April 1, 2010 to March 31, 2011.





(2)As of March 31, 2011, the amount due to officer and shareholder includes accrued rent to Mr. Weibing Lu for the leased office space for the Company’s sales office in Xi’an and the Company’s Siqiang subsidiary in Shanghai.





Note 18 - COMMITMENTS AND CONTINGENCIES





(a) Lease commitments





The Company recognizes lease expense on a straight-line basis over the term of the lease in accordance to the FASB’s accounting standard of accounting for leases. The Company entered into a tenancy agreement for the lease of factory premises for a period of ten years from October 1, 2004 to December 31, 2014. The annual rent for the factory premises has been adjusted to about $17,713 (RMB 116,000) and subject to a 10% increase every two years starting October 1, 2009.





The Company leases office space from Weibing Lu, the Company’s chief executive officer, for a period of five years from January 1, 2007 to December 31, 2011, with annual rent of approximately $25,281 (or RMB 165,600). The Company also entered into a tenancy agreement with Weibing Lu for the lease of Shanghai Siqiang’s office for a period of ten years from August 1, 2007 to August 1, 2017, with annual rent of approximately $21,989 (or RMB 144,000).





The Company entered into a tenancy agreement for the lease of an office space in California for a period of three years from July 1, 2009 to July 1, 2012 with monthly rent of $1,100. The Company dissolved the California entity in December 2010. There are no future lease liabilities related to this office.





The Company entered into a one-year tenancy agreement for leasing Tianxing’s sales office space in Tianjin from April 21, 2010 to April 20, 2011 with annual rent of approximately $3,600 (RMB 24,000).




23





The minimum future lease payments for the next five years and thereafter are as follows:





Period

AmountNine months ending December 31, 2011

$
48,979Year ending December 31, 2012


39,702Year ending December 31, 2013


39,702Year ending December 31, 2014


35,274Year ending December 31, 2015


21,989Year ending December 31, 2016 and thereafter


34,815Total

$
220,461





Rental expense for the three months ended March 31, 2011 and 2010 amounted to $14,396 and $6,768, respectively.





(b)Legal proceedings





From time to time, the Companyis involved in legal matters arising in the ordinary course of business. Management currentlyis not aware of any legal matters or pending litigation which would have a significant effect on the Company’s consolidated financial statements as of March 31, 2011.





In May 2007, Andrew Chien filed suit against the Company, Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in United States District Court for the District of Connecticut, alleging causes of action for violation of Sections 10(b) and 20(a) of the Exchange Act. On July 17, 2008, in a decision that is now published, the Court granted defendants’ motion to dismiss and subsequently dismissed the lawsuit, entering judgment on behalf of the defendants. Mr. Chien filed a notice of appeal of the Court’s dismissal of his lawsuit, opposed by the defendants, which remains pending. Additionally, on February 5, 2009, the Court issued a ruling on defendants’ motion for sanctions, finding the action filed by Mr. Chien to have been entirely frivolous, and to have constituted a “substantial” violation of Federal Rule of Civil Procedure Rule 11, and imposed significant monetary sanctions on both Mr. Chien and his former attorney. As part of the basis for imposing sanctions on Mr. Chien personally, the Court specifically found that Mr. Chien had knowledge of facts directly contradicting the allegations of his complaint, as evident in internet postings he made on online message boards. Mr. Chien subsequently filed motions seeking to “re-open” this case, and to recuse the judge, but both motions were denied. A Notice of Appeal concerning the ruling awarding sanctions against him was also filed by Mr. Chien.  All appeals, including the one referenced below concerning Mr. Chien’s second lawsuit, were subsequently consolidated and remain pending, although briefing has been completed.





Subsequently, Mr. Chien, proceeding pro se (i.e., he represented himself without an attorney), filed another lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court, alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action. The case was removed to the U.S. District Court, District of Connecticut, and assigned to the same Judge who dismissed Mr. Chien’s related federal action. On June 8, 2009, the Court granted defendants’ motion to dismiss this action in its entirety, and denied Mr. Chien’s motion to further amend his complaint. Mr. Chien filed a Notice of Appeal concerning the ruling dismissing this lawsuit, which has been consolidated with Mr. Chien’s appeal of his other lawsuit.  On May 26, 2010, the court of appeals for the Second Circuit upheld Judge Kravtiz’s ruling against Mr. Chien.





Subsequently, The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing moderate sanctions against Chien in light of the circumstances and facts on record.  This Mandate was entered on November 8, 2010. On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. Appeals to the U.S. Supreme Court far exceed the number of cases it actually hears. As of this date we have not received notice of further action by the Supreme Court.





Other than the above described legal proceedings, the Company is not aware of any other legal matters in which purchasers, any director, officer, or any owner of record or beneficial owner of more than five percent of any class of voting securities of the Company, or any affiliate of purchaser, or of any such director, officer, affiliate of the Company, or security holder, is a party adverse to the Company or has a material adverse interest to the Company. No provision has been made in the consolidated financial statements for the above contingencies.




24





(c)Ownership of leasehold property





In 2005, a shareholder contributed a leasehold office building as additional capital of Xian Tianxing. However, the title of the leasehold property has not passed to the Company. The Company does not believe there are any legal barriers for the shareholder to transfer the ownership to the Company. However, in the event that the Company fails to obtain the ownership certificate for the leasehold property, there is a risk that the building will need to be vacated due to unofficial ownership. Management believes that this possibility is remote, and as such, no provision has been made in the consolidated financial statements for this potential occurrence.





(d) R&D Project





During the first quarter of 2008, Xian Tianxing contracted with Northwestern Agricultural Technology University to jointly work on an R&D project concerning the application of nano-technology in the prevention of major milk cow disease. The total projected budget for this project is approximately $610,800 (RMB 4 million), which is to be paid according to the completed stages of the project. The project’s completion date has been delayed.  The Company now expects this project to be completed in 2011. As of March 31, 2011 and 2010, the Company incurred no expenses relating to this project. The project reached trial stage in June 2009, and the Company expects to obtain veterinary permit for the new product from government on 2010.





During the year ended December 31, 2009, Xian Tianxing contracted with the Fourth Military Medical University to jointly work on a R&D project with a contracted amount of approximated $916,200 (RMB 6,000,000).  As of March 31, 2011 and 2010, the Company incurred approximately $0 and $43,995 (RMB 300,000) expenses, respectively, relating to this project.





During the first quarter of 2011, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on a R&D project to develop new treatment and diagnosis method for Mycoplasmal pneumona of swine.  The Project term is from January 2011 thru June 2013.  The cost to the Company for the initial phase is approximately $305,400 (RMB 2,000,000), of which $76,090 (RMB 500,000) has been paid in the first quarter of 2011.




25





ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.





Overview





We were incorporated in Nevada on September 24, 1998.  We are a holding company that, through our wholly owned subsidiaries in China, including Skystar Bio Technology (Jingzhou) Co. (“Skystar Jingzhou”), and variable interest entity (“VIE”), Xi’an Tianxing Bio-Pharmaceutical Co., Ltd. (“Xi’an Tianxing”), researches, develops, manufactures, and distributes veterinary health care and medical care products in the People’s Republic of China (“PRC”).





All of our operations are carried out by our subsidiaries in China and Xi’an Tianxing, which the Company controls through contractual arrangements between Xi’an Tianxing and Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), the wholly owned subsidiary of Fortunate Time International Limited, the wholly owned subsidiary of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), which became our wholly owned subsidiary in 2005.





Such contractual arrangements are necessary to comply with PRC laws limiting foreign ownership of certain companies.  Through these contractual arrangements, we have the ability to substantially influence Xi’an Tianxing’s daily operations and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval.  As a result of these contractual arrangements, which enable us to control Xi’an Tianxing, we are considered the primary beneficiary of Xi’an Tianxing.





On August 21, 2007, Xi’an Tianxing invested $68,550 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Company Limited (‘Shanghai Siqiang’).  Xi’an Tianxing is the 100% shareholder.  Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipments.





In addition to Xi’an Tianxing, Skystar Jingzhou also manufactures and distributes veterinary medicines including aquaculture medicines in China.  Skystar Jingzhou is a wholly owned subsidiary of the Company’s Sida entity.  It was formed with the August 2010 acquisition of a veterinary medicine manufacturing facility in Hubei Province, China.





Our financial statements are prepared in U.S. dollars and in accordance with accounting principles generally accepted in the United States of America. See “Exchange Rates” below for information concerning the exchanges rates at which Renminbi were translated into U.S. dollars at various pertinent dates and for pertinent periods.





Critical Accounting Policies and Estimates





In preparing the consolidated financial statements in accordance with U.S. GAAP, we make estimates and assumptions about the effect of matters that are inherently uncertain and may change in subsequent periods.  The resulting accounting estimates will, by definition, vary from the related actual results.  We consider the following to be the most critical accounting policies:





Principles of consolidation





The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of the Company, its wholly owned subsidiaries, and its VIEs.  All significant inter-company transactions and balances between the Company, its subsidiaries, and its VIEs have been eliminated in consolidation.





Revenue recognition





Revenue of the Company is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected on these consolidated financial statements as sales returns are de minimal based on historical experience.




26





There are two types of sales upon which revenue is recognized:





a.
Credit sales: revenue is recognized when the products have been delivered to the customers.





b.
Full payment before delivering: revenue is recognized when the products have been delivered to the customers.





Accounts receivable and other receivables





Accounts receivable are recorded at net realizable value consisting of the carrying amount less an allowance for uncollectible accounts, as needed. The Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, bad debt percentages determined by management, based on historical experience and current economic climate, are applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against allowance for doubtful accounts when identified.





Intangible assets





Land Use Rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on a straight-line basis over the term granted by the government.





Technological Know-How — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over the weighted average useful life of nine years, which reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.





Impairment of Intangible Assets —The Company evaluates the carrying value of intangible assets annually or more often when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of March 31, 2011, there was no impairment of its intangible assets.





Earnings per share





The Company reports earnings per share and present both basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including convertible preferred shares, warrants and stock options were converted or exercised. Further, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period, or retroactively if the stock dividends or stock splits occur after the end of the period but before the release of the financial statements, by considering it outstanding of the entirety of each period presented. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.





27





Recent Issued Accounting Pronouncements





In January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair Value Measurements. This update provides amendments to Subtopic 820-10 that requires new disclosure to include transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements.  Further, this update clarifies existing disclosures on level of disaggregation and Disclosures about inputs and valuation techniques.  A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.    The adoption of this ASU did not have a material impact on its consolidated financial statements.





In April 2010, the FASB issued Accounting Standards Update 2010-13, “Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” or ASU 2010-13. ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The adoption of this ASU did not have a material impact on its consolidated financial statements.





In December 2010, the FASB issued Accounting Standards Update 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force). ASU No. 2010-28 addresses questions about entities that have reporting units with zero or negative carrying amounts. The amendments modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In addition, current GAAP will be improved by eliminating an entity’s ability to assert that a reporting unit is not required to perform Step 2 because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired. As a result, goodwill impairments may be reported sooner than under current practice. The provisions of ASC No. 2010-28 are effective for fiscal years, and interim periods within those years, beginning after Dec. 15, 2010. Early adoption is not permitted. The adoption of this ASU did not have a material impact on its consolidated financial statements.





In December 2010, the FASB issued Accounting Standards Update 2010-29, Business Combinations (Topic 805) — Disclosure of Supplementary Pro Forma Information for Business Combinations. ASU No. 2010-29 clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The amendments expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010 with early adoption permitted.





28





Results of Operations – Three Months ended March 31, 2011 and 2010





The following table summarizes our results of operations for the three months ended March 31, 2011 and 2010.





Three Months Ended March 31,2011


2010Amount


% of

total revenue


Amount


% of

total revenueRevenue

$
7,086,954



100.0
%

$
4,869,243



100.0
%Gross Profit

$
3,595,608



50.7
%

$
2,578,024



52.9
%Operating Expenses

$
1,951,674



27.5
%

$
834,679



17.1
%Income from Operations

$
1,643,934



23.2
%

$
1,743,345



35.8
%Other Income

$
765,348



10.8
%

$
(321,779)



6.6
%Income Tax Expenses

$
477,450



6.7
%

$
325,319



6.7
%Net Income

$
1,931,832



27.3
%

$
1,096,247



22.5
%





Revenue.   All of our revenue is derived from the sale of veterinary healthcare and medical care products in the PRC. For the three months ended March 31, 2011, we had revenue of $7,086,954 as compared to revenue of $4,869,243 for the three months ended March 31, 2010, an increase of approximately 46%. We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines.  Selling price has not changed from the same period last year for most of our past customers.





Revenue—Veterinary Medications.   Revenue from sales of our veterinary medications increased by $1,668,788 or 52% from $3,196,259 for the three months ended March 31, 2010 to $4,865,047 for the three months ended March 31, 2011.  The increase was primarily due to improved utilization of our Huxian plant capacity and improved product mix that met market demands. Of total revenues from veterinary medications during the three months ended March 31, 2011, approximately 1,058,132 or 15% resulted from the sale of Praziquantel tablets which treats schistosomiasis.





Revenue — Micro-Organism.   Revenue from sales of our micro-organism products increased by $389,516 or 32% from $1,206,578 for the three months ended March 31, 2010 to $1,596,094 during the three months ended March 31, 2011. The increase was the result of increased utilization of the micro-organism production capacity completed at our Huxian plant, which commenced production in June 2010. We expect the micro-organism line to contribute more to our revenue mix as we continue to ramp up production in the coming months.





Revenue — Feed Additives.   Revenue from sales of our feed additives product line increased by $90,367 or 38% from $236,040 for the three months ended March 31, 2010 to $326,407 for the three months ended March 31, 2011. The increase was the result of increased sales efforts of our multi-enzyme feed additive products during the three months ended March 31, 2011.





Revenue — Vaccines.  Revenue from sales of our vaccines increased by $69,040 or 30% from $230,366 for the three months ended March 31, 2010 to $299,406 for the three months ended March 31, 2011. This increase was the result of increased demands for our vaccine products and added production shifts during the three months ended March 31, 2011. We are presently operating at full production capacity for our vaccine product line and therefore cannot significantly increase sales until we expand our production capabilities. The construction of the vaccine facility was completed in June 2010. We submitted an application for Good Manufacturing Practices (GMP) certification to the Ministry of Agriculture, and, as of the date of this report, we are waiting for a response from the Ministry. We expect the new vaccine facility to receive GMP certification by the end of the year or early next year to commence production shortly thereafter.




29





Cost of Sales.   Cost of revenue, which consists of raw materials, direct labor, and manufacturing overhead for our four product lines, was $3,491,346 for the three months ended March 31, 2011, as compared to $2,291,219 for the three months ended March 31, 2010, an increase of approximately 52%, as a result of increased sales and higher raw materials costs.  Cost of packaging materials also increased, but to a lesser degree compared to raw materials costs.  Labor cost also increased compared to same period last year.  However, labor accounted for a very small percentage in our total product cost.  The impact to our gross margins mainly comes from the higher raw materials cost.





Cost of Sales — Veterinary Medications.   Cost of revenue for our veterinary medications increased by $999,648 or approximately 55% from $1,822,258 for the three months ended March 31, 2010 to $2,821,906 for the three months ended March 31, 2011. This increase was mainly due to the corresponding increase in veterinary medication sales and higher raw materials costs. Cost increased more in percentage terms compared to the increase in sales mainly due to increased raw materials cost.





Cost of Sales — Micro-Organism.   Cost of revenue for our micro-organism products increased by $151,164 or 44%, from $343,018 for the three months ended March 31, 2010 to $494,182 for the three months ended March 31, 2011. This increase was mainly due to increased sales and higher raw materials costs.





Cost of Sales — Feed Additives.   Cost of revenue for our feed additives increased by $40,820 or 41% from $100,046 for the three months ended March 31, 2010 to $140,866 for the three months ended March 31, 2011. The increase was primarily due to increased sales and higher raw material costs.





Cost of Sales — Vaccines.   Cost of revenue for our vaccines products increased by $8,495 or 33% from $25,897 for the three months ended March 31, 2010 to $34,392 for the three months ended March 31, 2011. This increase was a result of increased sales and production.





Operating Expenses


Three Months Ended March 31,2011


2010Amount


% oftotal revenue


Amount


% oftotal revenueOperating ExpensesSelling Expenses

$
369,404



5.2
%

$
171,134



3.5
%General and Administrative Expenses

$
1,294,798



18.2
%

$
619,550



12.7
%Research and Development Costs

$
287,472



4.1
%

$
43,995



0.9
%Total Operating Expenses

$
1,951,674



27.5
%

$
834,679



17.1
%





Selling Expenses.  Selling expenses, which consist of commissions, advertising and promotion expenses, freight charges, and salaries, totaled $369,404 for the three months ended March 31, 2011 as compared to $171,134 for the three months ended March 31, 2010, an increase of approximately 115.9%. This increase is a result of increased sales between the two periods and an increase in our sales staff.





General and Administrative Expenses.  General and administrative expenses totaled $1,294,798 for the three months ended March 31, 2011, as compared to $619,550 for the three months ended March 31, 2010, an increase of approximately 109%. The increase was mainly due to higher salary costs in the Company’s corporate administration staff in the Company’s China subsidiaries, and higher depreciation expenses related to part of the vaccine facility that had been transferred out of CIP to fixed asset at the end of 2010.  The general and administration expenses in the Company’s US entity also increased due to higher professional service fees.  The increased operational scale of our Chinese operating entities also contributed to higher G&A expenses.





30





Research and Development Costs.  Research and development costs, which consist of salaries, professional fees, and technical support fees, totaled $287,472 for the three months ended March 31, 2011, as compared to $43,995 for the three months ended March 31, 2010, an increase of approximately 553.4%.   The high percentage increase was due to an unusually low base in the first quarter of 2010, when there were no significant expenditures for research and development during that period of time.





Liquidity





For the three months ended March 31, 2011, cash used in operating activities was $6,288,315 compared to cash provided by operations of $1,908,957 for the same period in 2010.  The major operating activities that provided cash during the quarter ended March 31, 2011 were net income of $1,931,832 and an increase in taxes payable of $1,566,418 mainly due to the timing difference in the payment schedule for VAT tax and income taxes to the Chinese tax authority.  The major operating activities that used cash during the quarter ended March 31, 2011 were a build-up in inventory that used $6,826,437, an increase in deposit and prepaid expenses related to prepaid construction projects and inventories that used $1,440,749, an increase in other receivables of $1,162,594 mainly related to customer collections that were held by the logistics and pending deposit to our bank account at the quarter end, and an increase in accounts receivable of $757,356. Based on the Company’s research and feedback from the market, the Company believes the current inflationary pressure will continue to build in 2011 and cost of raw materials will continue to escalate.  The Company has accumulated more inventory than in the past to ensure the supply of raw materials at lower cost levels and to protect the Company’s historical profit margins.  As a result, the negative impact to the gross margins from the cost increases of raw materials has been relatively small in the quarter ended March 31, 2011.  However, if the government is unsuccessful in reining in inflation, there may be greater negative impact to our gross margins from cost increases of raw materials in the future.As of March 31, 2011, we had approximately 38 suppliers that we made advances to in order to secure our raw material needs and to obtain favorable pricing.  We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.





Cash provided by investing activities for the three months ended March 31, 2011 was $6,462,736, as compared to using $7,355,381 in investing activities for the three months ended March 31, 2010. Cash provided by investing activities for the three months ended March 31, 2011 was mainly the result of the collection of short term loans we made in December 2010 to two of our suppliers totaling $7,609,000.  Among the investing activities that used cash is the payment of construction in progress of $634,222.





Cash used in financing activities was $298,244 for the three months ended March 31, 2010 as compared to cash generated in financing activities of $1,319,841 for the three months ended March 31, 2011. Cash generated by financing activities for the three months ended March 31, 2011 was primarily the result of short-term loans the Company took out from a local bank in China.





As of March 31, 2011, we had cash of $7,403,389. Our total current assets were $49,098,741, and our total current liabilities were $10,868,712, which resulted in a net working capital of $38,230,029.





Capital Resources





During the three months ended March 31, 2011, we made additional payments of $453,266 related to the acquisition of the Kunshan facility. We also took out $$1,261,302 in short-term loans. We have sufficient capital to support our ongoing operations.





Payments Due by PeriodContractual Obligations

Total


Less than

1 year


1 – 3 years


3 – 5 years


More than

5 yearsR&D Project Obligation

$
914,384


$
914,384


$
-


$
-


$
-Operating Lease Obligations


220,461



48,979



114,678



43,978



12,826Total

$
1,134,845


$
963,363



114,678



43,978



12,826





In addition to the contractual obligations listed above, we have a future registered capital commitment related to our newly created subsidiary Skystar Kunshan, located in Kunshan, Jiangsu province, China. The Skystar Kunshan subsidiary has a registered capital of $15,000,000, of which we invested $2,250,000 in cash. The remaining $12,750,000 of capital must be invested prior to May 7, 2012. We have also been making prepayments in an effort to acquire assets in a micro-organism manufacturing facility in Kunshan. Upon completion of such an acquisition, the assets purchased will be transferred to Skystar Kunshan to satisfy some of our registered capital commitment. If such an acquisition does not close, we may request a reduction or cancellation of the registered capital requirement. As of the date of this report, we have not completed the acquisition.




31





Off-Balance Sheet Arrangements





We do not have any outstanding financial guarantees or commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity, or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.





Exchange Rate





The Company’s operating subsidiaries in China maintain their books and records in Renminbi (“RMB”), the currency of China. In general, for consolidation purposes, we translate the subsidiaries’ assets and liabilities into US Dollars using the applicable exchange rates prevailing at the balance sheet date, and the statement of income is translated at average exchange rates during the reporting period. Adjustments resulting from the translation of the financial statements of the Company’s Chinese subsidiaries are recorded as accumulated other comprehensive income.





The exchange rates used to translate amounts in RMB into US Dollar for the purposes of preparing the consolidated financial statements or otherwise stated in this MD&A were as follows:





March 31, 2010

December 31, 2010

March 31, 2011Assets and liabilities

1 RMB = 0.14670 USD

1 RMB = 0.15170 USD

1 RMB = 0.15270 USDStatements of operations and cash flows for the period/year ended

1 RMB = 0.14665 USD

1 RMB = 0.14794 USD

1 RMB = 0.15218 USD




Inflation





We are seeing significant inflation pressures building in China.  We were able to secure favorable pricing by prepaying for major components to certain suppliers to lock in prices ahead of time.  As a result, we did not experience as much cost pressures as evidenced in the spot market prices of the raw materials.   However, we are seeing the rising costs of raw materials gradually starting to impact our margins in the quarter ended March 31, 2011, as evidenced by the slight decrease in gross margins.  We anticipate the inflationary pressures continuing in 2011.  We are focused on minimizing cost increases and are monitoring the situation closely.  We continue the practice of prepayments to suppliers in order to have better control of costs for raw materials.





ITEM 4. CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls and Procedures





Disclosure Controls and Procedures


We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer (Chief Executive Officer) and principal financial officer (Chief Financial Officer), as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the 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 necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.




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As of March 31, 2011, the end of the fiscal year covered by this report, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).





Based on the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2011, our disclosure controls and procedures were ineffective at the reasonable assurance level because of a lack of accounting and internal audit personnel with an appropriate level of knowledge, experience, and training in the application of U.S. GAAP.  We plan to implement the following measures as soon as possible to remediate this material weakness: 
 1.
Recruit sufficient qualified accounting and internal audit personnel and continue to engage outside contractor with technical accounting expertise, as needed.
 
 2.
Reorganize the accounting and finance department to ensure that accounting personnel with adequate experience, skills and knowledge are directly involved in the review and accounting evaluation of our complex, non-routine transactions.
 
 3.
Continue to evaluate our existing staffs and make adjustments as necessary, in addition to providing additional training on accounting principles and internal control procedures for our existing staffs.
 
 4.
Improve the interaction among our management, audit committee, independent auditors and other external advisors.


Changes in Internal Control over Financial Reporting





There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





PART II. OTHER INFORMATION





ITEM 6. EXHIBITS





Exh. No.

Description3.1

Articles of Incorporation, as amended  (2)3.2

Bylaws, as amended (1)31.1

Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *31.2

Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *32.1

Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *32.2

Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *





*
Filed herewith.(1)
Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 15, 2008.(2)
Incorporated by reference from Registrant’s Quarter Report on Form 10-Q filed on November 15, 2010.





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SIGNATURES





In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




SKYSTAR BIO-PHARMACEUTICAL COMPANYMay 23, 2011
By:
/s/ Weibing LuWeibing LuChief Executive Officer(Principal Executive Officer)




By:
/s/ Michael H. LanMichael H. LanChief Financial Officer(Principal Financial and Accounting Officer)
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