**UNITED STATES**


**SECURITIES AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549





**FORM
      10-Q**





x
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d)****OF
                THE SECURITIES EXCHANGE ACT OF
                1934**


For
      the
      quarterly period ended September
      30, 2008





or





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


For
      the
      transition period from _______ to _________





*Commission
      File No. 000-51379*





**CHINA
      MEDICINE CORPORATION**


(Exact
      name of registrant as specified in its charter)




Delaware
            
            51-0539830(State
                or other jurisdiction of incorporation)
            
            I.R.S.
                Employer Identification Number




Guangri
      Tower, Suite 702


No.
      8
      Siyou South 1st Street


Yuexiu
      District


Guangzhou,
      China 510600


(Address
      of principal executive offices)





(86-20)
      8739-1718 and (86-20)
      8737-8212


(Registrant's
      telephone number, including area code)




(Former
      name, former address and former fiscal year, if changed since last
      report)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the 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. x Yes o
      No





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 “small
      reporting company” in Rule 12b-2 of the Exchange Act.





Large accelerated filer
            o
            
            Accelerated filer
            oNon-accelerated filer
            o
            (Do not check if a smaller reporting company)
            Smaller reporting company
            x





Indicate by check mark
      whether the registrant is a shell company (as defined in Rule 12b-2 of the
      Exchange Act). o Yes xNo





The
      number of shares outstanding of the Registrant's Common Stock, par value $.0001
      per share, outstanding at September 30, 2008 was 15,226,742.










**CHINA
      MEDICINE CORPORATION**





TABLE
      OF
      CONTENTS





PagePART
                I
            FINANCIAL
                INFORMATION
            3Item
                1.
            Financial
                Statements
            3Item
                2.
            Management’s
                Discussion and Analysis or Plan of Operation
            25Item
                4.
            Controls
                and Procedures
            37PART
                II
            OTHER
                INFORMATION
            38Item
                5.
            Other Information
            38Item
                6.
            Exhibits
            39Signatures
            40Exhibits/Certifications






2





**PART
      I. FINANCIAL INFORMATION**





**Item
      1. Financial Statements**




CHINA
                  MEDICINE CORPORATION AND SUBSIDIARIESCONSOLIDATED
                  BALANCE SHEETSAS
                  OF SEPTEMBER 30, 2008 AND DECEMBER 31, 2007ASSETS
  September
                  30,
              
              December
                  31,2008
              
              2007UnauditedCURRENT
                  ASSETSCash
              
              $
              2,710,088
              
              $
              5,767,774Accounts
                  receivable, trade, net of allowance for doubtful accountsof
                  $59,374 and $55,640 as of September 30, 2008 andDecember
                  31, 2007, respectively
              
              
              15,282,094
              
              
              13,626,347Notes
                  receivables
              
              
              1,221,605
              
              
              -Inventories
              
              
              5,262,851
              
              
              3,948,460Advances
                  to suppliers
              
              
              9,976,022
              
              
              5,983,277Other
                  current assets
              
              
              88,640
              
              
              81,221Total
                  current assets
              
              
              34,541,300
              
              
              29,407,079EQUIPMENT,
                  net
              
              
              1,337,446
              
              
              1,388,919OTHER
                  ASSETSDeferred
                  expenses
              
              
              452,344
              
              
              678,237Long
                  term prepayment
              
              
              2,787,015
              
              
              -Intangible
                  assets, net
              
              
              1,331,965
              
              
              1,166,003Total
                  other assets
              
              
              4,571,324
              
              
              1,844,240Total
                  assets
              
              $
              40,450,070
              
              $
              32,640,238LIABILITIES
                  AND SHAREHOLDERS' EQUITYCURRENT
                  LIABILITIESAccounts
                  payable, trade
              
              $
              85,875
              
              $
              76,907Other
                  payables and accrued liabilities
              
              
              20,017
              
              
              70,343Customer
                  deposits
              
              
              230,276
              
              
              203,281Taxes
                  payable
              
              
              96,421
              
              
              468,184Liquidated
                  damages payable
              
              
              44,003
              
              
              44,003Total
                  liabilities
              
              
              476,592
              
              
              862,718MINORITY
                  INTEREST
              
              
              866,458
              
              
              893,337SHAREHOLDERS'
                  EQUITYPreferred
                  stock, $0.0001 par value; 10,000,000 shares authorized,0
                  and 111,649 shares issued and outstandingat
                  September 30, 2008 and December 31 2007,
                  respectively
              
              
              -
              
              
              11Common
                  stock, $0.0001 par value; 100,000,000 shares authorized,15,226,742
                  and 14,821,641 shares issued and outstandingat
                  September 30, 2008 and December 31, 2007,
                  respectively
              
              
              1,522
              
              
              1,482Paid-in
                  capital
              
              
              13,006,016
              
              
              12,560,078Statutory
                  reserves
              
              
              2,814,252
              
              
              2,191,230Retained
                  earnings
              
              
              18,992,742
              
              
              14,008,587Accumulated
                  other comprehensive income
              
              
              4,292,488
              
              
              2,122,795Total
                  shareholders' equity
              
              
              39,107,020
              
              
              30,884,183Total
                  liabilities and shareholders' equity
              
              $
              40,450,070
              
              $
              32,640,238


The
        accompanying notes are an integral part of this consolidated
        statement.
  3


CHINA
                  MEDICINE CORPORATION AND SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOMEFOR
                  THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND
                  2007(Unaudited)
  Three
                  months ended
              
              Nine
                  months endedSeptember,
                  30
              
              September,
                  302008
              
              2007
              
              2008
              
              2007REVENUESProduct
                  sales
              
              $
              9,963,571
              
              $
              11,904,525
              
              $
              27,882,029
              
              $
              24,552,269Medical
                  formula sales
              
              
              553,221
              
              
              684,413
              
              
              1,333,341
              
              
              1,393,632Total
                  revenues
              
              
              10,516,792
              
              
              12,588,938
              
              
              29,215,370
              
              
              25,945,901COST
                  OF GOOD SOLD
              
              
              7,255,635
              
              
              8,765,477
              
              
              19,485,824
              
              
              18,029,902GROSS
                  PROFIT
              
              
              3,261,157
              
              
              3,823,461
              
              
              9,729,546
              
              
              7,915,999OPERATING
                  EXPENSESResearch
                  and development
              
              
              288,353
              
              
              336,794
              
              
              484,569
              
              
              437,449Selling,
                  general and administrative
              
              
              642,919
              
              
              830,518
              
              
              2,515,509
              
              
              2,435,288Total
                  operating expenses
              
              
              931,272
              
              
              1,167,312
              
              
              3,000,078
              
              
              2,872,737INCOME
                  FROM OPERATIONS
              
              
              2,329,885
              
              
              2,656,149
              
              
              6,729,468
              
              
              5,043,262OTHER
                  INCOME (EXPENSE), NET
              
              
              7,368
              
              
              13,694
              
              
              45,455
              
              
              3,604INCOME
                  BEFORE INCOME TAXES
              
              
              2,337,253
              
              
              2,669,843
              
              
              6,774,923
              
              
              5,046,866AND
                  MINORITY INTERESTPROVISION
                  FOR INCOME TAXES
              
              
              411,890
              
              
              480,458
              
              
              1,252,833
              
              
              1,018,743INCOME
                  BEFORE MINORITY INTEREST
              
              
              1,925,363
              
              
              2,189,385
              
              
              5,522,090
              
              
              4,028,123MINORITY
                  INTEREST
              
              
              39,777
              
              
              16,529
              
              
              85,087
              
              
              68,646NET
                  INCOME
              
              
              1,965,140
              
              
              2,205,914
              
              
              5,607,177
              
              
              4,096,769OTHER
                  COMPREHENSIVE INCOMEForeign
                  currency translation adjustment
              
              
              97,869
              
              
              341,114
              
              
              2,169,693
              
              
              900,439COMPREHENSIVE
                  INCOME
              
              $
              2,063,009
              
              $
              2,547,028
              
              $
              7,776,870
              
              $
              4,997,208EARNINGS
                  PER SHARE:Basic
              
              $
              0.13
              
              $
              0.17
              
              $
              0.37
              
              $
              0.35Diluted
              
              $
              0.13
              
              $
              0.14
              
              $
              0.36
              
              $
              0.30WEIGHTED
                  AVERAGE SHARES OUTSTANDING:Basic
              
              
              15,226,742
              
              
              13,306,738
              
              
              15,153,824
              
              
              11,585,981Diluted
              
              
              15,547,840
              
              
              15,586,809
              
              
              15,567,627
              
              
              13,866,051


The
        accompanying notes are an integral part of this consolidated
        statement.
  4
 CHINA
                    MEDICINE CORPORATION AND SUBSIDIARIESCONSOLIDATED
                    STATEMENTS OF SHAREHOLDERS' EQUITYFOR
                    NINE MONTHS ENDED SEPTEMBER 30, 2008 AND
                    2007
 Retained
                  Earnings
              
              otherPreferred
                  Stock
              
              Common
                  Stock
              
              Paid-in
              
              Contribution
              
              Statutory
              
              
              
              comprehensiveShares
              
              Par
                  Value
              
              Shares
              
              Par
                  Value
              
              capital
              
              receivable
              
              reserves
              
              Unrestricted
              
              income
              
              TotalsBALANCE,
                  December 31, 2006
              
              
              2,340,000
              
              $
              234
              
              
              8,160,000
              
              $
              816
              
              $
              4,396,971
              
              $
              (961,500
              )
              $
              1,345,206
              
              $
              7,979,242
              
              $
              372,923
              
              $
              13,133,892Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,096,769
              
              
              
              
              
              4,096,769Adjustment
                  of statutory reserve
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              499,528
              
              
              (499,528
              )Preferred
                  stock converted to common stock
              
              
              (1,733,745
              )
              
              (173
              )
              
              1,773,448
              
              
              177
              
              
              (4
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              -Warrants
                  exercised for cash @ $1.75
              
              
              
              
              
              
              
              
              1,621,750
              
              
              162
              
              
              2,838,091
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,838,253Warrants
                  exercised for cash @ $1.70
              
              
              
              
              
              
              
              
              1,694,040
              
              
              169
              
              
              2,879,699
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,879,868Stock
                  option compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              78,497
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              78,497Common
                  stock issued for services
              
              
              
              
              
              
              
              
              57,500
              
              
              6
              
              
              179,394
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              179,400Foreign
                  currency translation adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              900,439
              
              
              900,439BALANCE,
                  September 30, 2007 (Unaudited)
              
              
              606,255
              
              $
              61
              
              
              13,306,738
              
              $
              1,330
              
              $
              10,372,648
              
              $
              (961,500
              )
              $
              1,844,734
              
              $
              11,576,483
              
              $
              1,273,362
              
              $
              24,107,118Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,778,600
              
              
              
              
              
              2,778,600Adjustment
                  of statutory reserve
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              346,496
              
              
              (346,496
              )
              
              
              
              
              -Preferred
                  stock converted to common stock
              
              
              (494,606
              )
              
              (50
              )
              
              509,903
              
              
              51
              
              
              (1
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              -Warrants
                  exercised for cash @ $2.43
              
              
              
              
              
              
              
              
              725,000
              
              
              73
              
              
              1,761,677
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,761,750Stock
                  options exercised for cash @ $1.25
              
              
              
              
              
              
              
              
              280,000
              
              
              28
              
              
              349,972
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              350,000Stock
                  option compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              75,782
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              75,782Common
                  stock issued for services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -Contribution
                  receivable
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              961,500
              
              
              
              
              
              
              
              
              
              
              
              961,500Foreign
                  currency translation adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              849,433
              
              
              849,433BALANCE,
                  December 31, 2007
              
              
              111,649
              
              $
              11
              
              
              14,821,641
              
              $
              1,482
              
              $
              12,560,078
              
              $
              -
              
              $
              2,191,230
              
              $
              14,008,587
              
              $
              2,122,795
              
              $
              30,884,183Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              5,607,177
              
              
              
              
              
              5,607,177Adjustment
                  of statutory reserve
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              623,022
              
              
              (623,022
              )Preferred
                  stock converted to common stock
              
              
              (111,649
              )
              
              (11
              )
              
              115,101
              
              
              11
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -Stock
                  options exercised for cash @ $1.25
              
              
              
              
              
              
              
              
              290,000
              
              
              29
              
              
              362,471
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              362,500Stock
                  option and warrant compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              83,467
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              83,467Foreign
                  currency translation adjustments
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,169,693
              
              
              2,169,693BALANCE,
                  September 30, 2008 (Unaudited)
              
              
              -
              
              $
              -
              
              
              15,226,742
              
              $
              1,522
              
              $
              13,006,016
              
              $
              -
              
              $
              2,814,252
              
              $
              18,992,742
              
              $
              4,292,488
              
              $
              39,107,020
  The
        accompanying notes are an integral part of this consolidated
        statement.





5


CHINA
                  MEDICINE CORPORATION AND SUBSIDIARIESCONSOLIDATED
                  STATEMENTS OF CASH FLOWSFOR
                  THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007(Unaudited)
  2008
              
              2007CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income
              
              $
              5,607,177
              
              $
              4,096,769Adjustments
                  to reconcile net income to cashused
                  in operating activities:Minority
                  interest
              
              
              (85,087
              )
              
              (68,646
              )Depreciation
                  and amortization
              
              
              289,935
              
              
              199,575Stock
                  issued for services
              
              
              -
              
              
              179,400Stock
                  option and warrant compensation
              
              
              83,467
              
              
              78,497Amortization
                  of deferred expenses
              
              
              265,971
              
              
              -Loss
                  on currency exchange
              
              
              -
              
              
              19,620Change
                  in operating assetsAccounts
                  receivable, trade
              
              
              (726,513
              )
              
              (1,638,087
              )Notes
                  receivables
              
              
              (1,197,140
              )
              
              -Inventories
              
              
              (1,028,416
              )
              
              (3,186,935
              )Advances
                  to suppliers
              
              
              (3,521,687
              )
              
              (2,014,715
              )Other
                  receivables
              
              
              (1,460
              )
              
              -Other
                  current assets
              
              
              -
              
              
              (41,847
              )Change
                  in operating liabilitiesAccounts
                  payable, trade
              
              
              3,731
              
              
              121,123Other
                  payables and accrued liabilities
              
              
              (52,263
              )
              
              (14,034
              )Other
                  payables-related parties
              
              
              -
              
              
              33,213Customer
                  deposits
              
              
              13,087
              
              
              318,533Taxes
                  payable
              
              
              (395,105
              )
              
              72,756Net
                  cash used in operating activities
              
              
              (744,303
              )
              
              (1,844,778
              )CASH
                      FLOWS FROM INVESTING ACTIVITIES:Purchase
                  of equipment
              
              
              (147,935
              )
              
              (228,213
              )Purchase
                  of intangible asset
              
              
              (2,817,221
              )
              
              (130,640
              )Net
                  cash used in investing activities
              
              
              (2,965,156
              )
              
              (358,853
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from exercise of options and warrants
              
              
              362,500
              
              
              5,718,121Net
                  cash provided by financing activities
              
              
              362,500
              
              
              5,718,121EFFECT
                  OF EXCHANGE RATE ON CASH
              
              
              289,273
              
              
              242,200(DECREASE)
                  INCREASE IN CASH
              
              
              (3,057,686
              )
              
              3,756,690CASH,
                  beginning of period
              
              
              5,767,774
              
              
              371,480CASH,
                  end of period
              
              $
              2,710,088
              
              $
              4,128,170SUPPLEMENTAL
                  CASHFLOW DISCLOSURE:Income
                  tax paid
              
              $
              1,315,776
              
              $
              708,845
 The
        accompanying notes are an integral part of this consolidated
        statement.
 6


CHINA
        MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
        TO
        CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2008
 (Unaudited)


**Note
        1 - Organization**
 
 China
        Medicine Corporation (the "Company") is a Delaware corporation, incorporated
        on
        February 10, 2005. The Company, through its subsidiaries in China, engages
        the
        wholesale of prescription and over the counter medicines, traditional Chinese
        medicines, which are medicines derived from Chinese herbs, dietary supplements,
        medical instruments and the sale of medical formula in PRC.
 
 **Note
        2 - Summary of significant accounting policies**
 
 Basis
        of presentation
 
 The
        consolidated financial statements of the Company reflect its wholly-owned
        subsidiary, Konzern, its 70% owned subsidiary, Co-win, both located in the
        PRC,
        and its wholly-owned subsidiary Konzern US Holding.
 
 The
        accompanying financial statements have been prepared in accordance with
        accounting principles generally accepted in the United States of America.
        All
        material intercompany transactions and balances have been eliminated in the
        consolidation.
 
 Management
        has included all normal recurring adjustments considered necessary to give
        a
        fair presentation of operating results for the periods presented. Interim
        results are not necessarily indicative of results for a full year. The
        information included in this Form 10-Q should be read in conjunction with
        information included in the 2007 annual report filed on Form
        10-KSB.
 
 Use
        of
        estimates
 
 In
        preparing financial statements in conformity with generally accepted accounting
        principles, management is required to make estimates and assumptions that
        affect
        the reported amounts of assets and liabilities and the disclosure of contingent
        assets and liabilities at the date of the financial statements and revenues
        and
        expenses during the reported period. For example, management estimates the
        amount of potentially uncollectible accounts and estimates the fair value
        of
        options and warrants granted. Actual results could differ from those
        estimates.
 
 Cash
        and concentration of risk
 
 For
        purposes of the cash flow statement, the Company considers all highly liquid
        investments with original maturities of three months or less at the time
        of
        purchase to be cash equivalents. Cash includes cash on hand and demand deposits
        in accounts maintained with PRC state owned banks and banks in the United
        States.
  7
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 The
        Company's operations may be adversely affected by significant political,
        economic and social uncertainties in China. Although the Chinese government
        has
        pursued economic reform policies in the past, there is no assurance that
        the
        Chinese government will continue to pursue such policies or that such policies
        may not be significantly altered, especially in the event of a change in
        leadership, social or political disruption or unforeseen circumstances affect
        China's political, economic and social conditions. There is also no guarantee
        that the Chinese government's pursuit of economic reforms will be consistent
        or
        effective.
 
 Financial
        instruments, which subject the Company to concentration of credit risk, consist
        of cash, accounts receivable, and accounts payable. The Company maintains
        balances at financial institutions which, from time to time, may exceed Federal
        Deposit Insurance Corporation insured limits for banks that are located in
        the
        Unites States, no deposits with the state owned banks within the PRC are
        covered
        by insurance. As of September 30, 2008 and December 31, 2007, the Company
        had
        deposits in excess of federally insured limits total of $2,577,366 and
        $4,987,180, respectively. The Company has not experienced any losses in such
        accounts and believes it is not exposed to any significant risks on its cash
        in
        bank accounts.
 
 Five
        suppliers accounted for approximately 47% and 70% of the Company’s purchases for
        the nine months ended September 30, 2008 and 2007 and approximately 50% and
        65%
        for the three months ended September 30, 2008 and 2007, respectively. Advances
        to these five suppliers represent 33% and 35% of the Company’s total advances to
        suppliers as of September 30, 2008 and 2007, respectively.
 
 Five
        customers accounted for approximately 50% and 46% of the Company's total
        sales
        for the nine months ended September 30, 2008 and 2007, 52% and 53% for the
        three
        months ended September 30, 2008 and 2007, respectively. The accounts receivable
        balance of these five customers amounted $8,794,247, representing 57% of
        the
        total accounts receivable as of September 30, 2008, and $2,456,834, representing
        27% of the total accounts receivable as of September 30, 2007,
        respectively.
  The
        top
        three products accounted for approximately 20% and 16% of the Company’s total
        sales for the nine months ended September 30, 2008 and 2007 and 23% and 27%
        for
        the three months ended September 30, 2008 and 2007, respectively.
 
 Accounts
        receivable, trade
 
 The
        Company’s business operations are conducted in the PRC. During the normal course
        of business, the Company extends unsecured credit to its customers. Management
        reviews its accounts receivable on a regular basis to determine if the allowance
        for doubtful accounts is adequate. An
        estimate for doubtful accounts is made when collection of the full amount
        is no
        longer probable. Known bad debts are written off against allowance for doubtful
        accounts when identified. Trade accounts receivable at September
        30, 2008 and
        December 31, 2007 consist of the following:
  8
  CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  September 30,
                2008
              
              December 31,
                2007Trade
                  accounts receivable
              
              $
              15,341,468
              
              $
              13,681,987Allowance
                  for bad debts
              
              
              (59,374
              )
              
              (55,640
              )Trade
                  accounts receivable, net
              
              $
              15,282,094
              
              $
              13,626,347
 
 September 30,
                2008Beginning
                  allowance for doubtful accounts
              
              $
              55,640Additions
                  charged to bad debt expense
              
              
              -Foreign
                  currency translation adjustments
              
              
              3,734Ending
                  allowance for doubtful accounts
              
              $
              59,374
 
 Notes
        receivables
 
 Notes
        receivable represent trade accounts receivable due from various customers
        where
        the customers’ banks have guaranteed the payment of the receivables. This amount
        is non-interest bearing and is normally paid within three to six months.
        The
        Company has the ability to submit a request for payment to the customer’s bank
        earlier than the scheduled payment date, but will incur an interest charge
        and a
        processing fee when it submits the early payment request. The Company had
        $1,221,605 and $0 outstanding as of September 30, 2008 and December 31, 2007,
        respectively.
 
 Inventories
 
 Inventories
        are stated at the lower of cost or market value, cost is determined using
        the
        weighted average method.
 
 Equipment
 
 Equipment
        is stated at the actual cost of acquisition less accumulated depreciation
        and
        amortization. Depreciation and amortization are provided in amounts sufficient
        to relate the cost of depreciation of assets to operations over their estimated
        service lives, principally on a straight-line basis. The estimated lives
        used in
        determining depreciation are:
 
 Leasehold
                  improvements
              5
                  yearsEquipment
              5
                  yearsFurniture
              5
                  yearsMotor
                  vehicles
              5
                  -
                  8 years
 
 The
        residual value is estimated to be 5% of the actual cost.
  9
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 The
        cost
        and related accumulated depreciation of assets sold or otherwise retired
        are
        eliminated from the accounts and any gain or loss is included in the statement
        of operations. Maintenance, repairs and minor renewals are expensed as
        incurred.
 Long
          term prepayment
 
 Long
          term
          prepayment represents deposit for the bidding of the BCG vaccine manufacturing
          license as of September 30, 2008. As of September 30, 2008, the bidding
          process
          has not started nor has the Company received the BCG vaccine manufacturing
          license.
 Intangibles
 
 Under
        the
        Statement of Accounting Standards ("SFAS") No.142, "Goodwill and Other
        Intangible Assets", all goodwill and certain intangible assets determined
        to
        have indefinite lives will not be amortized but will be tested for impairment
        at
        least annually. Intangible assets other than goodwill will be amortized over
        their useful lives and reviewed for impairment at least annually or more
        often
        whenever there is an indication that the carrying amount may not be
        recovered.
 
 The
        Company acquired technology during 2007 and 2008 to manufacture
        aflatoxin-detoxifizyme ("ADTZ"). The Company will begin amortizing costs
        once
        manufacturing begins. As of September 30, 2008, the Company had not yet begun
        operations.
 
 The
        intangible assets as of September 30, 2008 and December 31, 2007, net of
        amortization, amounted to $1,331,965 and $1,166,003, respectively.
 
 Impairment
        of long-lived assets
 
 Per
        SFAS
        No. 144, long-lived assets are analyzed for impairment. The Company tests
        for
        impairment of long-lived assets at least annually or more often whenever
        there
        is an indication that the carrying amount of the asset may not be recovered.
        Recoverability of these assets is determined by comparing the forecasted
        undiscounted cash flows generated by those assets to the assets' net carrying
        value. The amount of impairment loss, if any, is measured as the difference
        between the net book value of the assets and the estimated fair value of
        the
        related assets.
 
 Management
        evaluates the recoverability of long-lived assets by measuring the carrying
        amount of the assets against the estimated undiscounted future cash flows
        associated with them. At the time such flows of certain long-lived assets
        are
        not sufficient to recover the carrying value of such assets, the assets are
        adjusted to their fair values. As of September 30, 2008, the Company believes
        that there were no significant impairments of long-lived assets.
  Revenue
        recognition
 
 The
        Company recognizes revenue when all four of the following criteria are met:
        (1)
        persuasive evidence has been received that an arrangement exists; (2) delivery
        of the products and/or services has occurred; (3) the selling price is fixed
        or
        determinable; and (4) collectability is reasonably assured. The Company follows
        the provisions of SAB No. 104 which sets forth guidelines in the timing of
        revenue recognition based upon factors such as passage of title, installation,
        payments and customer acceptance. Any amounts received prior to satisfying
        the
        Company's revenue recognition criteria is recorded as deferred
        revenue.
  10
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  Sales
        revenue represents the invoiced value of goods, net of a value-added tax
        (VAT).
        All of the Company's products that are sold in the PRC are subject to a Chinese
        value-added tax at a rate of 17% of the gross sales price. This VAT may be
        offset by VAT paid by the Company on raw materials and other materials included
        in the cost of producing their finished product.
 
 VAT
        on
        sales and VAT on purchases amounted to $4,835,986 and $3,552,541 for the
        nine
        months ended September 30, 2008 and $4,173,685 and $3,488,057 for the nine
        months ended September 30, 2007, and $1,702,953 and $1,271,097 for the three
        months ended September 30, 2008 and $2,230,346 and $2,177,693 for the three
        months ended September 30, 2007, respectively. Sales and purchases are recorded
        net of VAT collected and paid as the Company acts as an agent for the
        government. VAT taxes are not impacted by the income tax holiday.
 
 Shipping
        and handling
  Shipping
        and handling costs related to costs of goods sold are included in selling,
        general and administrative costs and totaled $344,360 and $181,026 for the
        nine
        months ended September 30, 2008 and 2007 and totaled $96,906 and $86,443
        for the
        three months ended September 30, 2008 and 2007.
 
 Advertising
        costs
 
 The
        Company expenses the cost of advertising as incurred in selling, general
        and
        administrative costs. Advertising costs totaled $117,363 and $406,245 for
        the
        nine months ended September 30, 2008 and 2007 and totaled $39,777 and $325,189
        for the three months ended September 30, 2008 and 2007.
 
 Research
        and development costs
 
 Research
        and development costs are expensed as incurred. The costs of material and
        equipment that are acquired or constructed for research and development
        activities, and have alternative future uses, either in research and
        development, marketing, or sales, are classified as property and equipment
        or
        depreciated over their estimated useful lives.
 
 Foreign
        currency translation
  The
        reporting currency of the Company is the US dollar. The Company uses their
        local
        currency, Renminbi (RMB), as its functional currency. Results of operations
        and
        cash flow are translated at average exchange rates during the period, and
        assets
        and liabilities are translated at the unified exchange rate as quoted by
        the
        People’s Bank of China at the end of the period. Because cash flows are also
        translated at average translation rates, amounts reported on the statement
        of
        cash flows will not necessarily agree with changes in the corresponding balances
        on the balance sheet. Translation adjustments resulting from this process
        are
        included in accumulated other comprehensive income in the statement of
        shareholders’ equity.
  11
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 Translation
        adjustments amounted to $4,292,488 and $2,122,795 as of September 30, 2008
        and
        December 31, 2007, respectively. Asset and liability accounts at September
        30,
        2008 were translated at 6.84RMB to $1.00 as compared to 7.30 RMB at December
        31,
        2007. Equity accounts were stated at their historical rate. The average
        translation rates applied to income statements accounts for the nine months
        ended September 30, 2008 and 2007 were 6.97 RMB and 7.65 RMB, respectively.
 
 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. No material transaction gains and losses
        were
        recognized during the nine and three months ended September 30, 2008, and
        2007.
        Historically, the Company has not entered into any currency trading or hedging
        transactions, although there is no assurance that the Company will not enter
        into such transactions in the future.
 
 Income
        taxes
 
 The
        Company records income taxes pursuant to Statement of Financial Accounting
        Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires
        the recognition of deferred income tax liabilities and assets for the expected
        future tax consequences of temporary differences between income tax basis
        and
        financial reporting basis of assets and liabilities. Provision for income
        taxes
        consist of taxes currently due plus deferred taxes. There are no deferred
        tax
        amounts at September 30, 2008 and December 31, 2007.
 
 The
        charge for taxation is based on the results for the year as adjusted for
        items,
        which are non-assessable or disallowed. It is calculated using tax rates
        that
        have been enacted or substantially enacted by the balance sheet
        date.
 
 Deferred
        tax is accounted for using the balance sheet liability method in respect
        of
        temporary differences arising from differences between the carrying amount
        of
        assets and liabilities in the financial statements and the corresponding
        tax
        basis used in the computation of assessable tax profit. In principle, deferred
        tax liabilities are recognized for all taxable temporary differences, and
        deferred tax assets are recognized to the extent that it is probably that
        taxable profit will be available against which deductible temporary differences
        can be utilized. Deferred tax is calculated at the tax rates that are expected
        to apply to the period when the asset is realized or the liability is settled.
        Deferred tax is charged or credited in the income statement, except when
        it is
        related to items credited or charged directly to equity, in which case the
        deferred tax is also dealt with in equity. Deferred tax assets and liabilities
        are offset when they relate to income taxes levied by the same taxation
        authority and the Company intends to settle its current tax assets and
        liabilities on a net basis.
  12
  CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  The
        Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
        Taxes” (“FIN 48”), as of January 1, 2007. 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 adoption had no
        affect on the Company’s financial statements.
 
 China
        Medicine Corporation was incorporated in the United States and has incurred
        net
        operating losses for income tax purposes for the nine months ended September
        30,
        2008 and 2007. The net operating loss carry forwards for United States income
        taxes amounted to $3,017,289 which may be available to reduce future years’
taxable income. These carry forwards will expire, if not utilized, through
        2027.
        Management believes that the realization of the benefits from these losses
        appears uncertain due to the Company’s limited operating history and continuing
        losses for United States income tax purposes. Accordingly, the Company has
        provided a 100% valuation allowance on the deferred tax asset benefit to
        reduce
        the asset to zero. The valuation allowance as of September 30, 2008 was
        $1,026,000. The net change in the valuation allowance for the nine months
        ended
        September 30, 2008 was an increase of $414,000. Management will review this
        valuation allowance periodically and make adjustments as warranted.
 
 Fair
        value of financial instruments
 
 On
        January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements.
        SFAS
        No. 157 defines fair value, establishes a three-level valuation hierarchy
        for
        disclosures of fair value measurement and enhances disclosures requirements
        for
        fair value measures. The carrying amounts reported in the balance sheets
        for
        receivables and current liabilities each qualify as financial instruments
        and
        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
        their current market rate of interest. The three levels are defined as
        follow:
  ·
              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 asset or liability, either directly or indirectly, for
                  substantially the full term of the financial
                  instrument.
  ·
              Level
                  3 inputs to the valuation methodology are unobservable and significant
                  to
                  the fair value measurement.
  13
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 As
        of
        September 30, 2008 the Company did not identify any assets and liabilities
        that
        are required to be presented on the balance sheet at fair value.
 
 Stock-based
        compensation
 
 The
        Company adopted the Statement of Financial Accounting Standards No. 123 (revised
        2004), "Share-Based Payments," ("FAS 123R"), which established standards
        for the
        accounting for transactions in which an entity exchanges its equity instruments
        for goods or services. This statement requires a public entity to measure
        the
        cost of employee services received in exchange for an award of equity
        instruments based on the grant-date fair value of the award (with limited
        exceptions). That cost will be recognized over the period during which an
        employee is required to provide service in exchange for the award.
 
 Earnings
        per share
 
 The
        Company reports earnings per share in accordance with the provisions of SFAS
        No.
        128, "Earnings Per Share." SFAS No. 128 requires presentation of 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 are computed
        by dividing income available to common stockholders by the weighted average
        common shares outstanding during the period. Diluted earnings per share takes
        into account the potential dilution that could occur if securities or other
        contracts to issue common stock were exercised and converted into common
        stock.
  The
        following is a reconciliation of the basic and diluted earnings per share
        computations:
  For
                  the three months ended
              
              2008
              
              2007Net
                  income
              
              $
              1,965,140
              
              $
              2,205,914Shares
                  of common stock and common stock equivalents:Weighted
                  average shares - basic computation
              
              
              15,226,742
              
              
              13,306,738Diluted
                  effect of stock options, warrants, and preferred stocks
              
              
              321,098
              
              
              2,280,071Weighted
                  average shares - computation
              
              
              15,547,840
              
              
              15,586,809Earnings
                  per share:Basic
              
              $
              0.13
              
              $
              0.17Diluted
              
              $
              0.13
              
              $
              0.14For
                  the nine months ended September 30,
              
              
              2008
              
              
              2007Net
                  income
              
              $
              5,607,177
              
              $
              4,096,769Shares
                  of common stock and common stock equivalents:Weighted
                  average shares - basic computation
              
              
              15,153,824
              
              
              11,585,981Diluted
                  effect of stock options, warrants, and preferred stocks
              
              
              413,803
              
              
              2,280,070Weighted
                  average shares - diluted computation
              
              
              15,567,627
              
              
              13,866,051Earnings
                  per share:Basic
              
              $
              0.37
              
              $
              0.35Diluted
              
              $
              0.36
              
              $
              0.30
  14
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 The
        following warrants and options are excluded from the calculation because
        of
        their anti-dilutive nature.
  For
                  the three months ended
              
              September 30,
                2008
              
              September
                  30,
                2007Warrants
                  exercise price at $2.43
              
              
              2,969,738
              
              
              -Options
                  exercise price at $2.26
              
              
              70,000
              
              
              -Options
                  exercise price at $3.00
              
              
              15,000
              
              
              -
 
 For
                  the nine months ended
              
              September 30,
                2008
              
              September
                  30,
                2007Warrants
                  exercise price at $2.43
              
              
              2,969,738
              
              
              -Options
                  exercise price at $2.26
              
              
              15.000
              
              
              -Options
                  exercise price at $3.00
              
              
              15,000
              
              
              -
 
 Minority
        interest
 
 Minority
        interest consists of the 30% interest of minority shareholders in Guangzhou
        Co-win Bioengineering Co., Ltd. As of September 30, 2008 and December 31,
        2007,
        minority interest amounted to $866,458 and $893,337, respectively.
 
 Recently
        issued accounting pronouncements
 
 In
        February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
        Assets and Financial Liabilities—including an amendment of FASB Statement No.
        115 (“FAS 159”). FAS 159 permits companies to choose to measure many financial
        instruments and certain other items at fair value that are not currently
        required to be measured at fair value. The objective of FAS 159 is to provide
        opportunities to mitigate volatility in reported earnings caused
        by measuring related assets and liabilities differently without having to
        apply hedge accounting provisions. FAS 159 also establishes presentation
        and
        disclosure requirements designed to facilitate comparisons between
        companies that choose different measurement attributes for similar types
        of
        assets and liabilities. SFAS No. 159 is effective as of the beginning of
        an
        entity’s first fiscal year that begins after November 15, 2007. The Company
        adopted SFAS No. 159 on January 1, 2008. The Company chose not to elect the
        option to measure the fair value of eligible financial assets and
        liabilities.
  15
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  In
        September 2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting
        for Nonrefundable Advance Payments for Goods or Services Received for use
        in
        Future Research and Development Activities” (“FSP EITF 07-3”), which addresses
        whether nonrefundable advance payments for goods or services that used or
        rendered for research and development activities should be expensed when
        the
        advance payment is made or when the research and development activity has
        been
        performed. The Company adopted FSP EITF 07-3 and expensed the research and
        development as incurred.
 
 In
        December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
        Consolidated Financial Statements - an amendment of Accounting Research Bulletin
        No. 51” (“SFAS 160”), which establishes accounting and reporting standards for
        ownership interests in subsidiaries held by parties other than the parent,
        the
        amount of consolidated net income attributable to the parent and to the
        noncontrolling interest, changes in a parent’s ownership interest and the
        valuation of retained non-controlling equity investments when a subsidiary
        is
        deconsolidated. The Statement also establishes reporting requirements that
        provide sufficient disclosures that clearly identify and distinguish between
        the
        interests of the parent and the interests of the non-controlling owners.
        SFAS
        160 is effective for fiscal years beginning after December 15, 2008. The
        Company
        has not determined the effect that the application of SFAS 160 will have
        on its
        consolidated financial statements.
 
 In
        December 2007, Statement of Financial Accounting Standards No. 141(R), *Business
        Combinations* ,
        was
        issued. SFAS No. 141R replaces SFAS No. 141, *Business
        Combinations.* SFAS
        141R
        retains the fundamental requirements in SFAS 141 that the acquisition method
        of
        accounting (which SFAS 141 called the *purchase
        method* )
        be used
        for all business combinations and for an acquirer to be identified for each
        business combination. SFAS 141R requires an acquirer to recognize the assets
        acquired, the liabilities assumed, and any noncontrolling interest in the
        acquiree at the acquisition date, measured at their fair values as of that
        date,
        with limited exceptions. This replaces SFAS 141’s cost-allocation process, which
        required the cost of an acquisition to be allocated to the individual assets
        acquired and liabilities assumed based on their estimated fair values. SFAS
        141R
        also requires the acquirer in a business combination achieved in stages
        (sometimes referred to as a step acquisition) to recognize the identifiable
        assets and liabilities, as well as the noncontrolling interest in the acquiree,
        at the full amounts of their fair values (or other amounts determined in
        accordance with SFAS 141R). SFAS 141R applies prospectively to business
        combinations for which the acquisition date is on or after the beginning
        of the
        first annual reporting period beginning on or after December 15, 2008. An
        entity
        may not apply it before that date. The Company believes adopting SFAS No.
        141R
        will significantly impact its financial statements for any business combination
        completed after December 31, 2008.
  16
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  In
        June
        2008, the FASB issued Emerging Issues Task Force Issue 07-5 “Determining whether
        an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock” (“EITF
        07-5”). This Issue is effective for financial statements issued for fiscal years
        beginning after December 15, 2008, and interim periods within those fiscal
        years. Early application is not permitted. Paragraph 11(a) of Statement of
        Financial Accounting Standard No 133 “Accounting for Derivatives and Hedging
        Activities” (“SFAS 133”) specifies that a contract that would otherwise meet the
        definition of a derivative but is both (a) indexed to the Company’s own
        stock and (b) classified in stockholders’ equity in the statement of
        financial position would not be considered a derivative financial instrument.
        EITF 07-5 provides a new two-step model to be applied in determining whether
        a
        financial instrument or an embedded feature is indexed to an issuer’s own stock
        and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception.
        The
        Company believes adopting this statement will have a material impact on the
        financial statements because among other things, any option or warrant
        previously issued and all new issuances denominated is US dollars will be
        required to be carried as a liability and marked to market each reporting
        period.
 
 In
        April
        2008, the FASB issued 142-3 “Determination of the useful life of Intangible
        Assets”, which amends the factors a company should consider when developing
        renewal assumptions used to determine the useful life of an intangible asset
        under SFAS 142. This Issue is effective for financial statements issued for
        fiscal years beginning after December 15, 2008, and interim periods within
        those
        fiscal years. SFAS 142 requires companies to consider whether renewal can
        be
        completed without substantial cost or material modification of the existing
        terms and conditions associated with the asset. FSP 142-3 replaces the previous
        useful life criteria with a new requirement—that an entity consider its own
        historical experience in renewing similar arrangements. If historical experience
        does not exist then the Company would consider market participant assumptions
        regarding renewal including 1) highest and best use of the asset by a market
        participant, and 2) adjustments for other entity-specific factors included
        in
        SFAS 142. The Company is currently evaluating the impact that adopting FSP
        142-3
        will have on its financial statements.
 
 In
        June
        2008, FASB issued EITF Issue 08-4, “Transition Guidance for Conforming Changes
        to Issue No. 98-5 (“EITF 08-4”)”. The objective of EITF No.08-4 is to
        provide transition guidance for conforming changes made to EITF No. 98-5,
        “Accounting for Convertible Securities with Beneficial Conversion Features
        or
        Contingently Adjustable Conversion Ratios”, that result from EITF 00-27
“Application of Issue No. 98-5 to Certain Convertible Instruments”, and SFAS No.
        150, “Accounting for Certain Financial Instruments with Characteristics of both
        Liabilities and Equity”. This Issue is effective for financial statements issued
        for fiscal years ending after December 15, 2008. Early application is permitted.
         Management is currently evaluating the impact of adoption of EITF 08-4 on
        the accounting for the consolidated financial statements.
  **Note
        3 - Inventories**
 
 Inventories
        consisted of the following:
  17
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  September 30,
                2008
                (unaudited)
              
              December 31,
                2007Chemical
                  medicine - finished goods
              
              $
              5,262,851
              
              $
              3,948,460Inventories
              
              $
              5,262,851
              
              $
              3,948,460
 
 
 **Note
        4 - Equipment**
 
 Equipment
        consisted of the following:
 
 September 30,
                2008
                (unaudited)
              
              December 31,
                2007Furniture
                  and fixtures
              
              $
              186,557
              
              $
              174,086Equipment
              
              
              1,369,764
              
              
              1,259,434Motor
                  vehicles
              
              
              432,585
              
              
              405,382Leasehold
                  improvement
              
              
              317,530
              
              
              181,027Total
              
              
              2,306,436
              
              
              2,019,929Less
                  accumulated depreciation
              
              
              (968,990
              )
              
              (631,010
              )Equipment,
                  net
              
              $
              1,337,446
              
              $
              1,388,919
  Depreciation
        expense amounted to $96,363 and $69,245 for the three months ended September
        30,
        2008 and 2007 and $289,935, and $199,575 for the nine months ended September
        30,
        2008 and 2007, respectively.
  **Note
        5 - Customer deposits**
 
 The
        Company requires its customers to deposit monies with the Company when they
        place an order. The Company does not pay interest on these amounts. Customer
        deposits amounted to $230,276 and $203,281 as of September 30, 2008 and December
        31, 2007, respectively.
  **Note
        6 - Taxes**
 
 The
        Company is organized in the United States and no tax benefit is expected
        from
        tax credits in the future.
 
 Beginning
        January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the existing
        laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”).
  18
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 The
        key
        changes are:
 
 a.
              The
                  new standard EIT rate of 25% replaced the 33% rate currently applicable
                  to
                  both DES and FIEs, except for High Tech companies who pays a reduced
                  rate
                  of 15%;
 
 b.
              Companies
                  established before March 16, 2007 will continue to enjoy tax holiday
                  treatment approved by local government for a grace period of either
                  for
                  the next 5 years or until the tax holiday term is completed, whichever
                  is
                  sooner. These companies will pay the standard tax rate as defined
                  in point
                  “a” above when the grace period expires.
 
 The
        Company and its subsidiaries were established before March 16, 2007 and
        therefore are qualified to continue enjoying the reduced tax rate as described
        above.
 
 Under
        the
        Income Tax Laws of PRC, the Company is generally subject to income tax at
        an
        effective rate of 33% (30% state income taxes plus 3% local income taxes)
        on
        income reported in the statutory financial statements after appropriate tax
        adjustments, unless the enterprise is located in a specially designated region
        where it allows foreign enterprises a two-year income tax exemption and a
        50%
        income tax reduction for the following three years.
 
 The
        Company’s two subsidiaries, Konzern and Co-win are located and are doing
        business in China. Konzern was approved as a foreign Joint-venture enterprise
        in
        2004 and as a wholly-owned foreign enterprise in 2006. Konzern has an income
        tax
        exemption for 2004 and 2005 and a 50% reduction on the income tax rate for
        2006,
        2007 and 2008. Co-win has not obtained the approval for the tax exemption
        in
        2006, and was subjected to an effective rate of 33%.
 
 The
        estimated tax savings for the three months ended September 30, 2008 and 2007
        amounted $411,890 and $480,458 and amounted $1,252,833 and $1,018,743 for
        the
        nine months ended September 30, 2008 and 2007 respectively. The net effect
        on
        earnings per share if the income tax had been applied would decrease earnings
        per share from $0.13 to $0.10 for three months and from $0.37 to $0.29 for
        the
        nine months ended September 30, 2008 and from $0.17 to $0.13 for three months
        and from $0.36 to $0.28 for the nine months ended September 30, 2007,
        respectively
  The
        provision for income taxes for the three and nine months ended September
        30,
        2008 and 2007 consisted of the following:
 For
                  the three months ended
                September
                  30,
              
              For
                  the nine months ended
                September
                  30,2008
              
              2007
              
              2008
              
              2007Provision
                  for China income tax
              
              $
              374,445
              
              $
              436,780
              
              $
              1,138,939
              
              $
              926,130Provision
                  for local tax
              
              
              37,445
              
              
              43,678
              
              
              113,894
              
              
              92,613Tax
                  provision - PRC
              
              $
              411,890
              
              $
              480,458
              
              $
              1,252,833
              
              $
              1,018,743
   19
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 The
        following table reconciles the U.S. statutory rates to the Company's effective
        tax rate for the three months and nine months ended September 30, 2008 and
        2007:
 
 For
                  the three months ended
                September
                  30,
              
              For
                  the nine months ended
                September
                  30,2008
              
              2007
              
              2008
              
              2007U.S.
                  Statutory rates
              
              
              34.0
              %
              
              34.0
              %
              
              34.0
              %
              
              34.0
              %Foreign
                  Income not recognized
              
              
              (34.0
              )
              
              (35.0
              )
              
              (34.0
              )
              
              (34.0
              )China
                  Tax rates
              
              
              25.0
              
              
              33.0
              
              
              25.0
              
              
              33.0China
                  income tax exemption
              
              
              (8.5
              )
              
              (16.5
              )
              
              (8.5
              )
              
              (16.5
              )Effective
                  income tax rates
              
              
              16.5
              %
              
              16.5
              %
              
              16.5
              %
              
              16.5
              %
 
 
 Taxes
        payable consisted of the following:
 September 30,
                2008
              
              December 31,
                2007Income
                  taxes payable
              
              $
              16,344
              
              $
              61,908Value
                  added tax
              
              
              77,829
              
              
              405,264Other
                  income tax
              
              
              2,248
              
              
              1,012Taxes
                  payable
              
              $
              96,421
              
              $
              468,184
 
 **Note
        7 - Commitments and contingencies**
 
 The
        Company entered into a non-cancelable purchase commitment with a vendor.
        As of
        September 30, 2008, the Company was obligated under the non-cancelable
        commitment to purchase products amounting to $1,750,800. The Company has
        experienced no losses on these purchase commitments over the years.
 
 The
        Company leases its facilities under short-term and long-term, non-cancelable
        operating lease agreements expiring through September 2010. The non-cancelable
        operating lease agreement states that the Company pays certain operating
        expenses applicable to the leased premises.
  The
        future minimum annual lease payments required are as follows:
 
 Year Ending December
                  31,
              
              Amount2008
              
              $
              116,7752009
              
              
              136,7162010
              
              
              5,849Thereafter
              
              
              -
  20
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
 Total
        rent expense for the three months ended September 30, 2008 and 2007, total
        rent
        expense amounted to $24,709 and $91,866, respectively. For the nine months
        ended
        September 30, 2008 and 2007 rent expense amounted to $83,573 and $39,710,
        respectively.
 
 **Notes
        8 - Supplemental disclosure of cash flows**
 
 The
        Company received four patents for the value of $1.02 million (RMB 7.5 million)
        from its minority shareholders as payment for contributions
        receivable.
 
 For
        the
        period ended September 30, 2008, holders of preferred stock converted 111,649
        shares of Series A convertible preferred stock into 115,101 shares of common
        stock, par value $0.0001 per share.
  **Note
        9 - Statutory reserves**
 
 The
        laws
        and regulations of the People’s Republic of China require that before an
        enterprise distributes profits to its partners, it must first satisfy all
        tax
        liabilities, provide for losses in previous years, and make allocations,
        in
        proportions determined at the discretion of the board of directors, after
        the
        statutory reserve. The statutory reserves include surplus reserve fund and
        the
        enterprise fund and represent restricted retained earnings.
 
 Surplus
        reserve fund
 
 The
        Company is required to transfer 10% of its net income, as determined in
        accordance with the PRC accounting rules and regulations, to a statutory
        surplus
        reserve fund until such reserve balance reaches 50% of the Company’s registered
        capital.
 
 The
        transfer to this reserve must be made before distribution of any dividend
        to
        shareholders. For the six months ended September 30, 2008 and 2007, the Company
        did not transfer any fund to this reserve. The surplus reserve fund is
        non-distributable other than during liquidation and can be used to fund previous
        years’ losses, if any, and may be utilized for business expansion or converted
        into share capital by issuing new shares to existing shareholders in proportion
        to their shareholding or by increasing the par value of the shares currently
        held by them, provided that the remaining reserve balance after such issue
        is
        not less than 25% of the registered capital.
 
 Enterprise
        fund
 
 The
        enterprise fund may be used to acquire plant and equipment or to increase
        the
        working capital to expend on production and operation of the business. No
        minimum contribution is required and the Company did not make any contribution
        to this fund for the six months ended September 30, 2008 and 2007.
  21
  CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  **Note
        10 - Retirement benefit plans**
 
 Regulations
        in the PRC require the Company to contribute to a defined contribution
        retirement plan for all permanent employees. The contribution is based on
        a
        percentage required by the local government and the employees' current
        compensation. The Company contributed $48,484 and $32,052 for the nine months
        ended September 30, 2008 and 2007 and $18,469 and $11,816 for the three months
        ended September 30, 2008 and 2007, respectively.
 
 **Note
        11 - Shareholders’ equity**
 
 Common
        stock
  For
        the
        year ended December 31, 2007, 1,621,750 shares of warrants were exercised
        at
        $1.75 per share, 1,694,040 shares of warrants were exercised at $1.70 per
        share,
        and 725,000 shares of warrants were exercised at 2.43 per share for the year
        ended December 31, 2007. The Company received total of $7,479,681 cash from
        the
        exercise of warrants as of December 31, 2007.
 
 The
        Company entered into an investor relations consulting agreement with Hayden
        Communication International, Inc. (“HC”) dated October 11, 2006, pursuant to
        which HC is to provide the Company public relations consulting services for
        certain consideration including the issuance of 43,125 shares of the Company’s
        common stock. On July 19, 2007, these shares were issued to HC. The issuance
        of
        the shares is exempt from registration pursuant to Section 4(2) and regulation
        D
        promulgated under the Securities Act of 1933, as amended (the ‘1933 Act”) and
        should contain a standard 1933 Act restrictive legend. Therefore, the Company
        valued the common stock at $3.12 per share for a total of $179,400 for the
        43,125 shares issued; $179,400 was expensed for the year ended December 31,
        2007.
 
 During
        the period ended September 30, 2008, holders of Series A convertible preferred
        stock converted 111,649 shares into 115,101 shares of common stock. For the
        year
        ended December 31, 2007, holders converted 3,008,351 shares of Series A
        convertible preferred stock into 3,063,351 shares of common stock, par value
        $0.0001 per share.
 
 Stock
        options and warrants
 
 For
        the
        year ended December 31, 2007, 280,000 stock options were exercised at $1.25
        per
        share. The Company received a total of $350,000 cash from the stock options
        that
        were exercised.
 
 On
        April
        2, 2007, the Company granted a total of 15,000 stock options to three of
        its
        independent directors. The 7,500 options become exercisable six months from
        the
        grant date and the remaining 7,500 options, eighteen months from the grant
        date.
        For the year ended December 31, 2007, the Company expensed $16,492 related
        to
        these stock options.
  For
        the
        period ended September 30, 2008, 290,000 options were exercised at $1.25
        per
        share. The Company received a total of $362,500 cash from the exercise of
        stock
        options.
  22
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  SFAS
        requires compensation expense related to options be calculated based on the
        fair
        value of the options as of the date of grant. The fair value calculations
        take
        into account the exercise prices and expected lives of the options, the current
        price of the underlying stock, its expected volatility, the expected dividends
        on the stock, and the current risk-free interest rate for the expected life
        of
        the option. The Company has considered the volatility that might be expected
        to
        occur for companies comparable to the Company and, selected three
        publicly-traded companies whose business are similar to the Company's and
        who
        are classified in the same SIC code as the Company, have assumed a volatility
        of
        50% as being reasonably representative of the volatility that could be expected
        to occur in the future over the relevant periods. The risk-free rates used
        are
        based on Treasury Constant Maturity rates, published by the U.S. Federal
        Reserve.
 
 Since
        the
        Company does not have a history of employee stock options, the estimated
        life is
        based on one half of the sum of the vesting period and the contractual life
        of
        the option. The Company expensed $31,553 and $21,279 for the three months
        ended
        September 30, 2008 and 2007 and $42,465 and $62,005 for the nine months ended
        September 30, 2008 and 2007, respectively, for stock-based compensation.
        For the
        period ended September 30, 2008, the Company expensed $41,002 related to
        these
        warrants.
 
 The
        Company used the Cox-Ross-Rubinstein binomial model to value the options,
        Warrants and the embedded conversion option of the Series A Preferred Stock.
        The
        following assumptions were used in the preparation of the above valuations
        at
        inception:
  Assumption
              
              Preferred Stock
              
              Warrants A
              
              Warrants B
              
              Stock optionsMarket
                  price of stock
              
              $
              0.81
              
              $
              0.81
              
              $
              2.26
              
              $
              1.90-1.98Expected
                  life
              
              
              Perpetual
              
              
              5
                  years
              
              
              3.86
                  years
              
              
              2.5
                  yearsVolatility
              
              
              
              
              
              50
              %
              
              50
              %
              
              50-78
              %Risk-free
                  rate
              
              
              
              
              
              4.55
              %
              
              3.40
              %
              
              Varies
 
 Option
                  activity:
              
              Outstanding
              
              Exercisable
              
              Weighted-Average
                  Exercise Price
              
              Weighted-Average
                  Remaining Contractual Term (years)
              
              Intrinsic
                  ValueDec
                  31, 2006
              
              
              1,370,000
              
              
              944,000
              
              
              1.25
              
              
              1.48
              
              $
              2,479,700Granted
              
              
              15,000
              
              
              7,500
              
              
              3.00
              
              
              5.00Exercised
              
              
              (280,000
              )
              
              (280,000
              )
              
              1.25Forfeited
              
              
              -
              
              
              -Dec
                  31, 2007
              
              
              1,105,000
              
              
              671,500
              
              
              1.91
              
              
              0.53
              
              $
              1,041,750Granted
              
              
              15,000
              
              
              -
              
              
              2.01
              
              
              4.83Exercised
              
              
              (290,000
              )
              
              (290,000
              )
              
              1.25Forfeited
              
              
              -
              
              
              -Sep
                  30, 2008 (unaudited)
              
              
              830,000
              
              
              339,500
              
              
              1.28
              
              
              0.20
              
              $
              503,500
  23
 CHINA
          MEDICINE CORPORATION AND SUBSIDIARIES
 
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
          30, 2008
 (Unaudited)
  WarrantsWarrant activity:
              
              Outstanding
              
              Fair Market
                  Value
              
              Weighted
                  Average Exercise Price
              
              Weighted-Average
                  Remaining Contractual Term (years)Dec
                  31, 2006
              
              
              7,389,476
              
              
              0.81
              
              
              2.13
              
              
              4.17Granted
              
              
              70,000
              
              
              2.37
              
              
              2.26
              
              
              3.86Exercised
              
              
              (4,040,790
              )
              
              3.18
              
              
              1.85Forfeited
              
              
              -Dec
                  31, 2007
              
              
              3,418,686
              
              
              2.85
              
              
              2.35
              
              
              3.17Granted
              
              
              -Exercised
              
              
              -Forfeited
              
              
              -Sep
                  30, 2008 (unaudited)
              
              
              3,418,686
              
              
              2.85
              
              
              2.35
              
              
              2.68
 
 24





**Item
      2. Management’s Discussion and Analysis or Plan of
      Operation**





*FORWARD-LOOKING
      INFORMATION - Management's Discussion and Analysis of Financial Condition and
      Results of Operations ("MD&A") includes "forward-looking statements". All
      statements, other than statements of historical facts, included in this report
      regarding the Company's financial position, business strategy and plans and
      objectives of management of the Company for future operations are
      forward-looking statements. These forward-looking statements rely on a number
      of
      assumptions concerning future events and are subject to a number of
      uncertainties and other factors, many of which are outside of the Company's
      control, that could cause actual results to materially differ from such
      statements. While the Company believes that the assumptions concerning future
      events are reasonable, it cautions that there are inherent difficulties in
      predicting certain important factors, especially, the prospects for future
      acquisitions; the possibility that a current customer could be acquired or
      otherwise be affected by a future event that would diminish their medicine
      products requirements; the competition in the medical product market and
      governmental price policy on medical products and the impact of such factors
      on
      pricing, revenues and margins; and the cost of attracting and retaining highly
      skilled personnel.*





**Overview**





China
      Medicine Corporation (“we,” “us” or the “Company”), through Guangzhou Konzern
      Medicine Co., Ltd. (“Konzern”), our wholly owned subsidiary organized under the
      laws of the People’s Republic of China (the “PRC” or “China”), is a distributor
      of approximately 2,300 pharmaceutical products in China. Also as a developer
      of
      innovative pharmaceutical products, the Company currently has four patents
      registered with the PRC State Food and Drug Administration (the “SFDA”), and has
      seven other patents pending for approval. Co-win Bio-Engineering Ltd.
      (“Co-Win”), a PRC joint-venture company we created together with another entity
      (Konzern owns 70% ), has three patents related to ADTZ, an enzyme designed
      to
      eliminate a harmful toxin from food and animal feed. In 2007, Co-Win applied
      for
      patents in 20 different countries and regions including Australia, Canada,
      the
      European Union (including Germany, France, Britain, Italy, Spain, Portugal,
      Sweden, Swiss and Turkey), Indonesia, Israel, Japan, South Korea, Mexico,
      Russia, South Africa, the U.S., Hong Kong and India in 2007. Co-Win obtained
      a
      patent for ADTZ from the Australia Patent Office in July 2008 and a patent
      for
      ADTZ for South Africa in October 2008. Patent application approval for ADTZ from
      South Korea was made public in September 2008 and is pending; we expected to
      receive the official approval shortly. The other patent applications are under
      review as of the date of this report





We
      generate revenue in two ways, the distribution of pharmaceutical products
      obtained from suppliers and the sale of intellectual property, including drug
      formulas and technology, to third parties including manufacturing companies.
      In
      the future, we plan to obtain more national and provincial distribution rights
      for pharmaceutical products and therefore enhance our ability to gain higher
      profit.





The
      pharmaceutical products we distribute include prescription and over-the-counter
      (“OTC”) drugs, Chinese herbs, traditional Chinese medicines made from Chinese
      herbs, nutritional supplements, dietary supplements and medical instruments.





We
      believe that our unique competitive advantages include our ownership of good
      research and development facilities, our excellent after-sale customer service,
      and the sole nationwide or region-wide distribution rights to certain medical
      products. Our competitive pricing and our ability to provide timely delivery
      are
      also important factors to attract and retain our customers.





Our
      distribution business depends on our ability to acquire and distribute our
      products in the Chinese markets. Typically, exclusive nationwide or regional
      distribution rights yield higher profit margins than non-exclusive distribution
      rights. In addition to our exclusive rights to nationwide distribution of seven
      products made by our suppliers, we also have obtained distribution rights
      throughout Guangdong Province of 774 products made by our suppliers through
      that
      province’s on-line bidding system, called the Guangdong Sunshine Bid Program. We
      expect to obtain additional distribution rights through that system in the
      future.




25




In
      the
      nine months ended September 30, 2008, sales of the seven products as to which
      we
      had nationwide exclusive sales rights from our suppliers accounted for
      $10,992,735, or 37.63%, of our sales as compared to sales of those products
      (as
      to which we had the same rights) of $6,442,355, or 24.83% of sales in the nine
      months ended September 30, 2007. Sales revenue related to the seven products
      increased $4,550,380 during the same period. Sales revenue from products that
      we
      distribute in Guangdong province at September 30, 2008, amounted to $10,124,535,
      or 34.65% of sales in that period; an increase of $502,156 as compared to the
      period ended September 30, 2007.





Our
      contracts with our customers do not require minimum purchases, and our customers
      are not restricted from purchasing competitive products from others. Our
      customers are typically wholesale medical product companies, hospitals and
      retail drug stores. Our five largest customers accounted for 50.15% and 46%
      of
      our sales for the nine months ended September 30, 2008 and 2007, respectively.





Our
      largest account receivable at September 30, 2008 was approximately $5,118,277,
      representing approximately 12.65% of our total assets and approximately 15.03%
      of our working capital. Our three largest accounts receivable totaled
      approximately $7,891,854, representing approximately 19.51% of our total assets
      and approximately 23.17% of our working capital. Because a substantial portion
      of our sales are made to a small number of customers, our accounts receivable
      from a small number of customers may represent a large percentage of our
      accounts receivable and assets. We will continue to explore more customer groups
      in an effort to reduce our reliance on our major customers in the fourth
      quarter.





Our
      five
      largest suppliers accounted for 47.15% and 69.98% of our purchases for the
      nine
      months ended September 30, 2008 and September 30, 2007, respectively. Our
      agreements with our suppliers generally have a term of one year and state that
      the suppliers will provide us with the products we order. None of our supply
      agreements have minimum purchase requirements on our part. However, we are
      frequently required to make a significant down payment when we place an order.
      These down payments are made pursuant to contracts with the suppliers, and
      to
      the extent that we reduce the size of the order, we will receive a credit from
      the supplier. Down payments to our suppliers as of September 30, 2008 and
      December 31, 2007 accounted for 15% and 25% of the total advance payments to
      our
      suppliers respectively. In addition to down payments, we also make advance
      payments to our suppliers in exchange for receiving favorable prices, which
      enable us to offer competitive prices to our customers. The balance of our
      advances to suppliers was $9,976,022 and $5,983,277 as of September 30, 2008
      and
      December 31, 2007, respectively.





Our
      typical collection period ranges from three months to one year. In addition,
      because we generally need one to two months to receive products from our
      suppliers, we have been increasing our inventory in order to have product
      available to meet anticipated orders. Furthermore, we must pay our suppliers
      in
      advance, and in some cases we must maintain funds on deposit with the supplier.
      These factors require us to use significant cash in our operations.





*Developments
      That Will Affect Our Business Going Forward*





On
      August
      31, 2008, bidding and negotiation for the 2008 Guangdong Province On-Line
      Sunshine Bidding System ended. In each of the 22 provincial bidding districts,
      we succeeded in obtaining rights to distribute more than 100 products through
      the system. Also during the third quarter of 2008, we registered to participate
      in the 2009 Guangdong Province On-Line Sunshine Bidding System and renewed
      our
      registration as a distributor of pharmaceutical products to governmental public
      medical facilities for the period from September 1, 2008 to August 31, 2009.
      We
      expect that sales of products for which we gained distribution rights through
      the Sunshine Bidding System will continue to contribute significantly to our
      revenue over the next several quarters.




26




On
      July
      16, 2008, we began the first trial sales of products in the U.S. The product
      we
      are selling in the U.S. is a food supplement, Bethin Tablets, which is designed
      for use as a weight-loss aid. Bethin Tablets was developed by our subsidiary
      Konzern US Holding Corporation, and trial sales have occurred in Houston, Texas.
      We also attended the Natural Food Expo East, a trade show which was held in
      Boston in October, to explore resources and relationships that may assist us
      in
      distribution of Bethin Tablets in the U.S. and in making sales of the product
      in
      other countries. We are also actively exploring the Hong Kong market. We have
      obtained trademark protection from the Hong Kong government for our Konzern
      and
      Bethin marks and have registered with the Hong Kong Trade Development Council
      to
      search for potential distributors in Hong Kong.





We
      have
      communicated with a Pakistani importer for the export of Levocarnitine Powder
      Injection to Pakistan and delivered documentation and samples of the product.
      Currently, we are waiting for the official approval for the pricing of
      Levocarnitine Powder Injection from the food and drug regulatory authority
      in
      Pakistan. We expect that the export of Levocarnitine Powder Injection will
      help
      to extend our overseas business.





During
      the Beijing Olympic and Paralympic Games of 2008, for security reasons, the
      government ceased all toxic tests and prohibited the delivery of all toxic
      raw
      materials. Aflatoxin, a substance needed for tests of our ADTZ product, is
      a
      highly toxic substance. Suppliers in Beijing ceased the supply of aflatoxin
      throughout the third quarter, and our R&D staff called a halt to the tests
      that we worked on together with the Feed Research Institute of the Chinese
      Academy of Agriculture Sciences. We restarted the ADTZ tests in October and
      focused on the improvement of zymosis technology and the enhancement of ADTZ’s
      capacity to detoxify animal feeds. In addition, we expect to rent a
      manufacturing facility for ADTZ and to apply for a production permit, which
      will
      facilitate the commercialization of ADTZ.





The
      national government has announced its intention to establish a national health
      care system to cover over 90% of municipal and rural citizens by 2020, and
      the
      government also encourages large public hospitals and medical service facilities
      to provide citizens with safe, convenient and sufficient medical care. We
      believe this policy will boost the sales of pharmaceutical products. The more
      area the public medical care system covers, the larger demand of pharmaceutical
      products will be.





In
      addition, sales of daily health care and dietary supplements are growing rapidly
      in China, and sales of products that address the daily health needs of
      individuals with significant health issues population have been growing rapidly.
      Currently, we are actively participating in the development of daily health
      care
      products. We expect to launch a self-branded dietary supplement pack in the
      first six months of 2009.





On
      November 9, 2008, the State Council of the PRC announced a US$586 billion
      economic stimulus package aimed at bolstering the country's slowing economy
      and
      helping fight the effects of any global economic slowdown. This stimulus plan
      may facilitate our operation and development in the following ways.




·
            The
                government is committed to increase the investment in medical care
                and
                financial support to hospitals, which we believe is likely to reduce
                the
                collection period of accounts receivable from hospitals.





·
            The
                State Council passed revised regulations on VAT, consumption tax
                and
                business tax, a part of the stimulus package, which would enable
                companies
                to receive tax deductions on spending on fixed assets.




27




·
            The
                government loosened restrictions on commercial credit and provided
                greater
                financial support to medium and small size enterprises. We believe
                this
                will improve the cash flow situation of our suppliers and clients,
                which
                in turn may reduce our accounts
                receivable.





Because
      our business is conducted in the PRC, all of our transactions are accounted
      for
      in Chinese Yuan. Our financial condition and the results of our operations,
      expressed in terms of United States dollars, depend on the applicable currency
      exchange rate, which can change significantly from period to period and may
      be
      affected by the relationship between the United States and the PRC.




**Results
      of Operations**





The
      following table sets forth our statements of operations for the three and nine
      months ended September 30, 2008 and 2007, in U.S. dollars: (unaudited)




Three Months Ended
              September 30,
            
            Nine Months Ended
              September 30,2008
            
            2007
            
            2008
            
            2007Revenue
            
            $
            10,516,792
            
            $
            12,588,938
            
            $
            29,215,370
            
            $
            25,945,901Product
                sales
            
            
            9,963,571
            
            
            11,904,525
            
            
            27,882,029
            
            
            24,552,269Medical
                formula sales
            
            
            553,221
            
            
            684,413
            
            
            1,333,341
            
            
            1,393,632Costs
                of goods sold
            
            
            7,255,635
            
            
            8,765,477
            
            
            19,485,824
            
            
            18,029,902Gross
                profit
            
            
            3,261,157
            
            
            3,823,461
            
            
            9,729,546
            
            
            7,915,999R&D
                expenses
            
            
            288,353
            
            
            336,794
            
            
            484,569
            
            
            437,449Selling,
                general and administrative costs
            
            
            642,919
            
            
            830,518
            
            
            2,515,509
            
            
            2,435,288Income
                from operations
            
            
            2,329,885
            
            
            2,656,149
            
            
            6,729,468
            
            
            5,043,262Other
                income, net
            
            
            7,368
            
            
            13,694
            
            
            45,455
            
            
            3,604Income
                before income taxes & Minority interest
            
            
            2,337,253
            
            
            2,669,843
            
            
            6,774,923
            
            
            5,046,866Provision
                for income taxes
            
            
            411,890
            
            
            480,458
            
            
            1,252,833
            
            
            1,018,743Income
                before minority interest
            
            
            1,925,363
            
            
            2,189,385
            
            
            5,522,090
            
            
            4,028,123Minority
                interest
            
            
            39,777
            
            
            16,529
            
            
            85,087
            
            
            68,646Net
                income
            
            
            1,965,140
            
            
            2,205,914
            
            
            5,607,177
            
            
            4,096,769Other
                comprehensive income
              (Foreign
                currency translation adjustment)
            
            
            97,869
            
            
            341,114
            
            
            2,169,693
            
            
            900,439Comprehensive
                income
            
            $
            2,063,009
            
            $
            2,547,028
            
            $
            7,776,870
            
            $
            4,997,208





Our
      revenue is derived primarily from the sale of prescription and over the counter
      medicines, traditional Chinese medicines, which are medicines derived from
      Chinese herbs, dietary supplements and medical instruments (collectively
“Product Sales”) and the sale of medical formulas (“Medical Formula Sales”). The
      following table sets forth the revenues and percentage of revenues derived
      from
      each of these types of products.




28





Nine Months Ended September 30,2008
            
            2007Drugs
            
            $
            27,261,660
            
            
            93.31
            %
            $
            24,239,169
            
            
            93.42
            %Dietary
                Supplements
            
            
            177,949
            
            
            0.61
            %
            
            48,448
            
            
            0.19
            %Medical
                Equipment
            
            
            422,819
            
            
            1.45
            %
            
            79,950
            
            
            0.31
            %Others
            
            
            19,601
            
            
            0.07
            %
            
            179,693
            
            
            0.69
            %Herbs
                & Medicine materials
            
            
            0
            
            
            0
            %
            
            5,009
            
            
            0.02
            %Medical
                Formula
            
            
            1,333,341
            
            
            4.56
            %
            
            1,393,632
            
            
            5.37
            %Total
            
            $
            29,215,370
            
            
            100
            %
            $
            25,945,901
            
            
            100
            %







Nine Months Ended September 30,2008
            
            2007Western
                Prescription Products
            
            $
            17,899,710
            
            
            61.27
            %
            $
            12,916,645
            
            
            49.78
            %Western
                Over-the-Counter Products
            
            
            841,969
            
            
            2.88
            %
            
            634,949
            
            
            2.45
            %TCM
                Prescription Products
            
            
            5,612,014
            
            
            19.21
            %
            
            3,322,787
            
            
            12.81
            %TCM
                Over-the-Counter Products
            
            
            2,907,967
            
            
            9.95
            %
            
            7,364,789
            
            
            28.39
            %Drugs/Dietary
                Supplements Total
            
            $
            27,261,600
            
            
            93.31
            %
            $
            24,239,169
            
            
            93,42
            %








**THE
      THREE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THE THREE MONTHS ENDED
      SEPTEMBER 30, 2007**





Sales





Total
      revenue for the three months ended September 30, 2008 was $10,516,792, a
      decrease of $2,072,146, or 16.46%, from total revenue of $12,588,938 for the
      comparable period in 2007. Total revenue includes revenue from Product Sales
      and
      r evenue
      from Medical Formula Sales, which accounted for 94.75% and 5.25% of total
      revenue for the
      three
      months ended September 30, 2008 respectively.




Revenue
      from Product Sales for the three months ended September 30, 2008 was
      $ 9,963,571,
      a decrease of $1,940,954, or 16.30%, from $11,904,525 for the comparable period
      in 2007. Revenue from Product Sales includes revenue from sales of
      pharmaceutical products that we distribute and sales of products for which
      we
      hold a manufacturing license. Revenue from sales of pharmaceutical products
      we
      distribute for the three months ended September 30, 2008 was $9,004,779,
      accounting for 85.62% of the total revenue for the period, which was a decrease
      of $1,680,505, or 15.73%, from $10,685,284 for the comparable period in 2007.
      In
      particular, revenue from sales of products we distribute nationwide was
      $3,622,114, which accounts for 34.44% of the total revenue for the three months
      ended September 30, 2008. Revenue from sales of products we distribute
      regionally was $1,998,894, which accounts for 19.01% of the total revenue for
      the three months ended September 30, 2008. Revenue from sales of products for
      which we acquired distribution rights through the Guangdong Sunshine Bidding
      System was $3,383,772, which accounts for 32.17% of total revenue, for the
      three
      months ended September 30, 2008, a decrease of $1,383,533 from $4,767,305 for
      the same period in 2007.




29





Revenue
      from sales of products for which we hold a manufacturing license for the three
      months ended September 30, 2008 was $958,792, accounting for 9.12% of total
      revenue for the three months ended September 30, 2008, and representing a
      decrease of $260,449 or 21.36% from $1,219,241 for the comparable period in
      2007.





The
      decrease of revenue from product sales for three months ended September
      30, 2008 was
      due primarily to the following factors:





·
            Administrative
                delay in the execution of Guangdong Sunshine Medicine Public Internet
                Bidding Systems, which is typically held from May to July of each
                year.
                During the three months ended September 30, 2008, we had to allocate
                our
                resources to negotiating with hospitals, which is crucial to win
                bids in
                the public internet bidding systems. The sales from Guangdong Sunshine
                Medicine Public Internet Bidding Systems which would typically have
                been
                confirmed in the third quarter were postponed to be finalized in
                the
                fourth quarter. As of the date of this report, we have finalized
                all bids
                that we won through the system in September.





·
            Substantial
                decrease of revenue from sales of OTC products for the three months
                ended
                September 30, 2008.In
                order to increase our gross margin, we adjusted our sales strategy
                and
                distribution portfolio by focusing on increasing the sales of high-margin
                prescription products and reducing the sales of low-margin OTC products.
                Hence, revenue from sales of western OTC products for the three months
                ended September 30, 2008 was $189,603, a decrease of $55,008, or
                22.49%,
                from $244,611 for the comparable period in 2007. Revenue from sales
                of
                Traditional Chinese Medicine OTC products for three months ended
                September
                30, 2008 was $677,460, a decrease of $3,505,954, or 83.81%, from
                $4,183,414 for the comparable period in 2007. The decrease of sales
                of OTC
                products is part of our sales strategy, which is designed to promote
                our
                gross margin and gross profit in the long term.





Revenue
      from sales of western prescription products for the three months ended September
      30, 2008 was $6,763,825, an increase of $1,150,061 or 20.49% from $5,613,764
      for
      the comparable period in 2007. Revenue from sales of TCM prescription products
      for the three months ended September 30, 2008 was $2,102,322, an increase of
      $305,905 or 17.03% from $1,796,417 for the comparable period in
      2007.





Revenue
      from Medical Formula Sales for the three months ended September 30, 2008 was
      $553,221, a decrease of $131,192 or 19.17%, from $684,413 for the comparable
      period in 2007. Medical For mula
      Sales revenues represent proceeds from the sale of certain technology and
      know-how relating to the production of medicines. We improve and develop the
      technology in its preliminary stage and then sell the improved technology to
      other pharmaceutical companies. Recent PRC government regulation has focused
      increasing attention to the effectiveness and safety of pharmaceutical products
      and food, has increased the burdens of our research and development efforts,
      and
      has resulted in the slower pace of our medical formula sales. In the future,
      we
      believe our medical formula sales will greatly rely on the sales of formulas
      relating to ADTZ.





Cost
      of Sales





Cost
      of
      sales for the three months ended September 30, 2008 was $7,255,635 a decrease
      of
      $1,509,842, or 17.22%, from $8,765,477 for the comparable period in 2007. Gross
      profit for the three months ended September 30, 2008 was $3,261,157, a decrease
      of $562,304, or 14.71 %, from $3,823,461 for the comparable period of 2007.
      Our
      gross margin for the three months ended September 30, 2008 was 31.01% as
      compared with 30.37% for the three months ended September 30, 2007, an increase
      of 0.64%. The
      main
      reasons for the decrease in gross profit for three months ended September 30,
      2008 are the decrease of revenue from sales of medical formulas, the decrease
      of
      revenue from sales of both western and Traditional Chinese Medicine OTC
      products, and a delay in collection of accounts receivable from our hospitals
      customers. The increase in gross margin is due to our strategy of decreasing
      sales of lower-margin OTC products in order to increase our gross margin. We
      intend to continue to improve our product portfolio in order to maintain a
      high
      gross margin. In the long run, we intend to increase total sales as well as
      gross margin.




30




Research
      and Development





Research
      and development expenses for the three months ended September 30, 2008 were
      $288,353, an amount equal to 2.74% of total revenue, which was dedicated to
      further study of the molecular structure and technology improvement of the
      Yutian capsule. Research and development expenses for the same period of 2007
      were $336,794, or approximately 2.67% of total revenue. Research and development
      expense for the whole year 2007 was $651,990, or 1.55% of total revenue. We
      expect research and development expense as a percentage of revenues in 2008
      to
      remain consistent with that of 2007.





Selling,
      General and Administrative Expenses





Selling,
      general and administrative expenses were $642,919 for the three months ended
      September 30, 2008, a decrease of $187,599, or 22.59%, from $830,518 for the
      comparable period in 2007. Selling, general and administrative expenses include
      freight, professional service fees and advertising expenses. The reduction
      in
      selling, general and administrative expenses was due primarily to the reduction
      in advertising expenses, which were $39,777 for the three months ended September
      30, 2008, compared to $325,189 for the comparable period of 2007. Advertising
      expenses were lower in the more recent period because most of our advertising
      during that period had been prepaid. Due to the increase in worldwide oil
      prices, freight for the three months ended September 30, 2008 was $96,906.




Income
      Taxes





Provision
      for income taxes was $411,890 for the three months ended September 30, 2008
      as
      compared with $480,458 for the comparable period in 2007. The decrease was
      due
      to the decrease of product sales and operating income.




Comprehensive
      Income





Comprehensive
      income for the three months ended September 30, 2008, was $2,063,009, a decrease
      of $484,019 from $2,547,028 for the comparable period in 2007. The decrease
      was
      mainly due to the decrease in total revenues, the revenue from medical formula
      and the collection of account receivable from hospitals in
      particular.





**THE
      NINE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
      30, 2007**





Sales





Total
      revenue for the nine months ended September 30, 2008 was $29,215,370, an
      increase of $3,269,469, or 12.60%, from the total revenues of $25,945,901 for
      the comparable period in 2007.




31




Revenue
      from Product Sales for the nine months ended September 30, 2008 was $27,882,029,
      an increase of $3,329,760, or 13.56%, from $24,552,269 for the comparable period
      in 2007. The
      main
      reason for the increase of Revenue from Product Sales for the nine months ended
      September 30, 2008 was the increase of revenue from sales of products for which
      we have national exclusive distribution rights in the latter period. The revenue
      from national exclusive distribution for the nine months ended September 30,
      2008 was $8,752,860, an increase of $4,345,209, or 98.58%, from $4,407,651
      for
      the comparable period in 2007. Revenue from sales of regional distribution
      for
      the nine months ended September 30, 2008 was $6,757,421, a decrease of
      $1,716,695 or 20.26%, from $8,474,116 for the comparable period in
      2007.





Revenue
      from sales of products for which we hold a manufacturing license for the nine
      months ended September 30, 2008 was $2,247,214, an increase of $199,091 from
      $2,048,123 for the comparable period in 2007. Revenues from sales of products
      for which we have exclusive distribution rights for the nine months ended
      September 30, 2008 were $16,630,036, an increase of $4,811,174 from $11,818,862
      for the comparable period in 2007.





Revenues
      from Medical Formula Sales for the nine months ended September 30, 2008 were
      $1,333,341, a decrease of $60,291, or 4.33%, from $1,393,632 for the comparable
      period in 2007.





Cost
      of Sales





Cost
      of
      sales for the nine months ended September 30, 2008 was $19,485,824, an increase
      of $1,455,922, or 8.08%, from $18,029,902 for the first nine months of 2007.
      Gross profit for the nine months ended September 30, 2008 was $9,729,546, an
      increase of $1,813,547, or 22.91%, from $7,915,999 for the comparable period
      of
      2007. Our gross margin for the nine months ended September 30, 2008 was 33.30%
      as compared with 30.51% for the nine months ended September 30, 2007, an
      increase of 2.79%. The reason for the increase in cost of sales is the increase
      in total revenue described above.





Research
      and Development





Research
      and development expense was $484,569, an amount equal to 1.66% of total revenue
      for the nine months ended September 30, 2008. It was used for the further study
      of molecular structure and technology improvement of the Yutian capsule.
      Research and development expense for the same period of 2007 was $437,449,
      or
      1.69% of total revenue. Research and development expense for the whole year
      2007
      was $651,990, or 1.55% of total revenue. We expect our research and development
      expense as a percentage of revenues will remain consistent for 2008 compared
      to
      2007.





Selling,
      General and Administrative Expenses





Selling,
      general and administrative expenses were $2,515,509, which accounted for 8.61%
      of total revenue for the nine months ended September 30, 2008, an increase
      of
      $80,221, or 3.29%, from $2,435,288, which accounted for 9.39% of total revenue
      for the comparable period in 2007. Selling, general and administrative expenses
      included transportation, salary, and advertising expense, which increased $239,506 for the
      nine months ended September 30, 2008 as compared to the same period in 2007. The
      amortization expense for the nine months ended September 30, 2008 decreased
      by
      $174,620 compared with the comparable period of 2007.





The
      increase of selling, general and administrative expense is primarily due to
      the
      increase in international oil prices in the nine months ended September 30,
      2008, causing our fuel costs and transportation costs to increase greatly.
      The
      increase in salary expenses also contributed to the increase in selling, general
      and administrative expenses. The primary reasons for the increase in salary
      expenses are that China is experiencing nationwide inflation, which we believe
      requires us to increase salaries in order to remain competitive, and that the
      Guangzhou Municipality Board of Labor and Social Security recently published
      guidance encouraging private enterprises to increase their salaries by 14%.




32




Income
      Taxes





Provision
      for income taxes was $1,252,833 for the nine months ended September 30, 2008
      as
      compared with $1,018,743 for the comparable period in 2007. The increase was
      due
      to the increase of product sales and operating income.





Comprehensive
      Income





Comprehensive
      income for the nine months ended September 30, 2008, was $7,776,870, an increase
      of $2,779,662 from $4,997,208 for the comparable period in 2007. The increase
      was mainly due to the increase in revenues from our Product Sales.




**Liquidity
      and Capital Resources**





As
      of
      September 30, 2008, we had working capital of $34,064,708, an increase of
      $5,520,347 from $28,544,361 as of December 31, 2007.





We
      used
      cash of $744,303 in our operations for the nine months ended September 30,
      2008,
      a decrease of $1,100,475 from $1,844,778 of cash used for the comparable period
      of 2007.





The
      following table sets forth the changes in certain balance sheet items, in
      dollars and percentages, from December 31, 2007 to September 30, 2008.





Balance Sheet Caption
            
            Change in dollars
              12/31/07 to 09/30/08
            
            Percentage Change
              12/31/07 to 09/30/08Accounts
                receivable
            
            $
            1,655,747
            
            
            12.15
            %Notes
                receivables
            
            
            1,221,605
            
            
            100
            %Inventories
            
            
            1,314,391
            
            
            33.29
            %Advances
                to suppliers
            
            
            3,992,745
            
            
            66.73
            %Accounts
                payable
            
            
            8,968
            
            
            11.66
            %Customer
                deposits
            
            
            26,995
            
            
            13.28
            %








The
      change in these balance sheet captions reflects the nature of the cash
      requirements of our business. In the nine months ended September 30, 2008,
      due
      to both increasing inflation rates and cash flow pressures from our clients,
      our
      receivables collection cycle was extended to 142 days, compared to 94 days
      for
      the comparable period in 2007. Because we require one to two months to receive
      products we order, we have been increasing our inventories in order to enable
      us
      to meet anticipated increases in sales. From December 31, 2007 to September
      30,
      2008, our inventories increased 33.29%. The increase of inventory reflects
      the
      increase of our purchase of goods compared with our sales.





Our
      advances to suppliers increased 66.73% in the first half of 2008 because of
      an
      increase in our purchases resulting from increased sales and our payment
      policies, whereby we try to pay our suppliers in advance. In addition, our
      customer deposits increased 13.28% from December 31, 2007 to September 30,
      2008,
      reflecting increased sales. Because of the significant increase in sales, we
      have managed to maintain the cash turnover cycle. We expect that the advances
      we
      pay to our suppliers will decrease gradually at the end of the fiscal year
      ending December 31, 2008. We require our customers to pay a certain percentage
      of the sales price as deposit before we ship products to the customers. During
      the period ended September 30, 2008, we received $1.2 million in notes
      receivable from our customers. Notes receivable are guarantees of payment from
      the customers’ banks.




33




In
      addition, we paid $2,787,015 as a deposit on a patent for a method of
      manufacturing BCG (Bacillus Calmette-Guerin) vaccine, which was developed as
      a
      vaccine for tuberculosis and is now used as a treatment for bladder cancer.
      Specifically, in on June 1, 2008, we entered into an agreement relating to
      the
      patent with Guangzhou Hongyuan Pharmaceutical Company (“Hongyuan”). Hongyuan and
      the Drug Research Centre of Guangdong Province are carrying out research on
      BCG.
      Under the agreement, we paid to Hongyuan a deposit of approximately $2.8 million
      toward the purchase of a manufacturing license for BCG vaccine. The deposit
      was
      paid to Hongyuan in three installments in June, July and September 2008. We
      expect that it will take approximately two years for Hongyuan to complete
      clinical experiments for the BCG project, and Hongyuan will return the entire
      deposit to us if it fails to complete the experiments within two years. The
      agreement with Hongyuan is attached as Exhibit 10.1 to this report.





We
      intend
      to use our available funds to accelerate the development and testing of new
      drugs. We believe that our available funds will provide us with sufficient
      capital for at least the next twelve months; however, we may acquire one or
      two
      production facilities to manufacture our own products. To the extent that we
      make acquisitions or establish our own production facilities, we may require
      additional capital for the acquisition or for the operation of the combined
      companies. We cannot assure that such funding will be available.





**Recently
      Issued Accounting Pronouncements**





In
      February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
      Assets and Financial Liabilities—including an amendment of FASB Statement No.
      115 (“FAS 159”). FAS 159 permits companies to choose to measure many financial
      instruments and certain other items at fair value that are not currently
      required to be measured at fair value. The objective of FAS 159 is to provide
      opportunities to mitigate volatility in reported earnings caused by measuring
      related assets and liabilities differently without having to apply hedge
      accounting provisions. FAS 159 also establishes presentation and disclosure
      requirements designed to facilitate comparisons between companies that choose
      different measurement attributes for similar types of assets and liabilities.
      SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year
      that begins after November 15, 2007. The Company adopted SFAS No. 159 on January
      1, 2008. The Company chose not to elect the option to measure the fair value
      of
      eligible financial assets and liabilities.





In
      June
      2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
      Nonrefundable Advance Payments for Goods or Services Received for use in Future
      Research and Development Activities” (“FSP EITF 07-3”), which addresses whether
      nonrefundable advance payments for goods or services that used or rendered
      for
      research and development activities should be expensed when the advance payment
      is made or when the research and development activity has been performed. The
      Company adopted FSP EITF 07-3 and expensed the research and development as
      incurred.





In
      December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
      Consolidated Financial Statements - an amendment of Accounting Research Bulletin
      No. 51” (“SFAS 160”), which establishes accounting and reporting standards for
      ownership interests in subsidiaries held by parties other than the parent,
      the
      amount of consolidated net income attributable to the parent and to the
      noncontrolling interest, changes in a parent’s ownership interest and the
      valuation of retained non-controlling equity investments when a subsidiary
      is
      deconsolidated. The Statement also establishes reporting requirements that
      provide sufficient disclosures that clearly identify and distinguish between
      the
      interests of the parent and the interests of the non-controlling owners. SFAS
      160 is effective for fiscal years beginning after December 15, 2008. The Company
      has not determined the effect that the application of SFAS 160 will have on
      its
      consolidated financial statements.




34




In
      December 2007, Statement of Financial Accounting Standards No. 141(R), Business
      Combinations, was issued. SFAS No. 141R replaces SFAS No. 141, Business
      Combinations. SFAS 141R retains the fundamental requirements in SFAS 141 that
      the acquisition method of accounting (which SFAS 141 called the purchase method)
      be used for all business combinations and for an acquirer to be identified
      for
      each business combination. SFAS 141R requires an acquirer to recognize the
      assets acquired, the liabilities assumed, and any noncontrolling interest in
      the
      acquiree at the acquisition date, measured at their fair values as of that
      date,
      with limited exceptions. This replaces SFAS 141’s cost-allocation process, which
      required the cost of an acquisition to be allocated to the individual assets
      acquired and liabilities assumed based on their estimated fair values. SFAS
      141R
      also requires the acquirer in a business combination achieved in stages
      (sometimes referred to as a step acquisition) to recognize the identifiable
      assets and liabilities, as well as the noncontrolling interest in the acquiree,
      at the full amounts of their fair values (or other amounts determined in
      accordance with SFAS 141R). SFAS 141R applies prospectively to business
      combinations for which the acquisition date is on or after the beginning of
      the
      first annual reporting period beginning on or after December 15, 2008. An entity
      may not apply it before that date. The Company believes adopting SFAS No. 141R
      will significantly impact its financial statements for any business combination
      completed after December 31, 2008.





In
      June
      2008, the FASB issued Emerging Issues Task Force Issue 07-5 “Determining whether
      an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock” (“EITF
      No. 07-5”). This Issue is effective for financial statements issued for fiscal
      years beginning after December 15, 2008, and interim periods within those fiscal
      years. Early application is not permitted. Paragraph 11(a) of Statement of
      Financial Accounting Standard No 133 “Accounting for Derivatives and Hedging
      Activities” (“SFAS 133”) specifies that a contract that would otherwise meet the
      definition of a derivative but is both (a) indexed to the Company’s own stock
      and (b) classified in stockholders’ equity in the statement of financial
      position would not be considered a derivative financial instrument. EITF No.07-5
      provides a new two-step model to be applied in determining whether a financial
      instrument or an embedded feature is indexed to an issuer’s own stock and thus
      able to qualify for the SFAS 133 paragraph 11(a) scope exception. The Company
      believes adopting this statement will have a material impact on the financial
      statements because among other things, any option or warrant previously issued
      and all new issuances denominated is US dollars will be required to be carried
      as a liability and marked to market each reporting period.





In
      April
      2008, the FASB issued 142-3 “Determination of the useful life of Intangible
      Assets”, which amends the factors a company should consider when developing
      renewal assumptions used to determine the useful life of an intangible asset
      under SFAS142. This Issue is effective for financial statements issued for
      fiscal years beginning after December 15, 2008, and interim periods within
      those
      fiscal years. SFAS 142 requires companies to consider whether renewal can be
      completed without substantial cost or material modification of the existing
      terms and conditions associated with the asset. FSP 142-3 replaces the previous
      useful life criteria with a new requirement—that an entity consider its own
      historical experience in renewing similar arrangements. If historical experience
      does not exist then the Company would consider market participant assumptions
      regarding renewal including 1) highest and best use of the asset by a market
      participant, and 2) adjustments for other entity-specific factors included
      in
      SFAS 142. The Company is currently evaluating the impact that adopting SFAS
      No.142-3 will have on its financial statements.





In
      June
      2008, FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming
      Changes to Issue No. 98-5 (“EITF No. 08-4”)”. The objective of EITF No.08-4
      is to provide transition guidance for conforming changes made to EITF No. 98-5,
      “Accounting for Convertible Securities with Beneficial Conversion Features or
      Contingently Adjustable Conversion Ratios”, that result from EITF No. 00-27
“Application of Issue No. 98-5 to Certain Convertible Instruments”, and SFAS No.
      150, “Accounting for Certain Financial Instruments with Characteristics of both
      Liabilities and Equity”. This Issue is effective for financial statements issued
      for fiscal years ending after December 15, 2008. Early application is permitted.
       Management is currently evaluating the impact of adoption of EITF No. 08-4
      on the accounting for the consolidated financial statements.




35




**Critical
      Accounting Policies and Estimates**





We
      have
      disclosed in Note 2 to our financial statements those accounting policies that
      we consider to be significant in determining our results of operations and
      our
      financial position which are incorporated by reference herein.





Management's
      discussion and analysis of its financial condition and results of operations
      are
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with accounting principles generally accepted in the United States.
      Our financial statements reflect the selection and application of accounting
      policies which require management to make significant estimates and judgments.
      See note 2 to our consolidated financial statements, "Summary of Significant
      Accounting Policies." Management bases its estimates on historical experience
      and on various other assumptions that are believed to be reasonable under the
      circumstances. Actual results may differ from these estimates under different
      assumptions or conditions. We believe that the following reflect the more
      critical accounting policies that currently affect our financial condition
      and
      results of operations.





The
      significant accounting policies which we believe are the most critical to aid
      in
      fully understanding and evaluating our reported financial results include the
      following:





*Revenue
      recognition*





The
      Company recognizes revenue when all four of the following criteria are met:
      (1)
      persuasive evidence has been received that an arrangement exists; (2) delivery
      of the products and/or services has occurred; (3) the selling price is fixed
      or
      determinable; and (4) collectability is reasonably assured. The Company follows
      the provisions of SAB No. 104 which sets forth guidelines in the timing of
      revenue recognition based upon factors such as passage of title, installation,
      payments and customer acceptance. Any amounts received prior to satisfying
      the
      Company’s revenue recognition criteria is recorded as deferred revenue.





Sales
      revenue represents the invoiced value of goods, net of a value-added tax (VAT).
      All of the Company’s products, which are sold exclusively in the PRC, are
      subject to a Chinese value-added tax at a rate of 13% to 17% of the gross sales
      price. This VAT may be offset by VAT paid by the Company on raw materials and
      other materials included in the cost of producing their finished product.





*Research
      and development costs*





Research
      and development costs are expensed as incurred. To the extent that research
      and
      development services are performed for us by third parties, these costs are
      expensed when the services are performed by the third party. The costs of
      material and equipment that are acquired or constructed for research and
      development activities, and have alternative future uses, either in research
      and
      development, marketing, or sales, are classified as property and equipment
      or
      depreciated over their estimated useful lives.





*Use
      of estimates*




36




The
      preparation of financial statements in conformity with generally accepted
      accounting principles of the United States of America requires management to
      make estimates and assumptions that affect the amounts reported in the combined
      financial statements and accompanying notes. Management believes that the
      estimates utilized in preparing its financial statements are reasonable and
      prudent. Actual results could differ from these estimates.





*Inventories*





We
      record
      reserves against our inventory to provide for estimated obsolete or unsalable
      inventory based on assumptions about future demand for its products and market
      conditions. If future demand and market conditions are less favorable than
      management's assumptions, additional reserve could be required. Likewise,
      favorable future demand and market conditions could positively impact future
      operating results if previously reserved inventory is sold.





**Item
      4. Controls and Procedures**





***Disclosure
      Controls and Procedures***





We
      maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under
      the Exchange Act). Disclosure controls and procedures refer to controls and
      other procedures designed to ensure that information required to be disclosed
      in
      the reports we file or submit under the Securities Exchange Act is recorded,
      processed, summarized and reported within the time periods specified in the
      rules and forms of the SEC and that such information is accumulated and
      communicated to our management, including our chief executive officer and chief
      financial officer, as appropriate, to allow timely decisions regarding required
      disclosure. In designing and evaluating our disclosure controls and procedures,
      management recognizes that any controls and procedures, no matter how well
      designed and operated, can provide only reasonable assurance of achieving the
      desired control objectives, and management is required to apply its judgment
      in
      evaluating and implementing possible controls and procedures.





As
      required by Rule 13a-15(e) and 15d-15(e) under the Exchange Act, our management
      carried out an evaluation, with the participation and under the supervision
      of
      our Chief Executive Officer, Mr. Senshan Yang, and our Chief Financial Officer,
      Ms. Huizhen Yu, assessing the effectiveness of the design and operation of
      our
      disclosure controls and procedures as of September 30, 2008. Management
      conducted its evaluation of disclosure controls and procedures and determined
      that as of September 30, 2008, and as of the date of this Report, our disclosure
      controls and procedures contained a significant deficiency, described below,
      and
      were otherwise effective.





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





During
      our assessment of the effectiveness of internal control over financial reporting
      as of September 30, 2008, management identified significant deficiencies in
      U.S.
      GAAP expertise and internal audit functions. The current staff in the accounting
      department of our subsidiaries is relatively new to U.S. GAAP and internal
      control procedures and requires additional training. This significant deficiency
      in internal audit function is due to the Company’s lack of qualified resources
      to perform internal audit functions.





We
      have
      taken measures and plan to continue to take measures to remediate this
      deficiency as soon as practicable, including the following measures:




37





(i)
      We
      have committed to engage a senior financial executive from the U.S., who has
      extensive experience in internal control and US GAAP reporting compliance,
      to
      take charge of the financial reporting process and training of the accounting
      staff. In addition, we have also committed to recruit an experienced accounting
      manager from the U.S. to strengthen the Company’s financial reporting and
      internal control functions; and





(ii)
      We
      have committed to establish effective internal audit functions; however, due
      to
      the scarcity of qualified candidates with extensive experience in U.S. GAAP
      reporting and accounting in the region, we have not been able to hire sufficient
      internal audit resources as of the date of this report. However, we intend
      to
      continue our search for qualified candidates with assistance from recruiters
      and
      through referrals.





Our
      management does not believe that this significant deficiency is a material
      weakness or that it had a material effect on our financial condition or results
      of operations or caused our financial statements as of and for the three and
      nine months ended September 30, 2008 to contain a material misstatement.




**PART
      II OTHER INFORMATION**


**Item
        5. Other Information**
 
 On
        June
        1, 2008, our subsidiary, Konzern, entered into an agreement and memorandum
        with
        Guangzhou Hongyuan Pharmaceutical Company (“Hongyuan”) under which we made a
        deposit payment toward the potential purchase of a manufacturing license
        (or
        patent) for a method of manufacturing a BCG (Bacillus Calmette-Guerin) vaccine,
        which was developed as a vaccine for tuberculosis and is now used as a treatment
        for bladder cancer. We have made payments totaling approximately $2.8 million
        to
        Hongyuan in connection with the agreement and memorandum.
 
 Under
        the
        agreement and memorandum:
 
 ·
              We
                  were required to pay five million RMB (approximately $715,000)
                  to Hongyuan
                  by June 21, 2008.
 
 ·
              If
                  within two years, Hongyuan has successfully completed clinical
                  experiments
                  for the BCG project, we will participate in the bidding process
                  for the
                  manufacturing permit, which will be sold to the highest bidder.
                  We will
                  pay Hongyuan a deposit of 20 million RMB in order to attend the
                  bidding
                  session. If we do not win the manufacturing license in the bidding
                  session, Hongyuan will refund the entire 20 million RMB
                  deposit.
 
 ·
              If
                  within two years, Hongyuan has not successfully completed the experiments,
                  Hongyuan will refund our five million RMB
                  deposit.
 
 ·
              If
                  we cancel the agreement before the clinical experiments are complete,
                  Hongyuan will refund 4.8 million RMB of our deposit.
 
 ·
              Hongyuan
                  will provide us with technical information relating to the production
                  of
                  the vaccine.
 
 ·
              We
                  may purchase from Hongyuan a permit that entitles us to exclusive
                  use of
                  the BCG vaccine manufacturing technology, either at a price determined
                  at
                  auction or for 30 million RMB.
 
 ·
              If
                  Hongyuan receives a new drug certificate from the PRC government
                  allowing
                  production of the vaccine, we will pay Hongyuan an amount equal
                  to either
                  10 million RMB or a price determined at
                  auction.
 
 ·
              If
                  either party breaches the agreement, or if Hongyuan’s manufacturing
                  license for the vaccine lapses, the other party will pay damages
                  of
                  500,000 RMB.
 
 English-language
        translations of the agreement and memorandum with Hongyuan are attached as
        Exhibits 10.1 and 10.2 to this report.


**Item
      6. Exhibits.**





(a)
      Exhibits




10.1
      - English-language translation of agreement between
      Konzern and Hongyuan.




10.2
      - English-language translatin of memorandum between
      Konzern and Hongnyan.





31.1 -
      Certification of Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.





31.2 -
      Certification of Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.





32.1 -
      Certification of Chief Executive Officer and Chief Financial Officer pursuant
      to
      Section 906 of the Sarbanes-Oxley Act of 2002.




39










SIGNATURES





Pursuant
      to the requirements of the Securities Act of 1934, the Registrant has duly
      caused this report to be signed on its behalf by the undersigned there unto
      duly
      authorized.




CHINA
                MEDICINE CORPORATIONDate:
                November 13, 2008
            By:
            /s/Senshan
                YangChief
                Executive Officer
              (principal
                executive officer)


By:
            /s/Huizhen
                YuChief
                Financial Officer
              (principal
                financial officer and accounting
                officer)




40