UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q


(Mark
One)





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





For the
quarterly period ended September
30, 2010





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





For
the transition period from ____________ to ____________





Commission
File Number 000-51379





CHINA MEDICINE
CORPORATION


(Exact
name of registrant as specified in its charter)





Nevada
                
                51-0539830(State
      or other jurisdiction of
                
                (IRS
      Employerincorporation
      or organization)
                
                Identification
      No.)





2/F,
Guangri Tower


No. 9
Siyounan Road, 1st
Street


Yuexiu
District


Guangzhou, China
510600


(Address
of principal executive offices) (Zip Code)





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


(Registrant
's telephone number, including area code)


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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  ̈  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 “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer ̈
            
            Accelerated
      filer  ̈Non-accelerated
      filer   ̈
              (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). Yes  ̈  No x





APPLICABLE
ONLY TO CORPORATE ISSUERS:





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: 23,712,061 shares of common stock, par
value $.0001 per share, were outstanding as of November 10, 2010.







TABLE
OF CONTENTS





PagePART I  FINANCIAL INFORMATIONItem
      1.
                                Financial
      Statements
                                1Consolidated
      Balance SheetsAs
      of September 30, 2010 (Unaudited) and December 31, 2009
                                1Consolidated
      Statements of Income and Other Comprehensive IncomeFor
      the Three Months Ended September 30, 2010 and 2009 and for the Nine Months
      Ended September 30, 2010 and 2009 (Unaudited)
                                2Consolidated
      Statement of Changes in Equity for the Year Ended December 31, 2009 and
      for the Nine Months Ended September 30, 2010 and 2009
      (Unaudited)
                                3Consolidated
      Statements of Cash FlowsFor
      the Nine Months Ended September 30, 2010 and 2009
    (Unaudited)
                                4Notes
      to Consolidated Financial Statements as of September 30,
    2010(Unaudited)
                                5Item
      2.
                                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                27Item
      3.
                                Quantitative
      and Qualitative Disclosures About Market Risk
                                38Item
      4.
                                Controls
      and Procedures.
                                39PART II OTHER INFORMATIONItem
      2.
                                Unregistered
      Sales of Equity Securities and Use of Proceeds
                                41Item
      6.
                                Exhibits
                                41Signatures
                                42Exhibits/Certifications
                                43







PART
I - FINANCIAL INFORMATION





Amounts
in thousands, except the statement of equity and per share data in this
form.





Item
      1.
              Financial
  Statements




CHINA
MEDICINE CORPORATION AND SUBSIDIARIES




CONSOLIDATED
BALANCE SHEETS





$
      amounts in thousands
                                      
                                      September 30,
                                        2010
                                      
                                      
                                      December 31,
                                        2009UnauditedASSETSCURRENT
      ASSETSCash
                                      
                                      $
                                      7,854
                                      
                                      
                                      $
                                      472Restricted
      cash
                                      
                                      
                                      48,474
                                      
                                      
                                      
                                      1,760Accounts
      receivable, trade, net of allowance for doubtful accounts of $160 and $157
      as of September 30, 2010 and December 31, 2009,
    respectively
                                      
                                      
                                      17,273
                                      
                                      
                                      
                                      22,315Inventories
                                      
                                      
                                      5,867
                                      
                                      
                                      
                                      2,731Advances
      to suppliers
                                      
                                      
                                      13,231
                                      
                                      
                                      
                                      2,518Other
      current assets
                                      
                                      
                                      1,499
                                      
                                      
                                      
                                      465Total
      current assets
                                      
                                      
                                      94,198
                                      
                                      
                                      
                                      30,261PROPERTY,
      PLANT AND EQUIPMENT, NET
                                      
                                      
                                      15,943
                                      
                                      
                                      
                                      12,001OTHER
      ASSETSLong
      term prepayments
                                      
                                      
                                      7,267
                                      
                                      
                                      
                                      7,900Intangible
      assets, net
                                      
                                      
                                      16,637
                                      
                                      
                                      
                                      16,682Total
      other assets
                                      
                                      
                                      23,904
                                      
                                      
                                      
                                      24,582Total
      assets
                                      
                                      $
                                      134,045
                                      
                                      
                                      $
                                      66,844LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIESShort
      term loans
                                      
                                      $
                                      3,201
                                      
                                      
                                      $
                                      9,506Notes
      payable
                                      
                                      
                                      847
                                      
                                      
                                      
                                      -Accounts
      payable, trade
                                      
                                      
                                      864
                                      
                                      
                                      
                                      1,324Other
      payables and accrued liabilities
                                      
                                      
                                      1,010
                                      
                                      
                                      
                                      940Customer
      deposits
                                      
                                      
                                      648
                                      
                                      
                                      
                                      483Taxes
      payable
                                      
                                      
                                      1,837
                                      
                                      
                                      
                                      2,120Liquidated
      damages payable
                                      
                                      
                                      44
                                      
                                      
                                      
                                      44Total
      current liabilities
                                      
                                      
                                      8,451
                                      
                                      
                                      
                                      14,417Fair
      value of warrant liabilities
                                      
                                      
                                      71
                                      
                                      
                                      
                                      6,918Total
      liabilities
                                      
                                      
                                      8,522
                                      
                                      
                                      
                                      21,335Commitments
      and contingenciesRedeemable
      convertible preferred stock, $0.0001 par value, 1,586,666.6 and Nil shares
      issued and outstanding at September 30, 2010 and December 31, 2009,
      respectively
                                      
                                      
                                      47,600
                                      
                                      
                                      
                                      -SHAREHOLDERS'
      EQUITYCommon
      stock, $0.0001 par value; 90,000,000 shares authorized, 23,712,061 and
      15,451,105 shares issued and outstanding at September 30, 2010 and
      December 31, 2009, respectively
                                      
                                      
                                      2
                                      
                                      
                                      
                                      2Treasury
      stock, at cost
                                      
                                      
                                      (185
                                      )
                                      
                                      
                                      -Stock
      subscription
                                      
                                      
                                      1,392
                                      
                                      
                                      
                                      -Paid-in
      capital
                                      
                                      
                                      41,320
                                      
                                      
                                      
                                      13,380Statutory
      reserves
                                      
                                      
                                      4,390
                                      
                                      
                                      
                                      4,293Retained
      earnings
                                      
                                      
                                      24,760
                                      
                                      
                                      
                                      22,876Accumulated
      other comprehensive income
                                      
                                      
                                      5,954
                                      
                                      
                                      
                                      4,438Total
      shareholders' equity
                                      
                                      
                                      77,633
                                      
                                      
                                      
                                      44,989NONCONTROLLING
      INTERESTS
                                      
                                      
                                      290
                                      
                                      
                                      
                                      520Total
      equity
                                      
                                      
                                      77,923
                                      
                                      
                                      
                                      45,509Total
      liabilities and shareholders' equity
                                      
                                      $
                                      134,045
                                      
                                      
                                      $
                                      66,844


1




CHINA MEDICINE CORPORATION AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


Amounts
in thousands, except per share data


(UNAUDITED)





For Three Months Ended September 30,
                                      
                                      
                                      For Nine Months Ended September 30,2010
                                      
                                      
                                      2009
                                      
                                      
                                      2010
                                      
                                      
                                      2009REVENUESDistribution products
                                      
                                      $
                                      15,093
                                      
                                      
                                      $
                                      18,314
                                      
                                      
                                      $
                                      39,802
                                      
                                      
                                      $
                                      42,514Proprietary products
                                      
                                      
                                      2,457
                                      
                                      
                                      
                                      476
                                      
                                      
                                      
                                      5,361
                                      
                                      
                                      
                                      1,429Medical technology
                                      
                                      
                                      -
                                      
                                      
                                      
                                      366
                                      
                                      
                                      
                                      150
                                      
                                      
                                      
                                      366Total revenues
                                      
                                      
                                      17,550
                                      
                                      
                                      
                                      19,156
                                      
                                      
                                      
                                      45,313
                                      
                                      
                                      
                                      44,309COST
      OF REVENUESDistribution products
                                      
                                      
                                      10,338
                                      
                                      
                                      
                                      13,095
                                      
                                      
                                      
                                      27,130
                                      
                                      
                                      
                                      31,267Proprietary products
                                      
                                      
                                      1,408
                                      
                                      
                                      
                                      227
                                      
                                      
                                      
                                      3,024
                                      
                                      
                                      
                                      900Medical technology
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Total cost of revenues
                                      
                                      
                                      11,746
                                      
                                      
                                      
                                      13,322
                                      
                                      
                                      
                                      30,154
                                      
                                      
                                      
                                      32,167GROSS
      PROFIT
                                      
                                      
                                      5,804
                                      
                                      
                                      
                                      5,834
                                      
                                      
                                      
                                      15,159
                                      
                                      
                                      
                                      12,142OPERATING
      EXPENSESResearch and development
                                      
                                      
                                      1,252
                                      
                                      
                                      
                                      362
                                      
                                      
                                      
                                      1,961
                                      
                                      
                                      
                                      1,128Selling, general and administrative expenses
                                      
                                      
                                      2,066
                                      
                                      
                                      
                                      935
                                      
                                      
                                      
                                      5,677
                                      
                                      
                                      
                                      2,932Total operating expenses
                                      
                                      
                                      3,318
                                      
                                      
                                      
                                      1,297
                                      
                                      
                                      
                                      7,638
                                      
                                      
                                      
                                      4,060INCOME 
      FROM OPERATIONS
                                      
                                      
                                      2,486
                                      
                                      
                                      
                                      4,537
                                      
                                      
                                      
                                      7,521
                                      
                                      
                                      
                                      8,082OTHER
      INCOME (EXPENSE):Other income (expense), net
                                      
                                      
                                      32
                                      
                                      
                                      
                                      (48
                                      )
                                      
                                      
                                      (135
                                      )
                                      
                                      
                                      (69
                                      )Change in fair value of warrant liabilities
                                      
                                      
                                      564
                                      
                                      
                                      
                                      (142
                                      )
                                      
                                      
                                      3,045
                                      
                                      
                                      
                                      (2,114
                                      )INCOME
      BEFORE INCOME TAXESAND NONCONTROLLING INTERESTS
                                      
                                      
                                      3,082
                                      
                                      
                                      
                                      4,347
                                      
                                      
                                      
                                      10,431
                                      
                                      
                                      
                                      5,899PROVISION
      FOR INCOME TAXES
                                      
                                      
                                      941
                                      
                                      
                                      
                                      1,216
                                      
                                      
                                      
                                      2,543
                                      
                                      
                                      
                                      2,331NET
      INCOME (CHINA MEDICINE CORPORATION ANDNONCONTROLLING INTERESTS)
                                      
                                      
                                      2,141
                                      
                                      
                                      
                                      3,131
                                      
                                      
                                      
                                      7,888
                                      
                                      
                                      
                                      3,568Add:
      Net loss attributable to noncontrolling interests
                                      
                                      
                                      82
                                      
                                      
                                      
                                      88
                                      
                                      
                                      
                                      236
                                      
                                      
                                      
                                      243NET
      INCOME ATTRIBUTABLE TO CHINA MEDICINECORPORATION
                                      
                                      
                                      2,223
                                      
                                      
                                      
                                      3,219
                                      
                                      
                                      
                                      8,124
                                      
                                      
                                      
                                      3,811OTHER
      COMPREHENSIVE INCOMEForeign currency translation adjustment
                                      
                                      
                                      1,221
                                      
                                      
                                      
                                      63
                                      
                                      
                                      
                                      1,516
                                      
                                      
                                      
                                      4Foreign currency translation attributable to noncontrolling
      interests
                                      
                                      
                                      6
                                      
                                      
                                      
                                      1
                                      
                                      
                                      
                                      6
                                      
                                      
                                      
                                      -COMPREHENSIVE
      INCOME
                                      
                                      $
                                      3,450
                                      
                                      
                                      $
                                      3,283
                                      
                                      
                                      $
                                      9,646
                                      
                                      
                                      $
                                      3,815Less:
      Deemed preferred stock dividend
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (6,144
                                      )
                                      
                                      
                                      -NET
      INCOME AVAILABLE TO CHINA MEDICINE
                                        CORPORATION
      COMMON SHAREHOLDERS
                                      
                                      $
                                      2,223
                                      
                                      
                                      $
                                      3,219
                                      
                                      
                                      $
                                      1,980
                                      
                                      
                                      $
                                      3,811EARNINGS
      PER SHAREBasicRedeemable convertible preferred stock
                                      
                                      
                                      0.06
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      0.05
                                      
                                      
                                      
                                      -Common stock
                                      
                                      
                                      0.06
                                      
                                      
                                      
                                      0.21
                                      
                                      
                                      
                                      0.05
                                      
                                      
                                      
                                      0.25Earnings per share - Basic
                                      
                                      $
                                      0.12
                                      
                                      
                                      $
                                      0.21
                                      
                                      
                                      $
                                      0.10
                                      
                                      
                                      $
                                      0.25Diluted
                                      
                                      $
                                      0.06
                                      
                                      
                                      $
                                      0.21
                                      
                                      
                                      $
                                      0.09
                                      
                                      
                                      $
                                      0.25WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDINGBasicRedeemable convertible preferred stock
                                      
                                      
                                      15,924,637
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      15,628,815
                                      
                                      
                                      
                                      -Common stock
                                      
                                      
                                      23,563,225
                                      
                                      
                                      
                                      15,265,904
                                      
                                      
                                      
                                      21,490,264
                                      
                                      
                                      
                                      15,241,333Total weighted average shares outstanding - basic
                                      
                                      
                                      39,487,862
                                      
                                      
                                      
                                      15,265,904
                                      
                                      
                                      
                                      37,119,079
                                      
                                      
                                      
                                      15,241,333Diluted
                                      
                                      
                                      39,592,389
                                      
                                      
                                      
                                      15,411,154
                                      
                                      
                                      
                                      22,063,965
                                      
                                      
                                      
                                      15,305,452




2





CHINA MEDICINE CORPORATION AND
SUBSIDIARIES


CONSOLIDATED
STATEMENT OF CHANGES IN EQUITY




AccumulatedRetained earnings
                                          
                                          
                                          otherCommon stock
                                          
                                          
                                          
                                          
                                          Treasury stock
                                          
                                          Stock
                                          
                                          
                                          Paid-in
                                          
                                          
                                          Statutory
                                          
                                          
                                          
                                          
                                          
                                          comprehensive
                                          
                                          
                                          Noncontrollingshares
                                          
                                          
                                          Par value
                                          
                                          in cost
                                          
                                          subscription
                                          
                                          
                                          capital
                                          
                                          
                                          reserves
                                          
                                          
                                          Unrestricted
                                          
                                          
                                          income
                                          
                                          
                                          interests
                                          
                                          
                                          TotalBALANCE,
      January 1, 2009
                                          
                                          
                                          15,226,742
                                          
                                          
                                          $
                                          1,522
                                          
                                          $
                                          
                                          
                                          
                                          
                                          
                                          
                                          12,469,477
                                          
                                          
                                          $
                                          3,178,861
                                          
                                          
                                          $
                                          22,272,565
                                          
                                          
                                          $
                                          4,428,294
                                          
                                          
                                          $
                                          835,532
                                          
                                          
                                          $
                                          43,186,251Net income
      (loss)
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          1,717,677
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (315,531
                                          )
                                          
                                          
                                          1,402,146Adjustment of
      statutory
      reserve
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          1,114,255
                                          
                                          
                                          
                                          (1,114,255
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          -Stock
      options exercised at $1.25
                                          
                                          
                                          40,000
                                          
                                          
                                          
                                          4
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          49,996
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          50,000Cashless
      exercise of warrants
                                          
                                          
                                          184,363
                                          
                                          
                                          
                                          18
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          729,844
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          729,862Stock option and
      warrant
      compensation
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          131,127
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          131,127Foreign currency
      translation
      adjustments
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          9,800
                                          
                                          
                                          
                                          (194
                                          )
                                          
                                          
                                          9,606BALANCE,
      December 31, 2009
                                          
                                          
                                          15,451,105
                                          
                                          
                                          
                                          1,544
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          13,380,444
                                          
                                          
                                          
                                          4,293,116
                                          
                                          
                                          
                                          22,875,987
                                          
                                          
                                          
                                          4,438,094
                                          
                                          
                                          
                                          519,807
                                          
                                          
                                          
                                          45,508,992Net income
      (loss)
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          8,124,143
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (236,027
                                          )
                                          
                                          
                                          7,888,116Adjustment of
      statutory
      reserve
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          96,549
                                          
                                          
                                          
                                          (96,549
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          -Issuance of common
      stock
                                          
                                          
                                          4,000,000
                                          
                                          
                                          
                                          400
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          11,999,600
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          12,000,000Redeemable
      convertible preferred stock - beneficial conversion
feature
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          6,144,000
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          6,144,000Redeemable
      convertible preferred stock - deemed dividend
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (6,144,000
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (6,144,000
                                          )Conversion
      of redeemable convertible preferred stock
                                          
                                          
                                          3,333,334
                                          
                                          
                                          
                                          334
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          9,999,666
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          10,000,000Cash exercise of
      warrants at
      $2.43
                                          
                                          
                                          440,475
                                          
                                          
                                          
                                          44
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          2,095,734
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          2,095,778Cashless exercise of
      warrants at
      $2.43
                                          
                                          
                                          486,179
                                          
                                          
                                          
                                          49
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          2,776,447
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          2,776,496Cashless
      exercise of warrants at $0.85
                                          
                                          
                                          53,380
                                          
                                          
                                          
                                          5
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (5
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          -Stock option
      compensation
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          233,363
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          233,363Stock
      subscription
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          2,088,000
                                          
                                          
                                          
                                          (2,088,000
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          -Issuance of common
      stock - conversion from stock
      subsription
                                          
                                          
                                          232,000
                                          
                                          
                                          
                                          23
                                          
                                          
                                          
                                          
                                          (696,000
                                          )
                                          
                                          
                                          695,977
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          -Treasury
      stock
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (185,221
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (185,221
                                          )Cancellation of
      stock
                                          
                                          
                                          (284,412
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (697,430
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (697,430
                                          )Financing related
      fees
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (3,219,552
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (3,219,552
                                          )Foreign currency
      translation
      adjustments
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          1,516,811
                                          
                                          
                                          
                                          6,458
                                          
                                          
                                          
                                          1,523,269BALANCE,
      September 30, 2010 (Unaudited)
                                          
                                          
                                          23,712,061
                                          
                                          
                                          $
                                          2,399
                                          
                                          $
                                          (185,221
                                          )
                                          
                                          1,392,000
                                          
                                          
                                          $
                                          41,320,245
                                          
                                          
                                          $
                                          4,389,665
                                          
                                          
                                          $
                                          24,759,581
                                          
                                          
                                          $
                                          5,954,905
                                          
                                          
                                          $
                                          290,238
                                          
                                          
                                          $
                                          77,923,812




3




CHINA MEDICINE CORPORATION AND SUBSIDIARIES




CONSOLIDATED
STATEMENTS OF CASH FLOWS




(UNAUDITED)





Nine months ended September 30,2010
                                        
                                        
                                        2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net income
      attributable to China Medicine Corporation
                                        
                                        $
                                        8,124
                                        
                                        
                                        $
                                        3,812Net loss
      attributable to noncontrolling interests
                                        
                                        
                                        (236
                                        )
                                        
                                        
                                        (243
                                        )Net
      income
                                        
                                        
                                        7,888
                                        
                                        
                                        
                                        3,569Adjustments to
      reconcile net income to cashprovided
      by (used in) operating activities:Depreciation and amortization
                                        
                                        
                                        1,353
                                        
                                        
                                        
                                        664Bad
      debt expense
                                        
                                        
                                        119
                                        
                                        
                                        
                                        -Loss
      on sale of assets
                                        
                                        
                                        -
                                        
                                        
                                        
                                        27Stock-based compensation
                                        
                                        
                                        233
                                        
                                        
                                        
                                        101Change in fair value of warrants liabilities
                                        
                                        
                                        (3,045
                                        )
                                        
                                        
                                        2,114Change in operating assets and liabilities:Accounts receivable, trade
                                        
                                        
                                        5,403
                                        
                                        
                                        
                                        4,279Inventories
                                        
                                        
                                        (3,048
                                        )
                                        
                                        
                                        (3,220
                                        )Notes
      receivables
                                        
                                        
                                        (100
                                        )
                                        
                                        
                                        (454
                                        )Advances to suppliers
                                        
                                        
                                        (10,476
                                        )
                                        
                                        
                                        (2,269
                                        )Other
      current assets
                                        
                                        
                                        (937
                                        )
                                        
                                        
                                        (874
                                        )Accounts payable, trade
                                        
                                        
                                        (478
                                        )
                                        
                                        
                                        243Notes
      payable
                                        
                                        
                                        833
                                        
                                        
                                        
                                        -Other
      payables and accrued liabilities
                                        
                                        
                                        (1
                                        )
                                        
                                        
                                        (21
                                        )Customer deposits
                                        
                                        
                                        152
                                        
                                        
                                        
                                        (107
                                        )Taxes
      payable
                                        
                                        
                                        (320
                                        )
                                        
                                        
                                        (523
                                        )Net cash provided by (used in) operating
      activities
                                        
                                        
                                        (2,424
                                        )
                                        
                                        
                                        3,529CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of intangible assets
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (235
                                        )Purchase
      of building improvement and equipment
                                        
                                        
                                        (4,607
                                        )
                                        
                                        
                                        (3,470
                                        )Cash
      proceeds from disposition of fixed assets
                                        
                                        
                                        -
                                        
                                        
                                        
                                        22Advances
      on long-term prepayments
                                        
                                        
                                        782
                                        
                                        
                                        
                                        (3,376
                                        )Net cash used in investing activities
                                        
                                        
                                        (3,825
                                        )
                                        
                                        
                                        (7,059
                                        )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds from exercise of options and warrants
                                        
                                        
                                        1,070
                                        
                                        
                                        
                                        50Loan proceeds
                                        
                                        
                                        5,058
                                        
                                        
                                        
                                        2,932Repayment of Loans
                                        
                                        
                                        (11,444
                                        )Sales of the common stock
                                        
                                        
                                        12,000
                                        
                                        
                                        
                                        -Sales of the redeemable convertible preferred stock
                                        
                                        
                                        57,600
                                        
                                        
                                        
                                        -Payment for the financing operation
                                        
                                        
                                        (3,220
                                        )
                                        
                                        
                                        -Stock repurchase
                                        
                                        
                                        (883
                                        )
                                        
                                        
                                        -Increase in restricted cash
                                        
                                        
                                        (46,694
                                        )
                                        
                                        
                                        -Net cash provided by financing activities
                                        
                                        
                                        13,487
                                        
                                        
                                        
                                        2,982EFFECT
      OF EXCHANGE RATE ON CASH
                                        
                                        
                                        144
                                        
                                        
                                        
                                        (1
                                        )CHANGE
      IN CASH
                                        
                                        
                                        7,382
                                        
                                        
                                        
                                        (549
                                        )CASH,
      beginning of period
                                        
                                        
                                        472
                                        
                                        
                                        
                                        2,792CASH,
      end of period
                                        
                                        $
                                        7,854
                                        
                                        
                                        $
                                        2,243Supplemental
      disclosure of cash flows:Cash paid
      interest
                                        
                                        $
                                        226
                                        
                                        
                                        $
                                        -Cash paid income
      tax
                                        
                                        $
                                        1,545
                                        
                                        
                                        $
                                        2,119




4


CHINA
MEDICINE CORPORATION AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Note
1 - Organization


Principal
Activities





China
Medicine Corporation (“CMC” or the "Company") was incorporated on February 10,
2005.  The Company, through its subsidiaries in the People’s Republic of
China (“PRC” or “China”), engages in the wholesale distribution, research and
development, and manufacture of prescription and over the counter medicines,
traditional Chinese medicines, which are medicines derived from Chinese herbs,
dietary supplements, medical instruments and the sales of medical technology in
the PRC. The Company primarily operates through its wholly-owned subsidiaries,
Guangzhou Konzern Medicine Co., Ltd. (“Konzern”) and Guangzhou LifeTech
Pharmaceutical Co., Ltd (“LifeTech”).  Both companies are organized under
the laws of the PRC.  All other subsidiaries are still in the development
stage and either had not undertaken significant operating activities or had no
activities as of September 30, 2010.





Current
Development





On
January 7, 2010, the Company set up Konzern Company Limited (“Konzern Ltd.”)
which is 100% owned by the Company. Konzern Ltd. was established in China under
PRC law. Its business license is valid for 50 years from January 7, 2010. The
registered capital of Konzern Ltd. is approximately $29.3 million (RMB 200
million) of which $16.0 million has been contributed as of September 30, 2010.
To fulfill the requirement of the PRC local authority, the remaining capital of
approximately $13.3 million has to be invested in Konzern Ltd. within 2 years
after the issuance date of the business license.





As of May
12, 2010, CMC completed reorganizing its PRC subsidiaries. All PRC subsidiaries
are controlled by Konzern Ltd. On May 26, 2010, Konzern Ltd. changed its
registered name to Konzern Group Ltd. (“Konzern Group”).





Note
2 - Summary of Significant Accounting Policies





Basis of
Presentation





The
consolidated financial statements of the Company reflect its subsidiaries,
Konzern Group, Konzern, Konzern US Holdings (“Konzern Holding”), Konzern
Biotechnology Co., Ltd. (“Konzern Bio”), LifeTech, and LifeTech Medicine
Technologies Co., Ltd (“LifeTech Technology”), all of which are directly or
indirectly 100% owned subsidiaries. Guangzhou Co-Win Bioengineering Co., Ltd.
(“Co-Win”) is a 70% owned subsidiary of Konzern. The accompanying consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America. All material inter-company
transactions and balances have been eliminated in consolidation.





While
management has included all normal recurring adjustments considered necessary to
give a fair presentation of the operating results for the periods, 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 2009 annual report filed on Form 10-K.





Use of
Estimates





In
preparing financial statements in conformity with accounting principles
generally accepted in the United States (U.S.), 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 fair value of its options and
warrants as well as the amount of potentially uncollectible accounts. 
Management believes that the estimates utilized in preparing its consolidated
financial statements are reasonable and prudent. Actual results could differ
from those estimates.





5


Cash and Cash
Equivalents





For
purposes of the cash flow statements, the Company considers all highly liquid
investments with original maturities of three months or less at the time of
purchase to be cash equivalents. Cash includes cash on hand and demand deposits
in accounts maintained with banks in the PRC and Hong Kong.





Restricted
Cash





Restricted
cash represents amounts set aside by the Company in accordance with the
Company’s debt agreements with a financial institution, deposits for notes
payable and the Stock Subscription Agreement that was completed on January 29,
2010. As part of the Company’s loan agreements with a bank in the PRC, the
Company is expected to maintain certain compensating cash balances at the bank’s
desires. As of September 30, 2010, the compensating cash balances have been
released as the loan has been fully repaid.  Deposits for notes payable
represented deposits saved in the bank for issuance of notes to suppliers for
purchase of materials.  Pursuant to the Stock Subscription Agreement, the
use of funds has to be approved by the board of directors and to be used on
certain acquisitions and capital expenditures with the consent of OEP CHME
Holdings, LLC (“OEP”), the holder of the Company’s redeemable convertible
preferred stock.





Concentrations and
Risks





Financial
instruments, which subject the Company to concentration of credit risk, consist
of cash. The Company maintains balances at financial institutions or state-owned
banks within China, Hong Kong and U.S. which, from time to time, may exceed
Federal Deposit Insurance Corporation insured limits for banks that are located
in the Unites States. No deposits within the PRC are covered by insurance. As of
September 30, 2010 and December 31, 2009, the Company had deposits in excess of
federally insured limits totaling $55.0 million and $2.2 million, 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.





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 affecting
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.





For the
nine months ended September 30, 2010, the top five suppliers accounted for
approximately 50% of the Company’s total purchases.  For the nine months
ended September 30, 2009, the top five suppliers accounted for approximately 54%
of the Company’s total purchases.





For the
three months ended September 30, 2010, the top five suppliers accounted for
approximately 53% of the Company’s total purchases.  For the three months
ended September 30, 2009, the top five suppliers represented 56% of the
Company’s total purchases.





For the
nine months ended September 30, 2010, the top five customers accounted for
approximately 48% of the Company's total sales. The accounts receivable balances
of these customers amounted to $7.0 million, representing 40% of the total
accounts receivable as of September 30, 2010. For the nine months ended
September 30, 2009, the top five customers accounted for approximately 47% of
the Company’s total sales. The accounts receivable balance of those five
customers amounted to $9.5 million , representing 63% of the total accounts
receivable as of September 30, 2009.





For the
three months ended September 30, 2010, the top five customers accounted for
approximately 49% of the Company’s total sales. For the three months ended
September 30, 2009, the top five customers accounted for approximately 46% of
the Company’s total sales.





6


For the
three and nine months ended September 30, 2010, only one of the Company’s
products represented greater than 10% of the Company’s revenue.  The top
three products accounted for approximately 35% and 22% of the Company’s total
sales for the nine months ended September 30, 2010 and 2009, respectively, and
32% and 27% for the three months ended September 30, 2010 and 2009,
respectively.




Accounts Receivable,
Trade





The
Company extends unsecured credit to its customers in the ordinary course of
business.  Management reviews the composition of accounts receivable and
analyzes historical credit losses, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns 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. Account balances are written off after management has exhausted all
collection efforts.





Inventories





Inventories
are stated at the lower of cost or market value. Cost is determined using the
weighted average method. Management reviews inventories for obsolescence or cost
in excess of net realizable value periodically and records an inventory
write-down and additional cost of goods sold when the carrying value exceeds net
realizable value.





Advances to
Suppliers





Advances
on inventory purchases are down payments or deposits for inventory
purchases. The inventory is normally delivered within one to two months
after the payments have been made except for vendors who have an agency
relationship with the Company. This amount is refundable and bears no
interest. The Company has legally binding contracts with its vendors, which
require the payments to be returned to the Company when the contract
ends.





Related Party
Transactions





As of
September 30, 2010, receivables from related parties are immaterial and are
included in other current assets.  Such receivables are received from
customers.  Due to banking restriction on these customers, such collection
is deposited in a key executive’s personal bank account for ordinary course of
business; the bank account is controlled by the Company.  As of December
31, 2009, there was no receivable from related parties.





Property, Plant and
Equipment





Property,
plant and equipment are stated at the actual cost of acquisition less
accumulated depreciation. Major additions and improvements are capitalized.
Expenditures for maintenance and repairs are charged to earnings as incurred.
When assets are retired or otherwise disposed of, the related cost and
accumulated depreciation are removed from the respective accounts, and any gain
or loss is included in operations. Depreciation is provided using the
straight-line method for substantially all assets with a residual value of 5% of
the actual cost and estimated lives as follows:





Buildings
      and leasehold improvements
              50
      yearsLeasehold
      improvements
              5
      yearsProduction
      equipment
              10
      -12 yearsFurniture,
      fixtures and office equipment
              5
      yearsMotor
      vehicles
              5 -
      10 years





A
majority of the construction in progress represents costs incurred in connection
with the construction of equipment for manufacturing aflatonix-detoxifizyme
(“rADTZ”) and the expansion of LifeTech’s manufacturing facilities.  No
depreciation is provided for construction in progress until such time as the
assets are completed and placed into service.





7


Long Term
Prepayments





Long term
prepayments mostly represent partial payments or deposits on acquiring
technology and exclusive distribution rights; these payments and deposits are
refundable.





Intangible
Assets





Intangible
assets mainly include land use rights and patents.  Intangible assets are
stated at cost (actual costs or estimated fair value upon acquisition), less
accumulated amortization.  Amortization expense is recognized on the
straight-line basis over the estimated useful lives of the assets as
follows:





Intangible assets
                  
                  Weighted averageestimated usefullivesLand
      use rights
                  
                  41-46
      yearsManufacturing
      patents
                  
                  16
      yearsrADTZ
      patent
                  
                  11
      years





All land
in the PRC is government owned.  However, the government grants “land use
rights.”  LifeTech acquired land use rights in 2002 and 2007 and has the
right to use the land for 50 years.  The rights are amortized on a straight
line basis over the weighted average useful lives.





The
Company acquired manufacturing patents through the acquisition of LifeTech and
LifeTech Technology.  Acquired patents were measured based on their fair
values.  Generally, the manufacturing patents in PRC are being amortized on
a straight-line basis over a period of 20 years from the application date. 
The weighted average remaining life of the acquired patents was 16 years on the
date of the acquisition.





Beginning
in 2007, the Company acquired technology to manufacture rADTZ.  The major
costs of intangibles include patent and technology acquired and the related
final experiment costs required by the government. The Company will begin
amortizing costs once manufacturing begins. In 2009, the Company made trial
production to meet government requirements and is in the process of applying the
government permit to allow the Company to manufacture rADTZ. The Company expects
to obtain the permit by the end of 2010.




Under the
FASB’s accounting standard for 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.





Impairment of Long-Lived
Assets





Per
FASB’s accounting standards, long-lived assets are analyzed for impairment. The
Company reviews and 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, 2010, the Company believes
that there were no impairments of long-lived assets.





8


Fair Value of Financial
Instruments





The
accounting standards regarding fair value of financial instruments and related
fair value measurements defines financial instruments and requires fair value
disclosures of those financial instruments.  The fair value measurement
accounting standard defines fair value, establishes a three-level valuation
hierarchy for disclosures of fair value measurement and enhances disclosure
requirements for fair value measures. The carrying amounts reported in the
balance sheets for current assets and current liabilities qualifying as
financial instruments 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.





Determining
the category into which an asset or liability falls within the hierarchy
requires significant judgment. The Company evaluates the hierarchy disclosures
each quarter. Liabilities measured at fair value on a recurring basis are
summarized as follows:





(amounts in thousands)
                      
                      Carrying Value as
                        of September 30,
                        2010
                      
                      Fair Value Measurements at September 30, 2010
                        Using Fair Value Hierarchy(Unaudited)
                      
                      Level 1
                      
                      Level 2
                      
                      Level 3Warrant
      liabilities
                      
                      $
                      71
                      
                      
                      
                      $
                      71




A
discussion of the valuation techniques used to measure fair value for the
liabilities listed above and activity for these liabilities for the nine and
three months ended September 30, 2010, is provided elsewhere in the
footnotes.





In
addition to assets and liabilities that are recorded at fair value on a
recurring basis, the Company is required to record assets and liabilities at
fair value on a non-recurring basis.  Generally, assets are recorded at
fair value on a non-recurring basis as a result of impairment charges. For the
nine and three months ended September 30, 2010, there were no impairment
charges.





Redeemable Convertible
Preferred Stock





In
accordance with ASC 480-10-S99, the Company’s preferred stock is classified as
mezzanine equity.  The preferred stock holder can request redemption at the
liquidation value in the event of a material adverse effect; however, such
condition is not considered mandatory.





At the
issuance date, the Company allocated the gross proceeds received between
preferred stocks and common stocks.  Based on the initial carrying value, a
beneficial conversion feature in the amount of $6.1 million was recognized,
which was credited to additional paid-in-capital. As preferred stocks can be
converted at any time at the option of the holder and is immediately
convertible, the entire beneficial conversion feature was recognized immediately
as a deemed dividend to the investors of the preferred stock.





Treasury
Stock





In
accordance with ASC 505-30, treasury stock should not be classified as an asset
since a corporation cannot own itself.





9


Dividends
on treasury stock should never be included as income, but should be credited
directly to retained earnings, against which they were incorrectly charged.
Since treasury stock cannot be considered an asset, dividends on treasury stock
are not properly included in net income.




Noncontrolling
Interest





Noncontrolling
interest consists of the 30% equity interest in Co-Win owned by the
noncontrolling interest holders. Effective on January 1, 2009, the Company
adopted the FASB’s standard regarding noncontrolling interests in consolidated
financial statements.  Certain provisions of this statement are required to
be adopted retrospectively for all periods presented. Such provisions include a
requirement that the carrying value of noncontrolling interests (previously
referred to as minority interests) be removed from the mezzanine section of the
balance sheet and reclassified as equity; and consolidated net income to be
recast to include net income attributable to the noncontrolling
interest.





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 accounting standard regarding revenue recognition 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. 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.





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
VAT 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.





Output
VAT on sales and input VAT on purchases amounted to $7.8 million and $5.2
million, respectively, for the nine months ended September 30, 2010, and $7.5
million and $3.8 million, respectively, for the nine months ended September 30,
2009 and $3.1 million and $2.1 million for the three months ended September 30,
2010 and $3.2 million and $2.0 million for the three months ended September 30,
2009, 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.





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
or sales and marketing, are classified as equipment and depreciated over their
estimated useful lives.





Shipping and Handling
Costs




Shipping
and handling costs related to costs of goods sold are included in selling
expenses and totaled $675,000 and $400,000 for the nine months ended September
30, 2010 and 2009, and totaled $281,000 and $318,000 for the three months ended
September 30, 2010 and 2009.




Advertising
Costs





The
Company expenses the cost of advertising as incurred in selling, general and
administrative costs. For the nine months ended September 30, 2010 and 2009,
advertising expenses amounted to $388,000 and $333,000, respectively. For the
three months ended September 30, 2010 and 2009, advertising expenses amounted to
$235,000 and $20,000, respectively.




10


Foreign Currency
Translation




The
reporting currency of the Company is the United States (U.S.) dollar. The
Company uses its 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.
Translation adjustments resulting from this process are included in accumulated
other comprehensive income in the Consolidated Statements of Shareholders’
Equity.  Because cash flows are also translated at average exchange rates,
amounts reported on the Consolidated Statements of Cash Flows will not
necessarily agree with changes in the corresponding balances on the Consolidated
Balance Sheets.





Asset and
liability accounts at September 30, 2010 and December 31, 2009 were translated
at RMB 6.68 and RMB 6.82 to $1.00, respectively. Equity accounts were stated at
their historical rate. The average translation rates applied to income and cash
flow statements for the nine months ended September 30, 2010 and 2009, were RMB
6.80 and RMB 6.82 to $1.00, 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 months ended September 30, 2010, and 2009.
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 is subject to income taxes in the U.S. (including federal and state) and
several foreign jurisdictions in which it operates. Deferred income tax balances
reflect the effects of temporary differences between the carrying amounts of
assets and liabilities and their tax basis and are stated at enacted tax rates
expected to be in effect when taxes are actually paid or recovered. FASB ASC
740, Accounting for Income
Taxes, requires that deferred tax assets be evaluated for future
realization and reduced by a valuation allowance to the extent the Company
believes a portion will not be realized. The Company considers many factors when
assessing the likelihood of future realization of its deferred tax assets,
including its recent cumulative earnings experience and expectations of future
taxable income by taxing jurisdiction, the carry-forward periods available to
the Company for tax reporting purposes, and other relevant factors.




The
Company accounts for uncertain tax positions in accordance with FASB ASC 740,
which contains a two-step approach to recognizing and measuring uncertain tax
positions. The first step is to evaluate the tax position for recognition by
determining if the weight of available evidence indicates it is more likely than
not that the position will be sustained on audit, including resolution of
related appeals or litigation processes, if any. The second step is to measure
the tax benefit as the largest amount, which is more than 50% likely of being
realized upon ultimate settlement. The Company considers many factors when
evaluating and estimating its tax positions and tax benefits, which may require
periodicadjustments and which
may not accurately anticipate actual outcomes.




The
Company is subject to income tax examinations by tax authorities in the
jurisdictions in which it operates. There are currently no income tax returns
under examination by the U.S. Internal Revenue Service or any other major tax
authorities.





Penalties
and interest incurred related to underpayment of income tax are classified as
income tax expense in the year incurred.  No significant penalties or
interest relating to income taxes have been incurred during the nine months
ended September 30, 2010 and 2009.





11


Stock-Based
Compensation





The
Company records and reports the employee stock-based compensation in accordance
with FASB’s accounting standards for share-based payments. This accounting
standard requires a public entity to measure the cost of services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award. That cost is recognized over the period during which services are
received. Stock compensation for stock granted to non-employees is determined in
accordance with FASB’s accounting standards regarding accounting for stock-based
compensation and accounting for equity instruments that are issued to other than
employees for acquiring or in conjunction with selling goods or services, as the
fair value of the consideration received or the fair value of equity instruments
issued, whichever is more reliably measured.





Earnings Per
Share





The
Company reports earnings per share in accordance with FASB’s accounting
standards for earnings per share, which 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 net income (loss) available to common stockholders by the weighted
average common shares outstanding during the period using the two-class method.
Under the two-class method, net income (loss) is allocated between common stock
and redeemable convertible preferred stock as it is deemed to be a participating
security based on its participation rights. Diluted earnings per common 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. Diluted loss per common share is calculated by dividing net loss
attributable to common stockholders by the weighted average number of common and
potential dilutive securities outstanding during the period if the effect is
dilutive. The numerator of diluted earnings per share is calculated by starting
with income allocable to common stock under the two-class method and adding back
income allocable to preferred stock to the extend they are
dilutive.





Business
Combination





Effective
January 1, 2009, we account for business combinations using the acquisition
method of accounting. The acquisition method 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. The provisions of the acquisition method related to income tax adjustments
apply to all business combinations regardless of consummation date.




Fair
value is defined as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. This is an exit price concept for the valuation of the
asset or liability. In addition, market participants are assumed to be buyers
and sellers in the principal market for the asset or liability. Fair value
measurements for an asset assume the highest and best use by these market
participants. As a result of these standards, we may be required to record
assets which we do not intend to use or sell (defensive assets) and/or to value
assets at fair value measures that do not reflect our intended use of those
assets. Many of these fair value measurements can be highly subjective and it is
also possible that other professionals, applying reasonable judgment to the same
facts and circumstances, could develop and support a range of alternative
estimated amounts.




Segment
Reporting





The
Company uses a “management approach” model for segment reporting. The management
approach model is based on the way a company’s management organizes segments
within the company for making operating decisions and assessing performance. The
Company has determined that it has two reportable segments: LifeTech and
Konzern, which includes all the other subsidiaries.





Recently Issued Accounting
Pronouncements





In
December 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167, Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The Company adopted this standard and the standard did
not have material effect on the Company’s consolidated financial
statements.





12


In
January 2010, FASB issued ASU No. 2010-01, Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The Company adopted this standard and the standard did not
have material effect on the Company’s consolidated financial
statements.





In
January 2010, FASB issued ASU No. 2010-02 regarding accounting and reporting for
decreases in ownership of a subsidiary.  Under this guidance, an entity is
required to deconsolidate a subsidiary when the entity ceases to have a
controlling financial interest in the subsidiary.  Upon deconsolidation of
a subsidiary, an entity recognizes a gain or loss on the transaction and
measures any retained investment in the subsidiary at fair value.  In
contrast, an entity is required to account for a decrease in its ownership
interest of a subsidiary that does not result in a change of control of the
subsidiary as an equity transaction.  This ASU clarifies the scope of the
decrease in ownership provisions, and expands the disclosures about the
deconsolidation of a subsidiary or de-recognition of a group of assets. 
This ASU is effective beginning in the first interim or annual reporting period
ending on or after December 31, 2009.  The adoption of this ASU did not
have a material impact on the Company’s consolidated financial
statements.





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





In
February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855):
Amendments to Certain Recognition and Disclosure Requirements,” or ASU 2010-09.
ASU 2010-09 primarily rescinds the requirement that, for listed companies,
financial statements clearly disclose the date through which subsequent events
have been evaluated. Subsequent events must still be evaluated through the date
of financial statement issuance; however, the disclosure requirement has been
removed to avoid conflicts with other SEC guidelines. ASU 2010-09 was effective
immediately upon issuance and was adopted in February 2010.





13


In April
2010, the FASB issued Accounting Standards Update 2010-13, “Compensation—Stock
Compensation (Topic 718): Effect of Denominating the Exercise Price of a
Share-Based Payment Award in the Currency of the Market in Which the Underlying
Equity Security Trades,” or ASU 2010-13. ASU 2010-13 provides amendments to
Topic 718 to clarify that an employee share-based payment award with an exercise
price denominated in currency of a market in which a substantial porting of the
entity’s equity securities trades should not be considered to contain a
condition that is not a market, performance, or service condition. Therefore, an
entity would not classify such an award as a liability if it otherwise qualifies
as equity. The amendments in this Update are effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2010.  The Company does not expect the adoption of ASU 2010-17 to have a
significant impact on its consolidated financial statements.





Reclassification





The
Company reclassified the following items in prior year’s consolidated statement
of income and other comprehensive income to conform to classification used in
the current year: $444,000 and $148,000 for the nine and three months ended
September 30, 2009 were reclassified from selling, general and administrative
expenses to research and development; $1,429,000 and $476,000 for the nine
and three months ended September 30, 2009 were reclassified from distribution
products sales to proprietary products; and $900,000 and $227,000 for the nine
and three months ended September 30, 2009 were reclassified from distribution
products cost of revenues to proprietary products cost of revenue.





Note
3 – Accounts Receivable





Accounts
receivable consisted of the following:




(amounts in thousands)
                  
                  September 30, 2010
                  
                  
                  December 31, 2009(Unaudited)Trade
      accounts receivable
                  
                  $
                  17,433
                  
                  
                  $
                  22,472Allowance
      for doubtful accounts
                  
                  
                  (160
                  )
                  
                  
                  (157
                  )Trade
      accounts receivable, net
                  
                  $
                  17,273
                  
                  
                  $
                  22,315




September 30, 2010
                    
                    
                    December 31, 2009(amounts in thousands)
                    
                    (Unaudited)Beginning
      allowance for doubtful accounts
                    
                    $
                    157
                    
                    
                    $
                    97Additions
      charged to bad debt expense
                    
                    
                    -
                    
                    
                    
                    60Foreign
      currency translation adjustments
                    
                    
                    3
                    
                    
                    
                    -Ending
      allowance for doubtful accounts
                    
                    $
                    160
                    
                    
                    $
                    157





Note
4 – Inventories


Inventories
consisted of the following:


September 30, 2010
                    
                    
                    December 31, 2009(amounts in thousands)
                    
                    (Unaudited)Raw
      materials
                    
                    $
                    361
                    
                    
                    $
                    329Work
      in progress
                    
                    
                    483
                    
                    
                    
                    389Finished
      goods
                    
                    
                    5,023
                    
                    
                    
                    2,013Total
                    
                    $
                    5,867
                    
                    
                    $
                    2,731





Note 5 – Property, Plant and
Equipment


Property,
plant and equipment consisted of the following:


September 30,
                      2010
                    
                    
                    December 31, 2009(amounts in thousands)
                    
                    (Unaudited)Buildings
      and leasehold improvements
                    
                    $
                    4,814
                    
                    
                    $
                    5,089Production
      equipment
                    
                    
                    6,699
                    
                    
                    
                    7,025Furniture,
      fixture and office equipment
                    
                    
                    1,523
                    
                    
                    
                    271Motor
      vehicles
                    
                    
                    471
                    
                    
                    
                    409Construction
      in progress
                    
                    
                    7,351
                    
                    
                    
                    3,052Total
                    
                    
                    20,858
                    
                    
                    
                    15,846Less:
      accumulated depreciation
                    
                    
                    (4,915
                    )
                    
                    
                    (3,845
                    )Property,
      plant and equipment, net
                    
                    $
                    15,943
                    
                    
                    $
                    12,001





14


A
majority of the construction in progress represents the costs incurred in
connection with the construction of equipment for manufacturing
aflatonix-detoxifizyme “rADTZ” and the expansion of LifeTech’s manufacturing
facilities. Management expects the equipment for manufacturing rADTZ will be
completed in early 2011 and has outstanding commitments of approximately
$762,000 as of September 30, 2010. The expansion of LifeTech’s manufacturing
facilities are expected to be completed in the fourth quarter of 2011 with an
estimated total cost of approximately $11.0 million.





In
November 2009, the Company entered into a construction design contract for
expansion of LifeTech.  Refer to Note 6 for further
discussion.





Depreciation
expense amounted to $974,000 and $664,000 for the nine months ended September
30, 2010 and 2009, respectively, and $305,000 and $230,000 for the three months
ended September 30, 2010 and 2009, respectively.





Note
6 – Long Term Prepayments





Long term
prepayments consisted of the following:


(amounts in thousands)
                    
                    September
                      30, 2010
                    
                    
                    December 31, 2009(Unaudited)Prepayment
      for exclusive distribution rights
                    
                    $
                    898
                    
                    
                    $
                    880Advances
      to suppliers
                    
                    
                    1,303
                    
                    
                    
                    1,276Long
      term deferred expense
                    
                    
                    452
                    
                    
                    
                    71Deposit
      for exclusive distribution rights
                    
                    
                    2,218
                    
                    
                    
                    2,225Deposit
      for technology know-how
                    
                    
                    2,396
                    
                    
                    
                    2,348Deposit
      for construction design project
                    
                    
                    -
                    
                    
                    
                    1,100Total
      long term prepayment
                    
                    $
                    7,267
                    
                    
                    $
                    7,900




In
2008, the Company entered into two separate contracts to acquire distribution
rights to a multivitamin pack and manufacturing of the multivitamin pack and to
self-develop various types of herbal tea.  The Company prepaid $898,000 for
ten years of exclusive distribution rights, which will begin to be amortized
once the products are ready for commercial sale. The total contractual term of
the exclusive distribution rights is 15 years.  As of September 30, 2010,
the Company was in the process of applying for government approval.  The
Company also advanced the bio-technological company approximately $1.5 million
as payment for future inventory purchase, of which approximately $1.3 million
was included in advances to suppliers – long term as of September 30, 2010 and
December 31, 2009.





Long term
deferred expense represents prepayment for the research and development of
rADTZ.  For the nine months ended September 30, 2010, the Company had
amortized $54,000 over the term of the contract. Long term deferred expense at
September 30, 2010 also included $434,000 prepayment for extending term of
protection of two products. The total contracts amount is $479,000, and the
unpaid amount of $45,000 is due on receiving of the medicine protection
certificates.





As of
September 30, 2010 and December 31, 2009, the Company had made long term
deposits in the aggregate of $2.2 million and $2.2 million, respectively to
secure its position to purchase national exclusive distribution rights for
various products. Deposits are refundable upon the termination or signing of the
contracts.





15


In
November 2009, the Company entered into a construction design contract for
expansion of LifeTech.  The Company made a prepayment of $1.1 million
related to designing the plant, which was transferred to construction in
progress.





Note
7 – Intangible Assets





Intangible
assets consisted of the following:


September 30, 2010
                    
                    
                    December 31, 2009(amounts in thousands)
                    
                    (Unaudited)Land
      use rights
                    
                    $
                    12,113
                    
                    
                    $
                    11,878Patents
                    
                    
                    5,175
                    
                    
                    
                    5,063Total
                    
                    
                    17,288
                    
                    
                    
                    16,941Less:
      accumulated amortization
                    
                    
                    (651
                    )
                    
                    
                    (259
                    )Intangible
      assets, net
                    
                    $
                    16,637
                    
                    
                    $
                    16,682





Amortization
expense amounted to approximately $377,000 and $0 for the nine months ended
September 30, 2010 and 2009, respectively, and $117,000 and $1,000 for the three
months ended September 30, 2010 and 2009, respectively. As of September 30,
2010, future amortization expense for each of the years ending December 31, are
as follows:




(amounts in thousands)
                        
                        2010
                        
                        
                        2011
                        
                        
                        2012
                        
                        
                        2013
                        
                        
                        2014
                        
                        
                        ThereafterAmortization
      expense
                        
                        $
                        168
                        
                        
                        $
                        665
                        
                        
                        $
                        665
                        
                        
                        $
                        665
                        
                        
                        $
                        665
                        
                        
                        $
                        13,798




Note
8 – Short Term Debt





Notes
payable





Notes
payable are lines of credit extended by the banks.  When purchasing raw
materials, the Company often issues a short term note payable to the vendor
funded with draws on the lines of credit. This short term note payable is
guaranteed by the bank for its complete face value through a letter of credit
and usually matures within three to six months of issuance.  The banks
either charge interest or require the Company to deposit a certain amount of
cash at the bank as a guarantee deposit which is classified on the balance sheet
as restricted cash.  In addition, the banks charge processing fees based on
the face value of the note.  As of September 30, 2010, the Company’s notes
payable was fully secured by its guarantee deposits.





(amounts in thousands)
                  
                  September 30,
                    2010
                  
                  
                  December 31,(Unaudited)
                  
                  
                  2009Letters
      of credit from Wuyang Branch, Agricultural Bank of China
                  
                  $
                  847
                  
                  
                  $
                  -





Short
term loans represent amounts due to various banks and are normally due within
one year.  The principal is due at maturity and can be renewed with the
banks. The short-term loans consisted of the following:




September 30, 2010
                      
                      
                      December 31, 2009(Unaudited)Two
      loans with Industrial and Commercial Bank of China due on August 13, 2010
      with an annual interest rate of 5.31%, secured by the Company's
      properties
                      
                      $
                      -
                      
                      
                      $
                      5,839One
      loan with Industrial and Commercial Bank of China due on March 13, 2011
      with an annual interest rate of 4.86%, secured by the Company's account
      receivables
                      
                      $
                      209
                      
                      
                      $
                      -Four
      loans under a facility with Bank of China, due on December 20, 2010 with
      an annual interest rate of 5.31%, guaranteed and secured by Co-Win and the
      Company’s officers (a)
                      
                      
                      2,992
                      
                      
                      
                      3,667Total
      – bank loans
                      
                      $
                      3,201
                      
                      
                      $
                      9,506




16




(a)
            The
      Chinese government refunded a partial amount of interest paid by the
      Company as grants. For the nine months ended September 30, 2010, the
      Company received refunds of $6,000 which was recognized as a reduction of
      interest expense. The effective interest rate of these loans was 5.44% for
      the nine months ended September 30, 2010. These loans are drawn on a
      credit facility in the amount of $3.7 million. The four loans would be due
      on October 25, 2010, November 22, 2010, November 23, 2010 and December 20,
      2010 respectively.





For the
nine months ended September 30, 2010 and 2009, total interest expenses incurred
amounted to $226,000 and $34,000, respectively. For the three months ended
September 30, 2010 and 2009, total interest expenses incurred amounted to
$48,000 and $34,000, respectively.





Note
9 - Taxes





The
United States of America




The
Company and its subsidiaries file separate income tax returns. The Company is
incorporated in the U.S., and is subject to a graduated U.S. federal corporate
income tax of 15% to 35% if the Company has taxable
income.


PRC




The
Company’s subsidiaries are governed by the Income Tax Law of the PRC concerning
Foreign Investment Enterprises and Foreign Enterprises and various local income
tax laws (the Income Tax Laws). Beginning January 1, 2008, the new Chinese
Enterprise Income Tax (“EIT”) law replaced the existing laws for Domestic
Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”).





The key
changes are:





a.
            The
      new standard EIT rate of 25% replaced the 33% rate currently applicable to
      both DES and FIEs.





b.
            Companies
      established before March 16, 2007 will continue to enjoy tax holiday
      treatment approved by local government for a grace period of either 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.





All of
the Company’s subsidiaries except for Konzern Holding are located and doing
business in China.  Konzern was approved as a foreign joint-venture
enterprise in 2004 and as a wholly-owned foreign enterprise in 2006.  All
of the subsidiaries were subject to an effective tax rate of 25% for the periods
ended as of September 30, 2010 and 2009.


The
provision for income taxes consisted of the following:




For the nine months ended
                            September 30,
                          
                          
                          For the three months ended
                            September 30,2010
                          
                          
                          2009
                          
                          
                          2010
                          
                          
                          2009(amounts in thousands)
                          
                          (Unaudited)
                          
                          
                          (Unaudited)Provision
      for China income tax
                          
                          $
                          2,543
                          
                          
                          $
                          2,331
                          
                          
                          $
                          941
                          
                          
                          $
                          1,216Provision
      for local tax
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Tax
      provision – PRC
                          
                          $
                          2,543
                          
                          
                          $
                          2,331
                          
                          
                          $
                          941
                          
                          
                          $
                          1,216







17




The
following table reconciles the U.S. statutory rates to the Company's effective
tax rate for the nine and three months ended September 30:




For the nine months ended
                      September 30,
                    
                    
                    For the three months ended
                      September 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009(Unaudited)
                    
                    
                    (Unaudited)U.S.
      statutory rates
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %Foreign
      income not recognized
                    
                    
                    (34.0
                    )
                    
                    
                    (34.0
                    )
                    
                    
                    (34.0
                    )
                    
                    
                    (34.0
                    )China
      tax rates
                    
                    
                    25.0
                    
                    
                    
                    25.0
                    
                    
                    
                    25.0
                    
                    
                    
                    25.0China
      income tax exemption
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Other
      items
                    
                    
                    (0.7
                    )
                    
                    
                    14.5
                    
                    
                    
                    5. 5
                    
                    
                    
                    3.0Effective
      income tax rates
                    
                    
                    24.3
                    %
                    
                    
                    39.5
                    %
                    
                    
                    30.5
                    %
                    
                    
                    28.0
                    %





The other
items represent losses incurred by Chinese subsidiaries that are under
development stage and have no operations currently and losses from non-Chinese
entities; all were not subjected to PRC income taxes.





Taxes
payable consisted of the following:


September 30, 2010
                      
                      
                      December 31, 2009(amounts in thousands)
                      
                      (Unaudited)Income
      taxes payable
                      
                      $
                      1,447
                      
                      
                      $
                      664Value
      added tax
                      
                      
                      320
                      
                      
                      
                      1,452Other
      taxes
                      
                      
                      70
                      
                      
                      
                      4Total
                      
                      $
                      1,837
                      
                      
                      $
                      2,120





The
Company was incorporated in the United States and has incurred net operating
losses for income tax purposes for the nine months ended September 30, 2010 and
2009, respectively. The estimated net operating loss carry forwards for United
States income taxes amounted to $2.9 million and $2.5 million as of September
30, 2010 and December 31, 2009, respectively, which may be available to reduce
future years’ taxable income. These carry forwards will expire, if not utilized,
from 2025 and 2030. 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 at
September 30, 2010 and December 31, 2009 were approximately $987,000, and
$858,000, respectively. Management will review this valuation allowance
periodically and make adjustments as warranted.




The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $45.7 million as of September 30, 2010, which was included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations.  Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the
future.





Note
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 $190,000 and $66,000 for the nine months
ended September 30, 2010 and 2009, respectively, and $147,000 and $27,000 for
the three months ended September 30, 2010 and 2009.





18


Note
11 - Commitments and Contingencies





In 2008,
the Company entered into agreements to acquire distribution rights to a
multivitamin pack and manufacturing of the multivitamin pack and to self-develop
various types of herbal tea.  The total contractual term of the exclusive
distribution rights is 15 years.  The Company prepaid approximately
$898,000 for ten years of exclusive distribution rights, with the remaining
$440,000 to be fulfilled starting in 2019.





On
January 7, 2010, the Company set up Konzern Company Limited (“Konzern Ltd.”)
which is 100% owned by the Company. Konzern Ltd. was established in China under
PRC law. The registered capital of Konzern Ltd. is approximately $29.3 million
(RMB 200.0 million) of which $16.0 million has been contributed as of September
30, 2010. To fulfill the requirement of the PRC local authority, the remaining
capital of approximately $13.3 million  has to be invested in Konzern Ltd.
within 2 years after the issuance date of the business license.





The
Company leases its facilities under short-term and long-term, non-cancelable
operating lease agreements expiring through November 2013. The non-cancelable
operating lease agreement states for various lease periods that the Company pays
certain monthly operating expenses applicable to the leased
premises.




The
future minimum annual lease payments required are as follows:




For the year ending December 31,
                          
                          (Amounts in thousands)2010
                          
                          $
                          432011
                          
                          
                          832012
                          
                          
                          102013
                          
                          
                          1Thereafter
                          
                          
                          -Total
                          
                          $
                          137




For the
nine months ended September 30, 2010 and 2009, total rental expense amounted to
$134,000 and $114,000, respectively. For the three months ended September 30,
2010 and 2009, total rental expense amounted to $49,000 and $42,000,
respectively.




As of
September 30, 2010, the Company had contractual capital commitments of
approximately $2.5 million for purchases of manufacturing facilities and
construction project and had outstanding commitments of approximately $1.1
million for research and development contracts with third parties.




Note
12 – Redeemable Convertible Preferred Stock




On
December 31, 2009, the Company entered into a Stock Subscription Agreement for
an equity private placement (the "Subscription Agreement") with an accredited
investor. This agreement became effective on January 29, 2010. According to the
Subscription Agreement, the investor purchased 4,000,000 shares of the Company's
common stock at $3 dollars per share and 1,920,000 shares of the Company's
preferred stock at $30.00 per share, for an aggregate purchase price of $69.6
million, of which $57.6 million is required to be placed in escrow. Each share
of Redeemable Convertible Preferred Stock is initially convertible into ten
shares of common stock and is entitled to receive dividends and have voting
rights based on the number of shares of common stock into which such share is
convertible.


The terms
of the Subscription Agreement also required the Company to issue to the investor
additional shares of Common Stock in the event the Company fails to achieve
certain revenue targets in 2010 and 2011.  However, the aggregate of all
such issuances of additional shares will not cause the Investor’s ownership
percentage to be greater than 75%.


19


In the
event of any voluntary or involuntary liquidation, dissolution or winding up of
the Corporation (“Liquidation Event”), the holders of shares of redeemable
convertible stock are entitled to be paid out of the assets of the Company
available for distribution ratably with holders of common stock and any class or
series of stock ranking on parity on liquidation with the redeemable convertible
preferred stock, after payment to the holders of any other class or series of
stock ranking senior on liquidation but before any payment to the holders of any
class or series of stock of the Corporation ranking junior on liquidation, an
amount (the “Preference Amount”) equal to ((1.042)a * US$30)
(where a is a fraction, the numerator of which is the number of days passed
since the closing of the Subscription Agreement to the date of determination and
the denominator of which is 365) per share of redeemable convertible preferred
stock then outstanding plus any accrued but unpaid dividends thereon (whether or
not declared).  If upon any such Liquidation Event the remaining
assets of the Corporation available for distribution are insufficient to pay the
full Preference Amount, the holders of shares of redeemable convertible
preferred stock and any class or series of stock ranking on parity on
liquidation with the redeemable convertible preferred Stock shall share ratably
in any distribution of the remaining assets and funds of the
Corporation.
  In April
2010, 266,667 shares of preferred stock were converted to 2,666,667 shares of
common stock, and $8.0 million was released from the escrow account to
strengthen the working capital and to fund the LifeTech’s facility expansion
plan in 2010.
 
 In July
2010, 66,667 shares of preferred stock were converted to 666,667 shares of
common stock, and $2.0 million was released from the escrow account for the
stock repurchase plan.
 
 Note
13 - Statutory Reserves
 
 The laws
and regulations of the PRC 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 the surplus reserve fund and the enterprise fund and represents
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.  The surplus reserve fund is non-distributable other
than during liquidation. It 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, in each
case provided that the remaining reserve balance after such issue is not less
than 25% of the registered capital.
 
 All of
the PRC subsidiaries are subject to the statutory surplus reserve. The required
reserve, 50% of the Company’s total registered capital, approximated to $23.0
million (RMB 161.7 million ). As of September 30, 2010, Konzern and LifeTech had
appropriated $4,300,000 and $79,000, respectively, as allocations to the
statutory surplus reserve. The other subsidiaries were still in the development
stage and had not allocated any contribution to the statutory surplus reserve.
As of September 30, 2010, the Company needs to contribute an additional $19.0
million from future earnings to the statutory reserve.
 
 Enterprise
Fund
 
 The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital available to spend 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 nine and three months ended September 30, 2010
and 2009, respectively.
  20
 
 Note
14- Shareholders’ Equity
 
 Stock Repurchase
Plan
 
 On June
30, 2010, the Company's board of directors approved a stock repurchase
program for up to $2.0 million. The program is valid through July 2011 and
allows the Company to repurchase shares of the Company’s common stock from time
to time on the open market or in privately negotiated transactions. As of
September 30, 2010, the Company had repurchased 366,656 shares and retired
284,412 shares with the purchase cost totaling approximately
$900,000.
 
 Stock-Based
Compensation
 
 In
January 2006, the Company created the 2006 Long-Term Incentive Plan (“2006
Plan). This plan authorized the issuance of 1,575,000 shares of the
Company’s common stock.  All grants have been at prices which
approximate the fair market value of the Company’s common stock at the date of
grant.  The contractual term is generally 5 years. On May 27, 2010,
the 2006 Plan was amended such that the exercise price on awards granted to
newly elected independent director approximates to the greater of the fair
market value on the date of grant or $3.00.
 
 On June
2, 2009, the Company granted a total of 15,000 stock options to three of its
independent directors. The options become exercisable for 7,500 shares of common
stock six months from the grant date and the remaining 7,500 options, eighteen
months from the grant date.  The grant date fair value was $1.41 per
share. On April 30, 2010, an amendment was provided to extend the exercise
period for awards granted to three directors. The incremental compensation cost
resulting from the modification was approximately $27,000.
 
 On August
25, 2009, the Company granted 240,000 shares of stock options to the Company’s
former chief financial officer (“CFO”). The options become exercisable for
60,000 shares of common stock one year from the grant date, and the remaining
180,000 options will become exercisable on the second anniversary of the grant
date at a rate of 15,000 shares per quarter. The grant date fair value was $1.10
per share. The CFO resigned in December 2009; all 240,000 options were
forfeited in accordance with the employment agreement.
 
 On April
30, 2010, the Company granted a total of 15,000 stock options to one of its
independent directors and two of its former independent directors. The options
become exercisable for 7,500 shares of common stock six months from the grant
date and the remaining 7,500 options, eighteen months from the grant date. The
grant date fair value was $2.40 per share.
 
 On May
27, 2010, the Company granted a total of 150,000 stock options to three of its
new independent directors. The options become exercisable for 75,000 shares of
common stock six months from the grant date and the remaining 75,000 options,
eighteen months from the grant date. The grate date fair value was $1.90 per
share.
 
 On August
12, 2010, the Company granted 21,713 stock options to the Company’s finance
manager. 7,238 options were exercisable immediately, 7,238 options will become
exercisable one year from the grant date, and the remaining 7,237 options will
become exercisable on the second anniversary of the grant date. The grant date
fair value was $1.60 per share.
 
 The fair
value of the options was estimated on the date of grant using a Black-Scholes
Option Pricing model using the following assumptions:
 2010
                  
                  
                  2009Annual
      dividend yield
                  
                  
                  -
                  
                  
                  
                  -Expected
      life (years)
                  
                  
                  4.00
      -  5.00
                  
                  
                  
                  4.00
      - 5.00Risk-free
      interest rate
                  
                  
                  1.15%
      - 2.18
                  %
                  
                  
                  1.52%
      - 2.02
                  %Expected
      volatility
                  
                  
                  85.0%
      - 88.0
                  %
                  
                  
                  88.0%
      - 90.0
                  %
 
 The
Company expensed $233,000 and $101,000 related to the stock options and warrants
for the nine months ended September 30, 2010 and 2009, respectively, and
$157,000 and $91,000 for the three months ended September 30, 2010 and 2009,
respectively.
  21
  Summary of option
activity:
 Outstanding
                              Options
                            
                            
                            Weighted
                              Average
                              Exercise
                              Price
                            
                            
                            Average
                              Remaining
                              Contractual
                              Term
                              (Year)
                            
                            
                            Exercisable
                              Options
                            
                            
                            Weighted
                              Average
                              Exercise
                              Price
                            
                            
                            Intrinsic Value12/31/2008
                            
                            
                            380,000
                            
                            
                            $
                            1.35
                            
                            
                            
                            
                            
                            
                            372,500
                            
                            
                            $
                            1.34
                            
                            
                            $
                            -Granted
                            
                            
                            255,000
                            
                            
                            
                            1.67
                            
                            
                            
                            
                            
                            
                            15,000
                            
                            
                            
                            1.81Exercised
                            
                            
                            (40,000
                            )
                            
                            
                            1.25
                            
                            
                            
                            
                            
                            
                            (40,000
                            )
                            
                            
                            1.25
                            
                            
                            
                            30,000Forfeited
                            
                            
                            (240,000
                            )
                            
                            
                            1.70
                            
                            
                            
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -12/31/2009
                            
                            
                            355,000
                            
                            
                            
                            1.39
                            
                            
                            
                            
                            
                            
                            347,500
                            
                            
                            
                            1.38
                            
                            
                            
                            1,033,000Granted
                            
                            
                            186,713
                            
                            
                            
                            2.98
                            
                            
                            
                            
                            
                            
                            7,238
                            
                            
                            
                            2.57
                            
                            
                            
                            -Exercised
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -
                            
                            
                            
                            -Forfeited
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -9/30/2010
      (unaudited)
                            
                            
                            541,713
                            
                            
                            $
                            1.94
                            
                            
                            
                            2.29
                            
                            
                            
                            354,738
                            
                            
                            $
                            1.40
                            
                            
                            $
                            252,000Exercisable
      at 9/30/2010
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1.04
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            252,000
 
 On April
30, 2010, the Company agreed to issue 120,000 shares of common stock to its CFO
during the term of a four-year agreement, which would vest in four equal
installments of 30,000 shares on the date after each anniversary of the
employment. The trading value of the common stock on April 30, 2010 was $3.40
per share for a total value of $408,000. These shares were not vested as of
September 30, 2010.  Common stock compensation expense is recognized
on a straight-line basis over the vesting period. Total compensation expense of
$43,000 and $26,000 was charged to general and administrative expenses for the
nine and three months ended September 30, 2010.
 
 Warrants
 
 Contemporaneously
with the reverse acquisition, the Company entered into a Preferred Stock
Purchase Agreement (“PSPA”), dated February 8, 2006, with Barron Partners L.P.,
Ray and Amy Rivers, JTROS, Steve Mazur and William Denkin pursuant to which the
Company issued and sold 3,120,000 shares of its Series A convertible preferred
stock, a newly-created series of preferred stock, and warrants to purchase
3,694,738 shares of common stock at $1.75 per share and 3,694,738 shares of
common stock at $2.50 per share.  On April 23, 2007, the Company and
the holders of the warrants executed a Waiver and Agreement that reduced the
conversion price for the preferred stock and the exercise price of the warrants
by 3% from the original conversion amounts.  The warrants have a term
of five years and are exercisable by the holder at any time within the
term.
 
 Effective
January 1, 2009, the Company adopted the provisions of an accounting
standard regarding whether an instrument (or embedded feature) is indexed to an
entity’s own stock.  This accounting standard 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.  It 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 scope
exception within the standards.
 
 As a
result of adoption, 3,348,686 warrants previously treated as equity pursuant to
the derivative treatment exemption are no longer afforded equity treatment
because the strike price of the warrants is denominated in US dollars, a
currency other than the Company’s functional currency, RMB.  As a
result, the warrants are not considered indexed to the Company’s own stock, and
as such, all future changes in the fair value of these warrants will be
recognized currently in earnings until such time as the warrants are exercised
or expire.
 
 These
common stock purchase warrants do not trade in an active securities market, and
as such, we estimate the fair value of these warrants using the Black-Scholes
Option Pricing Model using the following assumptions:
  22
 
 September 30,
                      2010
                    
                    
                    December
                      31, 2009(Unaudited)Annual
      dividend yield
                    
                    
                    -
                    
                    
                    
                    -Expected
      life (years)
                    
                    
                    0.36
                    
                    
                    
                    1.10Risk-free
      interest rate
                    
                    
                    0.15
                    %
                    
                    
                    0.54
                    %Expected
      volatility
                    
                    
                    32
                    %
                    
                    
                    95
                    %
 
 Expected
volatility is based on historical volatility. Historical volatility was computed
using daily pricing observations for recent periods that correspond to the term
of the warrants. We believe this method produces an estimate that is
representative of our expectations of future volatility over the expected term
of these warrants. We have no reason to believe future volatility over the
expected remaining life of these warrants is likely to differ materially from
historical volatility. The expected life is based on the remaining term of the
warrants. The risk-free interest rate is based on U.S. Treasury securities
according to the remaining term of the warrants.
 
 For the
nine months ended on September 30, 2010, several investors exercised of 440,475
Series B warrants for cash, for an aggregate price of $1.1
million.  The Company valued the conversion on the exercise date and
recorded an aggregate of $37,000 income from changes in fair value of warrant
liabilities.
 
 For the
nine months ended on September 30, 2010, several investors performed cashless
exercise of 1,026,474 Series B warrants, which were converted into 486,179
shares of common stock.  The Company valued the conversion on the
exercise date and recorded an aggregate of $299,000 losses from changes in fair
value of warrant liabilities.
 
 For the
nine months ended on September 30, 2010, a vendor performed a cashless exercise
of 70,000 Series C warrants, which were converted in 53,380 shares of common
stock.
 
 Summary of
warrant activity:
 Outstanding
                                
                                
                                Weighted Average
                                  Exercise Price
                                
                                
                                Average Remaining
                                  Contractual
    Term (Years)December
      31, 2008
                                
                                
                                3,418,686
                                
                                
                                $
                                2.35
                                
                                
                                
                                2.17Granted
                                
                                
                                70,000Exercised
                                
                                
                                (485,422
                                )Forfeited
                                
                                
                                -December
      31, 2009
                                
                                
                                3,003,264
                                
                                
                                $
                                2.38
                                
                                
                                
                                1.15Granted
                                
                                
                                -Exercised
                                
                                
                                (1,536,949
                                )Forfeited
                                
                                
                                -September
      30, 2010 (Unaudited)
                                
                                
                                1,466,315
                                
                                
                                $
                                2.41
                                
                                
                                
                                0.39
  23
 
 Note
15 – Earnings Per Share
  For the nine months ended
                                        September 30,
                                      
                                      
                                      For the three months ended
                                        September 30,2010
                                      
                                      
                                      2009
                                      
                                      
                                      2010
                                      
                                      
                                      2009(Unaudited)
                                      
                                      
                                      (Unaudited)Net
      income
                                      
                                      $
                                      8,124,000
                                      
                                      
                                      $
                                      3,812,000
                                      
                                      
                                      $
                                      2,223,000
                                      
                                      
                                      $
                                      3,220,000Less:
      Deemed preferred stock dividend
                                      
                                      
                                      6,144,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Net
      income attributable to shareholders
                                      
                                      $
                                      1,980,000
                                      
                                      
                                      $
                                      3,812,000
                                      
                                      
                                      $
                                      2,223,000
                                      
                                      
                                      $
                                      3,220,000Shares
      of common stock and common stock equivalents:Weighted
      average redeemable convertible preferred stock used in basic
      computation
                                      
                                      
                                      15,628,815
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      15,924,637
                                      
                                      
                                      
                                      -Weighted
      average common shares used in basic computation
                                      
                                      
                                      21,490,264
                                      
                                      
                                      
                                      15,241,333
                                      
                                      
                                      
                                      23,563,225
                                      
                                      
                                      
                                      15,265,904Total
      weighted average shares used in basic computation
                                      
                                      
                                      37,119,079
                                      
                                      
                                      
                                      15,241,333
                                      
                                      
                                      
                                      39,487,862
                                      
                                      
                                      
                                      15,265,904Diluted
      effect of redeemable convertible preferred stock, stock options and
      warrants
                                      
                                      
                                      573,701
                                      
                                      
                                      
                                      64,119
                                      
                                      
                                      
                                      104,527
                                      
                                      
                                      
                                      145,250Weighted
      average common shares used in diluted computation
                                      
                                      
                                      22,063,965
                                      
                                      
                                      
                                      15,305,452
                                      
                                      
                                      
                                      39,592,389
                                      
                                      
                                      
                                      15,411,154Earnings
      per share:Redeemable
      convertible preferred stock
                                      
                                      $
                                      0.05
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      0.06
                                      
                                      
                                      $
                                      -Common
      stock
                                      
                                      
                                      0.05
                                      
                                      
                                      
                                      0.25
                                      
                                      
                                      
                                      0.06
                                      
                                      
                                      
                                      0.21Basic
                                      
                                      $
                                      0.10
                                      
                                      
                                      $
                                      0.25
                                      
                                      
                                      $
                                      0.12
                                      
                                      
                                      $
                                      0.21Diluted
                                      
                                      $
                                      0.09
                                      
                                      
                                      $
                                      0.25
                                      
                                      
                                      $
                                      0.06
                                      
                                      
                                      $
                                      0.21
  Due to
the similarities in the terms between the Company’s participating redeemable
convertible preferred stock and the Company’s common stock, the Company
considered the redeemable convertible preferred stock to be common stock
equivalent for purposes of earnings per share calculation. Net income
attributable to shareholders was allocated between redeemable convertible
preferred stock and common stock based on the dividend participation
rights. For the three and nine months ended September 30, 2010, convertible
preferred stock equivalent to 15,924,637 and 15,628,815 weighted average
common shares were used in basic earnings per share computation.
 
 For the
nine months ended September 30, 2009, 3,239,212 warrants whose exercise price
was between $1.70 to $2.43 and 22,500 options whose exercise price was $3.00
were excluded from the calculation because of their anti-dilutive nature. For
the three months ended September 30, 2009, 3,039,738 warrants whose exercise
price is between $2.26 to $2.43 and 22,500 options whose exercise price is
between $2.01 and $3.00 are exclude from the calculation because of their
anti-dilutive nature.
 
 For the
nine months ended September 30, 2010, 15,000 options whose exercise price was
$3.40, and 1,586,667 convertible preferred stock were excluded from the earnings
per share calculation because of their anti-dilutive nature. For the three
months ended September 30, 2010, 1,376,315 warrants whose exercise price was
between $2.43and 201,713 options whose exercise price is between $2.57 and $3.40
were excluded from the calculation because of their anti-dilutive
nature.
  Note
16 – Business Combination
 
 In 2009,
Konzern entered into an Equity Ownership Transfer Agreement with Sinoform
Limited (“Sinoform”) to acquire 100% of Sinoform’s equity interests in
LifeTech.  LifeTech was founded in 1992 and is a developer and
manufacturer of pharmaceutical products with a focus on vascular medicines,
anti-inflammatory medicines, women’s health and other general health traditional
Chinese medicines.  Concurrently, Konzern entered into a separate agreement
with Mcwalts Investment Holdings Limited (“Mcwalts”) to acquire 100% of Mcwalts
ownership in LifeTech Technology.  LifeTech Technology was in the
development stage and had no operations as of September 30,
2010.  LifeTech and LifeTech Technology were under common control and
ownership of Mcwalts.  The two acquisitions were considered as one
acquisition and are referred to as the “Acquisition” below.  Konzern
gained control of LifeTech and LifeTech Technology on October 26,
2009.
  24
  The
purchase price of the Acquisition included cash payments of approximately $8.2
million (RMB 55.8 million). In connection with the acquisition, an independent
third party appraiser which is a certified public appraiser under the laws of
PRC was engaged by Konzern to perform an appraisal of certain of the assets of
entities to be acquired.  The assets evaluated included fixed assets
(equipment and buildings) and intangible assets (land-use rights and patents).
The appraiser conducted an on-site visit, inspected each item, conducted market
research and investigation, followed some asset evaluation policies and
regulations issued by the Chinese government, and provided an evaluation report.
The Company’s management also performed an internal evaluation; taking into
account of the PRC certified public appraiser’s evaluation report, to determine
the fair value of these assets reported in the financial statements. Fair value
of other assets acquired and liabilities assumed approximated their book
value.  Net assets acquired after the fair value measurement exceeded
the purchase consideration.  Management reviewed the procedures and
methodologies used to measure the fair value of fixed assets and intangibles and
determined to reduce the excess to the value of intangible assets.
 
 The
following table summarizes the net book value and the fair value of the assets
acquired and liabilities assumed at the date of acquisition:
 Fair
      value
                
                
                Book
      value(amounts
      in thousands)Cash
      and cash equivalent
                
                $
                166
                
                
                $
                166Other
      current assets
                
                
                2,271
                
                
                
                2,271Buildings
      and equipment
                
                
                5,778
                
                
                
                4,155Intangible
      assets
                
                
                15,279
                
                
                
                1,474Total
      assets
                
                
                23,494
                
                
                
                8,066Total
      liabilities
                
                
                (15,306
                )
                
                
                (15,306
                )Net
      Asset
                
                $
                8,188
                
                
                $
                (7,240
                )
 
 For the
nine months ended September 30, 2010, LifeTech and LifeTech Technology’s revenue
and net loss included in the Company’s consolidated income statement was
approximately $5.3 million and $0.4 million, respectively. For the three months
ended September 30, 2010, LifeTech and LifeTech Technology’s revenue and net
loss included in the Company’s consolidated income statement was approximately
$2.5 million and $0.5 million, respectively.
 
 Note
17 – Segment Information
 
 Based on
its internal reporting and management structure, the Company has determined that
it has two reportable segments: LifeTech and Konzern. LifeTech derives its
revenue exclusively from distribution and direct sales of proprietary products
and Konzern derives its revenue primarily from distribution
products.
 
 The
Company evaluates segment performance and allocates resources based on segment
gross profit and segment operating income. The table below illustrates analysis
of reportable segments (management information):
 
 For the
nine months ended September 30, 2010 (a):
 
 (amounts
      in thousands)
                  
                  LifeTech
                  
                  
                  Konzern
                  
                  
                  Elimination
                  
                  
                  Total(Unaudited)Revenues
                  
                  $
                  5,301
                  
                  
                  
                  40,119
                  
                  
                  
                  (107
                  )
                  
                  
                  45,313Gross
      Profit
                  
                  
                  2,278
                  
                  
                  
                  12,903
                  
                  
                  
                  (22
                  )
                  
                  
                  15,159Operating
      income (loss)
                  
                  
                  (225
                  )
                  
                  
                  7,768
                  
                  
                  
                  (22
                  )
                  
                  
                  7,521Capital
      expenditures
                  
                  $
                  4,530
                  
                  
                  
                  77
                  
                  
                  
                  -
                  
                  
                  
                  4,607
 
 For the
three months ended September 30, 2010 (a):
 
 (amounts
      in thousands)
                  
                  LifeTech
                  
                  
                  Konzern
                  
                  
                  Elimination
                  
                  
                  Total(Unaudited)Revenues
                  
                  $
                  2,457
                  
                  
                  
                  15,138
                  
                  
                  
                  (45
                  )
                  
                  
                  17,550Gross
      Profit
                  
                  
                  1,038
                  
                  
                  
                  4,788
                  
                  
                  
                  (22
                  )
                  
                  
                  5,804Operating
      income (loss)
                  
                  
                  (456
                  )
                  
                  
                  2,964
                  
                  
                  
                  (22
                  )
                  
                  
                  2,486Capital
      expenditures
                  
                  $
                  4,372
                  
                  
                  
                  63
                  
                  
                  
                  -
                  
                  
                  
                  4,435
  25
  (a)
              Since
      the LifeTech was acquired in October 2009, there is no comparable
      operating information for the nine and three months ended September 30,
      2009.
 
 Total
      Assets(amounts
      in thousands)
                        
                        LifeTech
                        
                        
                        Konzern
                        
                        
                        Elimination
                        
                        
                        TotalAs
      of September 30, 2010 (Unaudited)
                        
                        $
                        29,692
                        
                        
                        
                        206,187
                        
                        
                        
                        (101,835
                        )
                        
                        
                        134,044As
      of December 31, 2009
                        
                        $
                        25,385
                        
                        
                        
                        114,721
                        
                        
                        
                        (73,262
                        )
                        
                        
                        66,844
  26
 
 Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
 
 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, which 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.
 
 Given
these uncertainties, we caution investors not to unduly rely on our
forward-looking statements. We do not undertake any obligation to review or
confirm analysts’ expectations or estimates or to release publicly any revisions
to any forward-looking statements to reflect events or circumstances after the
date of this report or to reflect the occurrence of unanticipated events, except
as required by applicable law or regulation.
 
 The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the financial statements and
accompanying notes and the other financial information appearing in Part I, Item
1 and elsewhere in this report, and the financial statements and notes in the
Company’s Annual Report on Form 10-K for the year ended December 31,
2009.
  Overview
 
 China
Medicine Corporation (“we,” “us”, or the “Company”), through our subsidiaries in
the People’s Republic of China (the “PRC” or “China”), engages in the wholesale
distribution, research and development, and manufacture of prescription and
over-the-counter medicines, Traditional Chinese Medicines (“TCM”), dietary
supplements, medical instruments and the sales of medical technology in the
PRC.  Through Guangzhou Konzern Medicine Co., Ltd. (“Konzern”), one of
our wholly owned subsidiaries organized under the laws of the PRC, we distribute
approximately 1,243 pharmaceutical products in China. Through Guangzhou LifeTech
Pharmaceutical Co., Ltd. (“LifeTech”), one of our wholly owned subsidiaries, we
manufacture TCM and lyophilized powder of injection in China. Through Guangzhou
Co-Win Bioengineering Co., Ltd. (“Co-Win”), a 70%-owned subsidiary of Konzern
organized under the laws of the PRC, we develop and manufacture Aflatoxin
Detoxifizyme (“rADTZ”).
 
 Our
revenues are derived from three sources: the resale of pharmaceutical products
and medicine devices purchased from suppliers (“distribution products”); the
manufacture, distribution and sale of the Company’s products under its own brand
names (“proprietary products”); and the royalty or techniques income derived
from customers for research and development of new or improved drug formulas and
production techniques (“medical technology”).
 
 Our
distribution products include prescription and over-the-counter drugs, Chinese
herbs, TCM made from Chinese herbs, nutritional supplements, dietary supplements
and medical instruments. The most significant portion of our distribution
products is Iopamidol Injection, a prescription medicine that is used in
angiographies & CT scanning.
 
 Our
proprietary products consist primarily of products acquired through our
acquisition of LifeTech. The most significant products include Shuangdan
Capsules, a prescription TCM that is used for the treatment of thoracic
obstruction and cardialgia, and Hoerhuan Capsules, a prescription TCM that is
used to treat upper respiratory infection, acute laryngopharyngitis, acute
tonsillitis and acute enterogastritis.
  27
 
 Our
medical technology revenues typically consist of sales of technologies that are
either self-developed or initially acquired in an undeveloped state from other
companies and that are then sold to drug manufacturers after we have made
improvements to the technologies.
 
 Following
the completion of the LifeTech acquisition in December 2009, we have
transitioned from being a pharmaceutical distributor to being a
vertically-integrated pharmaceutical enterprise that combines nationwide
pharmaceutical distribution with significant research and development and
manufacturing capabilities. The Company will expend more resources and effort on
LifeTech’s products in the future. The addition of LifeTech’s product portfolio
has enabled us to expand our portfolio of proprietary products, which typically
have higher gross margins than our distribution products. As we continue to
reposition and integrate LifeTech into our operations, we expect significant
gross margin improvement through the increased sale of proprietary products. We
also expect further gross margin improvement by strategically focusing more on
the sale of products with exclusive national and regional exclusive distribution
rights and reducing our sales of lower margin generic distribution
products.
 
 During
the nine months ended September 30, 2010, our revenues were up approximately
2.3% as compared to the corresponding period in the prior year. Our revenues
during the period in review were affected by (i) the aforementioned strategic
reduction in the sale of generic distribution products; (ii) the limited
production capacity of LifeTech; (iii) the re-positioning of LifeTech’s products
in the market in terms of pricing and marketing strategy; and (iv) the final
integration of LifeTech with our existing businesses.  In an effort to
alleviate our manufacturing capacity constraints, the board of directors has
approved the capacity expansion of LifeTech’s manufacturing facilities and
construction is expected to be completed in the third quarter of
2011.
 
 Corporate
Structure
 
 On
January 7, 2010, Konzern Company Limited (“Konzern Ltd.”), which is wholly owned
by the Company, was established in China under PRC law. Its business license is
valid for fifty (50) years from January 7, 2010. The registered capital of
Konzern Ltd. is approximately $29.3 million  (RMB 200.0 million) of
which $16.0 million has been contributed as of September 30, 2010. To fulfill
the requirements of the PRC local authority, the remaining capital of
approximately $13.3 million  has to be invested in Konzern Ltd. within
two (2) years after the issuance date of the business license.
 
 As of May
12, 2010, we completed reorganizing our PRC subsidiaries. All PRC subsidiaries
are controlled by Konzern Ltd. On May 26, 2010, Konzern Ltd. changed its
registered name to Konzern Group Ltd. (“Konzern Group”).
 
 As a
result of the restructuring referenced above, as of September 30, 2010, and as
of the date of this report, our corporate structure is as
follows:
  28
 
 
 
 Results
of Operations
 
 The
following table sets forth our statements of operations for the three months and
the nine months ended September 30, 2010 and 2009, in U.S. dollars:
  (amounts in thousands)
                                      
                                      Three Months Ended
                                        September 30,
                                      
                                      
                                      Nine Months Ended
                                        September 30,2010
                                      
                                      
                                      2009
                                      
                                      
                                      2010
                                      
                                      
                                      2009Revenue
                                      
                                      $
                                      17,550
                                      
                                      
                                      $
                                      19,156
                                      
                                      
                                      $
                                      45,313
                                      
                                      
                                      $
                                      44,309Costs
      of goods sold
                                      
                                      
                                      11,746
                                      
                                      
                                      
                                      13,322
                                      
                                      
                                      
                                      30,154
                                      
                                      
                                      
                                      32,167Gross
      profit
                                      
                                      
                                      5,804
                                      
                                      
                                      
                                      5,834
                                      
                                      
                                      
                                      15,159
                                      
                                      
                                      
                                      12,142R&D
      expenses
                                      
                                      
                                      1,252
                                      
                                      
                                      
                                      362
                                      
                                      
                                      
                                      1,961
                                      
                                      
                                      
                                      1,128Selling,
      general and administrative expenses
                                      
                                      
                                      2,066
                                      
                                      
                                      
                                      935
                                      
                                      
                                      
                                      5,677
                                      
                                      
                                      
                                      2,932Income
      from operations
                                      
                                      
                                      2,486
                                      
                                      
                                      
                                      4,537
                                      
                                      
                                      
                                      7,521
                                      
                                      
                                      
                                      8,082Other
      income (expense), net
                                      
                                      
                                      32
                                      
                                      
                                      
                                      (48
                                      )
                                      
                                      
                                      (135
                                      )
                                      
                                      
                                      (69
                                      )Change
      in fair value of warrants liabilities
                                      
                                      
                                      564
                                      
                                      
                                      
                                      (142
                                      )
                                      
                                      
                                      3,045
                                      
                                      
                                      
                                      (2,114
                                      )Income
      before income taxes and noncontrolling interest
                                      
                                      
                                      3,082
                                      
                                      
                                      
                                      4,347
                                      
                                      
                                      
                                      10,431
                                      
                                      
                                      
                                      5,899Provision
      for income taxes
                                      
                                      
                                      941
                                      
                                      
                                      
                                      1,216
                                      
                                      
                                      
                                      2,543
                                      
                                      
                                      
                                      2,331Net
      income before noncontrolling interest
                                      
                                      
                                      2,141
                                      
                                      
                                      
                                      3,131
                                      
                                      
                                      
                                      7,888
                                      
                                      
                                      
                                      3,568Add:
      net income attributable to noncontrolling interest
                                      
                                      
                                      82
                                      
                                      
                                      
                                      88
                                      
                                      
                                      
                                      236
                                      
                                      
                                      
                                      243Consolidated
      net income attributable to CHINA MEDICINE CORPORATION
                                      
                                      $
                                      2,223
                                      
                                      
                                      $
                                      3,219
                                      
                                      
                                      $
                                      8,124
                                      
                                      
                                      $
                                      3,811
 
 THE
THREE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2009
 
 Revenues
 
 Total
revenues for the three months ended September 30, 2010 was $17.6 million , a
decrease of $1.6 million, or 8.4%, from total revenues of $19.2 million for the
three months ended September 30, 2009.
 
 Our
revenues are derived from the sale of distribution products, proprietary
products and medical technology. The following table sets forth the revenues and
percentage of revenues derived from each of these types of
products.
  29
 
 Three
      Months Ended September 30,(amounts
      in thousands)
                                                    
                                                    2010
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    $
      Increase
                                                    
                                                    
                                                    %
      IncreaseDistribution
      products
                                                    
                                                    $
                                                    15,093
                                                    
                                                    
                                                    
                                                    86.0
                                                    %
                                                    
                                                    $
                                                    18,314
                                                    
                                                    
                                                    
                                                    95.6
                                                    %
                                                    
                                                    $
                                                    (3,221
                                                    )
                                                    
                                                    
                                                    (17.6
                                                    )%Proprietary
      products
                                                    
                                                    
                                                    2,457
                                                    
                                                    
                                                    
                                                    14.0
                                                    %
                                                    
                                                    
                                                    476
                                                    
                                                    
                                                    
                                                    2.5
                                                    %
                                                    
                                                    
                                                    1,981
                                                    
                                                    
                                                    
                                                    416.2
                                                    %Medical
      technology
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    366
                                                    
                                                    
                                                    
                                                    1.9
                                                    %
                                                    
                                                    
                                                    (366
                                                    )
                                                    
                                                    
                                                    (100
                                                    )%TTotal
      revenues
                                                    
                                                    $
                                                    17,550
                                                    
                                                    
                                                    
                                                    100.0
                                                    %
                                                    
                                                    $
                                                    19,156
                                                    
                                                    
                                                    
                                                    100.0
                                                    %
                                                    
                                                    $
                                                    (1,606
                                                    )
                                                    
                                                    
                                                    (8.4
                                                    )%
 
 Distribution
products revenues for the three months ended September 30, 2010 were $15.1
million, a decrease of $3.2 million, or 17.6%, from total revenues of $18.3
million for the three months ended September 30, 2009. The decrease was
primarily due to the change of the distribution products portfolio, as we
focused on high profit margin products and our own proprietary products, and
reduced the emphasis on certain low profit margin products. The change of our
emphasis has improved our overall profit margin to 33.1% for the three months
ended September 30, 2010 as compared to 30.5% for the same period of
2009.
 
 The most
significant product is Iopamidol Injection, a prescription medicine that is used
in angiographies and CT scanning. For the three months ended September 30, 2010
and 2009, our total revenues from the sale of this product amounted to $3.4
million and $3.2 million, respectively, which was 19.2% and 16.7% of our total
revenues, respectively. Our top five (5) distribution products generated
revenues of 44.4% of our total revenues for the three months ended September 30,
2010.
 
 Our
distribution products revenues can be further categorized as
follows:
 
 Three Months Ended September 30,(amounts in thousands)
                  
                  2010
                  
                  
                  2009Prescription
      products
                  
                  
                  12,433
                  
                  
                  
                  82.4
                  %
                  
                  
                  13,528
                  
                  
                  
                  73.9
                  %,Over-the-Counter
      products
                  
                  
                  2,310
                  
                  
                  
                  15.3
                  %
                  
                  
                  4,380
                  
                  
                  
                  23.9
                  %Other
      products
                  
                  
                  350
                  
                  
                  
                  2.3
                  %
                  
                  
                  406
                  
                  
                  
                  2.2
                  %Total
      distribution products
                  
                  
                  15,093
                  
                  
                  
                  100.0
                  %
                  
                  
                  18,314
                  
                  
                  
                  100.0
                  %
 
 Proprietary
products revenues for the three months ended September 30, 2010 were $2.5
million, an increase of $2.0 million, or 416.2%, from total revenues of $0.5
million for the three months ended September 30, 2009. The increase was
primarily due to the additional revenues from LifeTech’s products, and there was
no comparable revenue in the corresponding period in the prior
year.
 
 Our
proprietary products revenues can be further categorized as
follows:
 
 Three Months Ended September 30,(amounts in thousands)
                  
                  2010
                  
                  
                  2009Prescription
      products
                  
                  
                  2,219
                  
                  
                  
                  90.3
                  %
                  
                  
                  397
                  
                  
                  
                  83.4
                  %Over-the-Counter
      products
                  
                  
                  219
                  
                  
                  
                  8.9
                  %
                  
                  
                  
                  
                  
                  
                  %Other
      products
                  
                  
                  19
                  
                  
                  
                  0.8
                  %
                  
                  
                  79
                  
                  
                  
                  16.6
                  %Total
      proprietary products
                  
                  
                  2,457
                  
                  
                  
                  100.0
                  %
                  
                  
                  476
                  
                  
                  
                  100.0
                  %
 
 Medical
technology revenue for the three months ended September 30, 2010 and 2009 were
$0 and $366,000, respectively.
  30
  Cost of Revenues and Gross
Profit
  Three Months Ended September 30(amounts in thousands)
                                          
                                          2010
                                          
                                          
                                          2009
                                          
                                          
                                          $ Increase
                                          
                                          
                                          % IncreaseDistribution
      productsRevenues
                                          
                                          $
                                          15,093
                                          
                                          
                                          $
                                          18,314
                                          
                                          
                                          $
                                          (3,221
                                          )
                                          
                                          
                                          (17.6
                                          )%Cost
      of goods sold
                                          
                                          
                                          10,338
                                          
                                          
                                          
                                          13,095
                                          
                                          
                                          
                                          (2,757
                                          )
                                          
                                          
                                          (21.1
                                          )%Gross
      profit
                                          
                                          $
                                          4,755
                                          
                                          
                                          $
                                          5,219
                                          
                                          
                                          $
                                          (464
                                          )
                                          
                                          
                                          (8.9
                                          )%Gross
      margin %
                                          
                                          
                                          31.5
                                          %
                                          
                                          
                                          28.5
                                          %
                                          
                                          
                                          
                                          
                                          
                                          
                                          3.0
                                          %Proprietary
      productsRevenues
                                          
                                          $
                                          2,457
                                          
                                          
                                          $
                                          476
                                          
                                          
                                          $
                                          1,981
                                          
                                          
                                          
                                          416.2
                                          %Cost
      of goods sold
                                          
                                          
                                          1,408
                                          
                                          
                                          
                                          227
                                          
                                          
                                          
                                          1,181
                                          
                                          
                                          
                                          520.3
                                          %Gross
      profit
                                          
                                          $
                                          1,049
                                          
                                          
                                          $
                                          249
                                          
                                          
                                          $
                                          800
                                          
                                          
                                          
                                          321.3
                                          %Gross
      margin %
                                          
                                          
                                          42.7
                                          %
                                          
                                          
                                          52.3
                                          %
                                          
                                          
                                          
                                          
                                          
                                          
                                          (9.6
                                          )%TotalRevenues
                                          
                                          $
                                          17,550
                                          
                                          
                                          $
                                          19,156
                                          
                                          
                                          $
                                          (1,606
                                          )
                                          
                                          
                                          (8.4
                                          )%Cost
      of goods sold
                                          
                                          
                                          11,746
                                          
                                          
                                          
                                          13,322
                                          
                                          
                                          
                                          (1,576
                                          )
                                          
                                          
                                          (11.8
                                          )%Gross
      profit
                                          
                                          $
                                          5,804
                                          
                                          
                                          $
                                          5,834
                                          
                                          
                                          $
                                          (30
                                          )
                                          
                                          
                                          (0.5
                                          )%Gross
      margin %
                                          
                                          
                                          33.1
                                          %
                                          
                                          
                                          30.5
                                          %
                                          
                                          
                                          
                                          
                                          
                                          
                                          2.6
                                          %
 
 Our gross
profit for distribution products for the three months ended September 30, 2010
was $4.8 million , a decrease of $0.4 million, or 8.9%, from $5.2 million for
the three months ended September 30, 2009. Although we experienced a decrease in
gross profit, our gross margin of distribution products for the three months
ended September 30, 2010 improved to 31.5%, as compared with 28.5% for the three
months ended September 30, 2009. This increase in gross margin was due to the
increase in sales of higher gross margin distribution products .
 
 Our gross
profit for proprietary products for the three months ended September 30, 2010
was $1.0 million, an increase of $0.8 million, or 321.3%, from $0.2 million for
the three months ended September 30, 2009. Our gross margin of proprietary
products for the three months ended September 30, 2010 was 42.7%, as compared
with 52.3% for the three months ended September 30, 2009.  The
decrease in gross margin was primarily due to significant increases in the price
of certain herbal materials used in our products and we were unable to increase
the selling price of our products in time to neutralize the impact of the
rising material prices.
 
 The cost
of developing medical technology was expensed when incurred. Therefore, there
was no direct cost related to such sale.
 
 Research
and Development Expenses
 
 Research
and development expenses were $1.3 million for the three months ended September
30, 2010, as compared with $0.4 million for the three months ended September 30,
2009.  Research and
development expenses consisted primarily of the depreciation of $295,000 and
$148,000 of Co-Win, for the testing and technology optimization of rADTZ for the
three months ended September 30, 2010 and 2009 respectively, and clinical trials
costs of $749,000 and $0 for Zhimuhuangtong, a Diabetes drug, for the three
months ended September 30, 2010 and 2009 respectively.
 
 Selling,
General and Administrative Expenses
 
 Selling,
general and administrative expenses were $2.1 million for the three months ended
September 30, 2010, an increase of $1.1 million from $0.9 million for the three
months ended September 30, 2009. The increase was mainly due to: (i) combined
headcounts of LifeTech upon the acquisition and hiring of new officers, (ii)
amortization and depreciation of LifeTech, and (iii) freight expenses for the
sales of the goods.
  31
  Other Income (Expense),
net
  Other
expense primarily consists of interest expense on the short-term loans,
including interest expense of $78,000 for Konzern’s loans and the interest
revenue of $4,000 from the escrow fund established in connection with the
financing from OEP CHME Holdings, LLC (“OEP”) which was consummated on January
29, 2010.
 
 Due to
the change in the market price of our common stock from $2.42 on June 30, 2010
to $2.06 on September 30, 2010, there was a fair value gain on warrant
liabilities of $564,000 for the three months ended September 30,
2010.
 
 Income
Taxes
 
 The
provision for income taxes was $0.9 million for the three months ended September
30, 2010, compared with $1.2 million for the three months ended September 30,
2009. The income tax rate is 25% based on the tax law of the PRC.
 
 Net
Income Attributable to China Medicine Corporation
 
 Consolidated
net income attributable to China Medicine Corporation for the three months ended
September 30, 2010 was $2.2 million, a decrease of $1.0 million, or 30.9% from
$3.2 million for the three months ended September 30, 2009. The decrease was
mainly due to lower sales of distribution products and higher
expenses.
 
 We use
non-GAAP adjusted net earnings to measure the performance of our business
internally by excluding non-cash charges related to the warrants. We believe
that the non-GAAP adjusted financial measure allows us to focus on managing
business operating performance because the measure reflects our essential
operating activities and provides a consistent method of comparison to
historical periods. We believe that providing the non-GAAP measure that we use
internally is useful to investors for a number of reasons. The non-GAAP measure
provides a consistent basis for investors to understand our financial
performance in comparison to historical periods without variation of
non-recurring items and non-operating related charges.  In addition,
it allows investors to evaluate our performance using the same methodology and
information as that used by our management.  Non-GAAP measures are
subject to inherent limitations because they do not include all of the expenses
included under GAAP and because they involve the exercise of judgment regarding
which charges are excluded from the non-GAAP financial measure. However, we
compensate for these limitations by providing the relevant disclosure of the
items excluded.
 
 The
following table provides a non-GAAP financial measure and a reconciliation of
that non-GAAP measure to the GAAP net income:
 
 Three
      Months Ended(amounts
      in thousands, except per share data)
                
                30 September2010
                
                
                2009Net
      Income attributable to common shareholders
                
                $
                2,223
                
                
                $
                3,219Deemed
      preferred stock dividend
                
                
                -
                
                
                
                -Change
      in fair value of warrant liabilities
                
                
                (564
                )
                
                
                142Adjusted
      Net Income
                
                $
                1,659
                
                
                $
                3,361Diluted
      EPS
                
                $
                0.06
                
                
                $
                0.21Add
      back (Deduct):Deemed
      preferred stock dividend
                
                
                -
                
                
                
                -Change
      in fair value of warrant liabilities
                
                
                (0.02
                )
                
                
                0.01Adjusted
      EPS
                
                $
                0.04
                
                
                $
                0.22Diluted
      weighted average common shares outstanding
                
                
                39,592,389
                
                
                
                15,411,154
  32
 
 Excluding
these non-cash expenses, the adjusted net income for the three months ended
September 30, 2010 was approximately $1.7 million, or $0.04 per fully diluted
share. Earnings per share were calculated using a diluted weighted average
common share count of 39.6 million shares for the three months ended September
30, 2010 and 15.4 million shares for the three months ended September 30,
2009.
 
 THE
NINE MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2009
 
 Revenues
 
 Total
revenues for the nine months ended September 30, 2010 were $45.3 million, an
increase of $1.0 million, or 2.3%, from total revenues of $44.3 million for the
nine months ended September 30, 2009.
 
 Our
revenues are derived from the sale of distribution products, proprietary
products and medical technology. The following table sets forth the revenues and
percentage of revenues derived from each of these types of
products.
 Nine
      months ended September 30,
                                
                                
                                
                                
                                
                                %(amounts
      in thousands)
                                
                                2010
                                
                                
                                2009
                                
                                
                                $
      Increase
                                
                                
                                IncreaseDistribution
      products
                                
                                $
                                39,802
                                
                                
                                
                                87.8
                                %
                                
                                $
                                42,514
                                
                                
                                
                                95.9
                                %
                                
                                $
                                (2,712
                                )
                                
                                
                                (6.4
                                )%Proprietary
      products
                                
                                
                                5,361
                                
                                
                                
                                11.8
                                %
                                
                                
                                1,429
                                
                                
                                
                                3.2
                                %
                                
                                
                                3,932
                                
                                
                                
                                275.2
                                %Medical
      technology
                                
                                
                                150
                                
                                
                                
                                0.4
                                %
                                
                                
                                366
                                
                                
                                
                                0.9
                                %
                                
                                
                                (216
                                )
                                
                                
                                (59.0
                                )%TTotal
      revenues
                                
                                $
                                45,313
                                
                                
                                
                                100.0
                                %
                                
                                $
                                44,309
                                
                                
                                
                                100.0
                                %
                                
                                $
                                1,004
                                
                                
                                
                                2.3
                                %
 
 Distribution
products revenues for the nine months ended September 30, 2010 were $39.8
million, a decrease of $2.7 million, or 6.4%, from total revenues of $42.5
million for the nine months ended September 30, 2009.
 
 The most
significant product is Iopamidol Injection, a prescription medicine that is used
in angiographies and CT scanning. For the nine months ended September 30, 2010
and 2009, our total revenues from sale of this product amounted to $10.1 million
and $7.4 million, respectively, which represented 22.4% and 16.8% of our
total revenues, respectively. Our top five (5) distribution products generated
revenues of $43.0% of our total revenues.
 
 Our
distribution products revenues can be further categorized as
follows:
  Nine
      Months Ended September 30,(amounts
      in thousands)
                
                2010
                
                
                2009Prescription
      products
                
                $
                33,177
                
                
                
                83.3
                %
                
                $
                31,553
                
                
                
                74.2
                %Over-the-Counter
      products
                
                
                5,040
                
                
                
                12.7
                %
                
                
                9,990
                
                
                
                23.5
                %Other
      products
                
                
                1,585
                
                
                
                4.0
                %
                
                
                971
                
                
                
                2.3
                %Total
      distribution products
                
                $
                39,802
                
                
                
                100.0
                %
                
                $
                42,514
                
                
                
                100.0
                %
 
 Proprietary
products revenues for the nine months ended September 30, 2010 were $5.4
million, an increase of $4.0 million, or 275.2%, from total revenues of $1.4
million for the nine months ended September 30, 2009. The increase was primarily
due to the additional revenues from LifeTech’s products, and there was no
comparable revenue in the corresponding period in the prior year.
  33
  Our
proprietary products revenues can be further categorized as
follows:
 Nine
      Months Ended September 30,(amounts
      in thousands)
                                              
                                              2010
                                              
                                              
                                              2009Western
      prescription products
                                              
                                              $
                                              4,660
                                              
                                              
                                              
                                              86.9
                                              %
                                              
                                              $
                                              1,325
                                              
                                              
                                              
                                              92.7
                                              %TCM
      Over-the-Counter products
                                              
                                              
                                              664
                                              
                                              
                                              
                                              12.4
                                              %
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              %Other
      products
                                              
                                              
                                              37
                                              
                                              
                                              
                                              0.7
                                              %
                                              
                                              
                                              104
                                              
                                              
                                              
                                              7.3
                                              %Total
      proprietary products
                                              
                                              $
                                              5,361
                                              
                                              
                                              
                                              100.0
                                              %
                                              
                                              $
                                              1,429
                                              
                                              
                                              
                                              100.0
                                              %
 
 Medical
technology revenues for the nine months ended September 30, 2010 were $150,000
and $366,000 for the nine months ended September 30, 2009.
 
 Cost
of Revenues and Gross Profit
 Nine
      months ended September 30,(amounts
      in thousands)
                                        
                                        2010
                                        
                                        
                                        2009
                                        
                                        
                                        $
      Increase
                                        
                                        
                                        %
      IncreaseDistribution
      productsRevenues
                                        
                                        $
                                        39,802
                                        
                                        
                                        $
                                        42,514
                                        
                                        
                                        $
                                        (2,712
                                        )
                                        
                                        
                                        (6.4
                                        )%Cost
      of goods sold
                                        
                                        
                                        27,130
                                        
                                        
                                        
                                        31,267
                                        
                                        
                                        
                                        (4,137
                                        )
                                        
                                        
                                        (13.2
                                        )%Gross
      profit
                                        
                                        $
                                        12,672
                                        
                                        
                                        $
                                        11,247
                                        
                                        
                                        $
                                        1,425
                                        
                                        
                                        
                                        12.7
                                        %Gross
      margin %
                                        
                                        
                                        31.8
                                        %
                                        
                                        
                                        26.5
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        5.3
                                        %Proprietary
      productsRevenues
                                        
                                        $
                                        5,361
                                        
                                        
                                        $
                                        1,429
                                        
                                        
                                        $
                                        3,932
                                        
                                        
                                        
                                        275.2
                                        %Cost
      of goods sold
                                        
                                        
                                        3,024
                                        
                                        
                                        
                                        900
                                        
                                        
                                        
                                        2,124
                                        
                                        
                                        
                                        236.0
                                        %Gross
      profit
                                        
                                        $
                                        2,337
                                        
                                        
                                        $
                                        529
                                        
                                        
                                        $
                                        1,808
                                        
                                        
                                        
                                        341.8
                                        %Gross
      margin %
                                        
                                        
                                        43.6
                                        %
                                        
                                        
                                        37.0
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        6.6
                                        %TotalRevenues
                                        
                                        $
                                        45,313
                                        
                                        
                                        $
                                        44,309
                                        
                                        
                                        $
                                        1,004
                                        
                                        
                                        
                                        2.3
                                        %Cost
      of goods sold
                                        
                                        
                                        30,154
                                        
                                        
                                        
                                        32,167
                                        
                                        
                                        
                                        (2,013
                                        )
                                        
                                        
                                        (6.3
                                        )%Gross
      profit
                                        
                                        $
                                        15,159
                                        
                                        
                                        $
                                        12,142
                                        
                                        
                                        $
                                        3,017
                                        
                                        
                                        
                                        24.8
                                        %Gross
      margin %
                                        
                                        
                                        33.5
                                        %
                                        
                                        
                                        27.4
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        6.1
                                        %
 
 Our gross
profit for distribution products for the nine months ended September 30, 2010
was $12.7 million, an increase of $1.4 million, or 12.7%, from $11.2 million for
the nine months ended September 30, 2009. Our gross margin of distribution
products for the nine months ended September 30, 2010 was 31.8%, as compared
with 26.5% for the nine months ended September 30, 2009. This increase was due
to an increase in the sales of higher gross margin products and a reduced the
emphasis on lower gross margin products.
 
 Our gross
profit for proprietary products for the nine months ended September 30, 2010 was
$2.3 million, an increase of $1.8 million, or 341.8%, from $0.5 million for the
nine months ended September 30, 2009. Our gross margin of proprietary products
for the nine months ended September 30, 2010 was 43.6%, as compared with 37.0%
for the nine months ended September 30, 2009. This increase was due to the
higher gross margin of LifeTech’s products.
 
 The cost
of developing medical technology was expensed when
incurred.  Therefore, there was no direct cost related to such
sales.
 
 Research
and Development Expenses
 
 Research
and development expenses were $2.0 million for the nine months ended September
30, 2010, as compared with $1.1 million for the nine months ended September 30,
2009.  Research and
development expenses consisted primarily of the depreciation of $449,000 and
$444,000 of Co-Win, for the testing and technology optimization of rADTZ for the
nine months ended September 30, 2010 and 2009 respectively, and clinical trials
costs of $749,000 and $0 for Zhimuhuangtong, a Diabetes drug, for the three
months ended September 30, 2010 and 2009 respectively.
  34
  Selling, General and Administrative
Expenses
 
 Selling,
general and administrative expenses were $5.7 million for the nine months ended
September 30, 2010, an increase of $2.8 million from $2.9 million for the nine
months ended September 30, 2009. The increase was mainly due to: (i) combined
headcounts of LifeTech upon acquisition and hiring of new officers, (ii)
amortization and depreciation of LifeTech, (iii) allowance for the advances to a
supplier of Konzern, (iv) general office expenses for establishing the Konzern
group, and (v) freight expenses for the sales of the goods.
 
 Other
Income (Expense), net
 
 Other
expenses primarily consist of interest expense on the short-term loans,
including interest expense of $138,000 for Konzern’s loans, and the interest
expense of $88,000 for LifeTech’s loans, and the interest revenue of $61,000
from the fixed deposit of Konzern and $27,000 from the escrow fund.
 
 Due to
the change in the market price of our common stock from $4.30 on December 31,
2009 to $2.06 on September 30, 2010, there was a fair value gain on warrant
liabilities of $3.0 million for the nine months ended September 30,
2010.
 
 Income
Taxes
 
 The
provision for income taxes was $2.5 million for the nine months ended September
30, 2010, compared with the $2.3 million for the nine months ended September 30,
2009. The income tax rate is 25% based on the tax law of PRC.
 
 Net
Income Attributable to China Medicine Corporation
 
 Consolidated
net income attributable to China Medicine Corporation for the nine months ended
September 30, 2010 was $8.1 million, an increase of $4.3 million, or 113.2% from
$3.8 million for the nine months ended September 30, 2009. The increase was
mainly due to the change in the fair value of warrant liabilities.
 
 Deemed
Preferred Stock Dividend
 
 Pursuant
to the Stock Subscription Agreement (“Subscription Agreement”) dated as at
December 31, 2009 between the Company and OEP, 1,920,000 shares of redeemable
convertible preferred stock, which can be converted into 19,200,000 shares of
common stock, were issued at the price of $30.00 per share on January 29, 2010,
using the conversion price of our common stock on January 29, 2010 of $3.00.
Using the closing price of our common stock on January 29, 2010 of $3.32, the
beneficial conversion feature was accounted for at $6.1 million, and was treated
as a deemed preferred stock dividend in the income statement in accordance with
SAB No.98.
 
 Net
Income Attributable to Common Shareholders
 
 The net
income attributable to common shareholders was $2.0 million for the nine months
ended September 30, 2010, compared to net income attributable to common
shareholders of $3.8 million for the nine months ended September 30,
2009.  The decrease in net income attributable to common shareholders
was due to the deemed preferred stock dividend in $6.1 million for the nine
months ended September 30, 2010.
 
 We use
non-GAAP adjusted net earnings to measure the performance of our business
internally by excluding non-cash charges related to the warrants. We believe
that the non-GAAP adjusted financial measure allows us to focus on managing
business operating performance because the measure reflects our essential
operating activities and provides a consistent method of comparison to
historical periods. We believe that providing the non-GAAP measures that we use
internally is useful to investors for a number of reasons. The non-GAAP measure
provides a consistent basis for investors to understand our financial
performance in comparison to historical periods without variation of
non-recurring items and non-operating related charges.  In addition,
it allows investors to evaluate our performance using the same methodology and
information as that used by our management.  Non-GAAP measures are
subject to inherent limitations because they do not include all of the expenses
included under GAAP and because they involve the exercise of judgment regarding
which charges are excluded from the non-GAAP financial measure. However, we
compensate for these limitations by providing the relevant disclosure of the
items excluded.
  35
 
 The
following table provides a non-GAAP financial measure and a reconciliation of
that non-GAAP measure to the GAAP net income:
 
 Nine
      Months Ended(amounts
      in thousands, except per share data)
                          
                          30 September2010
                          
                          
                          2009Net
      income attributable to common shareholders
                          
                          $
                          1,980
                          
                          
                          $
                          3,815Add
      back (deduct):Deemed
      preferred stock dividend
                          
                          
                          6,144
                          
                          
                          
                          -Change
      in fair value of warrant liabilities
                          
                          
                          (3,045
                          )
                          
                          
                          2,114Adjusted
      net income
                          
                          $
                          5,079
                          
                          
                          $
                          5,929Diluted
      EPS
                          
                          $
                          0.09
                          
                          
                          $
                          0.25Add
      back (deduct):Deemed
      preferred stock dividend
                          
                          
                          0.28
                          
                          
                          
                          -Change
      in fair value of warrant liabilities
                          
                          
                          (0.14
                          )
                          
                          
                          0.14Adjusted
      EPS
                          
                          $
                          0.23
                          
                          
                          $
                          0.39Diluted
      weighted average common shares outstanding
                          
                          
                          22,063,965
                          
                          
                          
                          15,305,452
 
 Excluding
these non-cash expenses, adjusted net income for the nine months ended September
30, 2010 was approximately $5.1 million, or $0.23 per fully diluted share.
Earnings per share were calculated using a diluted weighted common share count
of 22.1 million shares for the nine months ended September 30, 2010 and 15.3
million shares for the nine months ended September 30, 2009.
 
 Liquidity
and Capital Resources
 
 As of
September 30, 2010, we had $56.3 million in cash and cash equivalents, which
included the restricted cash. We have historically funded our working capital
needs from operations, advance payments from customers, bank borrowings, and
capital from shareholders. Our working capital requirements are influenced by
the level of our operations, seasonal factors, the progress of our contract
execution, and the timing of accounts receivable collections.
 
 Pursuant
to the Subscription Agreement, on January 29, 2010, the Company completed an
equity private placement with OEP, and 4,000,000 shares of the Company's common
stock at $3.00 per share and 1,920,000 shares of the Company's redeemable
convertible preferred stock at $30 per share, were issued for an aggregate
purchase price of $69.6 million  (the “OEP Private Placement”). Each
share of redeemable convertible preferred stock is initially convertible into 10
shares of common stock.
 
 At the
closing, $57.6 million of the proceeds were placed in an escrow
account.  In April 2010, $8.0 million of the escrowed proceeds was
released to strengthen the working capital and fund the LifeTech’s facility
expansion plan. In July 2010, $2.0 million of the escrowed proceeds was released
to fund the Company's Stock repurchase plan.
 
 Operating
Activities
 
 Net cash
used by operating activities was $2.4 million for the nine months ended
September 30, 2010, a decrease of $5.9 million from net cash of $3.5 million
provided in our operations for the nine months ended September 30, 2009. The
decrease in net cash provided by operating activities was largely due to the
increase in inventories and advances to suppliers.
  36
 
 As of
September 30, 2010, we had working capital of $85.7 million, an increase of
$69.9 million or 441.2%, from $15.8 million as of December 31, 2009. The
increase was mainly due to the cash and the restricted cash coming from the OEP
Private Placement.
 
 In order
to present the results of operations precisely, the Company calculated the days
sales outstanding (“DSO”), days inventory outstanding (“DIO”), days payable
outstanding (“DPO”), and cash conversion cycle (“CCC”) in accordance with the
definitions as below: (i) the advances to suppliers and customer deposits on
September 30, 2010 and 2009, respectively, were included in the calculation of
DIO, (ii) the revenues and cost of revenues in the period of annual circle were
used.
 
 For the
nine months ended September 30, 2010 and 2009, DSO was 104 days and 89 days,
respectively, DIO was 180 days and 119 days, DPO was 8 days and 2 days,
respectively, and CCC was 276 days and 206 days, respectively. Please note that
the data of LifeTech wasn’t consolidated in the calculation of the aforesaid
indicators of 2009.
 
 The
following table sets forth the changes in certain balance sheet items, in
thousands U.S. dollars and percentages, comparing September 30, 2010 and
December 31, 2009.
 
 Balance Sheet Caption
                  
                  Change in thousands dollars
                    12/31/09 to 9/30/10
                  
                  
                  Percentage Change
                    12/31/09 to 9/30/10Accounts
      receivable, trade
                  
                  
                  (5,403
                  )
                  
                  
                  (24
                  )%Inventories
                  
                  
                  3,048
                  
                  
                  
                  112
                  %Advances
      to suppliers
                  
                  
                  10,476
                  
                  
                  
                  416
                  %Accounts
      payable, trade
                  
                  
                  (478
                  )
                  
                  
                  (36
                  )%Customer
      deposits
                  
                  
                  152
                  
                  
                  
                  31
                  %
  The
changes in these balance sheet captions reflect the nature of the cash
requirements of our business. Comparing September 30, 2010 and December 31,
2009, our inventories increased $3.0 million or 112%.
 
 Our
accounts receivable decreased $5.4 million or 24% from December 31, 2009 to
September 30, 2010. The decrease was attributed to a change in the sales network
and our increased collection efforts. As of September 30, 2010, our net accounts
receivable totaled approximately $17.6 million.
 
 In the
course of our business, we must make significant deposits with our suppliers
when we place orders. Our advances to suppliers increased $10.5 million or 416%
from December 31, 2009 to September 30, 2010. The increase was intended to
obtain better purchase prices for the Company from our suppliers. As of
September 30, 2010, our advance payments to our suppliers totaled approximately
$13.2 million.
 
 In
addition, our customer deposits increased $152,000 or 31 % comparing September
30, 2010 and December 31, 2009, which reflects our strategy change in the sales
policy of LifeTech’s products to obtain more market share. As of September 30,
2010, our customer deposits totaled approximately $648,000.
 
 Investing
Activities
 
 Net cash
used in investing activities was $3.8 million during the nine months ended
September 30, 2010, a decrease of $3.2 million from the net cash $7.0 million
used in investing activities during the nine months ended September 30,
2009.
 
 Financing
Activities
 
 Net cash
provided by financing activities was $13.5 million during the nine months ended
September 30, 2010.  Net cash provided by financing activities
consisted of $69.6 million in gross proceeds from the issuance of common stock
and convertible preferred stock to OEP, $1.1 million in proceeds from exercise
of warrants and options, $11.4 million in repayments on short-term loans of
LifeTech and Konzern and $5.1 million in loan proceeds, and was offset by
payments on the OEP Private Placement  related expenses of $3.2
million and an increase in restricted cash of $46.7 million, and stock
repurchase in $0.9 million.
  37
 
 Critical
Accounting Policies and Estimates
 
 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.
 
 Revenues
Recognition
 
 We
recognize revenues 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. We follow the
provisions of the SEC’s Staff Accounting Bulleting No. 104, which sets forth
guidelines for the timing of revenues recognition based upon factors such as
passage of title, installation, payments and customer acceptance. Any amounts
received prior to satisfying our revenues recognition criteria are recorded as
deferred revenues.
 
 Sales
revenues represent 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
products.
 
 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
 
 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 in our warehouse to provide for estimated
obsolete or unsalable inventory based on assumptions about future demand for our
products and market conditions. If future demand and market conditions are less
favorable than management's assumptions, additional reserves could be required.
Likewise, favorable future demand and market conditions could positively impact
future operating results if previously reserved inventory is sold.
 
 Item
      3.
              Quantitative and
      Qualitative Disclosures About Market
Risk
 
 Not
applicable.
  38
  Item
      4.
              Controls and
      Procedures
 
 Disclosure
Controls and Procedures
 
 As
required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange
Act”), our management evaluated the effectiveness of the design and operation of
our disclosure controls and procedures as of September 30, 2010.
 
 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 Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the SEC and that
such information is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. In designing and
evaluating our disclosure controls and procedures, management recognizes that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management is required to apply its judgment in evaluating and implementing
possible controls and procedures.
 
 Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our Chief Executive Officer and our Chief Financial Officer.
Based on that evaluation, management concluded that our disclosure controls and
procedures were not effective as of September 30, 2010.  While we have
implemented additional control procedures to mitigate the risks associated with
the material weakness, these controls have not been independently tested for
effectiveness as of September 30, 2010.  Thus, our material weakness
will not be considered remediated until all testing has been completed and
management has a basis to conclude that these controls are properly designed and
operating effectively.
 
 As
previously reported in our Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission on March 30, 2010, in connection with
our assessment of the effectiveness of our internal control over financial
reporting at the end of its last fiscal year, management identified a material
weakness in internal control over financial reporting because of significant
deficiencies in our U.S. GAAP expertise and internal audit functions.  This
section of Item 4, “Controls and Procedures,” should be read in conjunction with
Item 9A(T), “Controls and Procedures,” included in our Form 10-K for the
year ended December 31, 2009, for additional information on Management’s
Report on Internal Controls Over Financial Reporting.
 
 Management
is committed to remediating the material weakness as quickly as possible and has
implemented additional controls and procedures during the year to reach that
objective. We hired a Chief Financial Officer in April 2010 who has extensive
experience in internal control and certain level of knowledge of U.S. GAAP
reporting compliance, to take charge of the financial reporting process and
training of the accounting staff.  On May 27, 2010, a new Audit Committee
was formed with experienced non-executive independent directors who possess
extensive knowledge and experience in U.S. GAAP, internal control, accounting,
healthcare management and biochemistry. In particular, Mr. Ian Robinson, a
former senior partner of Ernst & Young Hong Kong, was selected as Chairman
of the Audit Committee and brings thirty (30) years of financial and accounting
experience to the Company. To enhance our financial reporting and internal
control function, we recruited a number of financial personnel with relevant
experiences in U.S. GAAP, including a senior internal audit manager in July
2010, a finance manager in September 2010, and a vice president of Finance and
Accounting in  October 2010. In addition, on July 7, 2010, the Company
entered into a consulting agreement with Ernst & Young (China) Advisory
Limited for advisory services with respect to the compliance with SOX 404. The
project will be completed in first quarter of 2011.
 
 We expect
that these enhancementswill improve the
effectiveness of our disclosure controls and procedures and remediate the
ineffectiveness of certain controls and procedures that existed as of September
30, 2010.
  39
 
 Changes
in Internal Controls over Financial Reporting
 
 Except
for above-mentioned improvements made, there were no changes in our internal
controls over financial reporting during the most recent quarter of fiscal year
2010 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
  40
  PART
II OTHER INFORMATION
 
 Item
      2.
              Unregistered Sales of
      Equity Securities and Use of
Proceeds
 
 Unregistered Sales of Equity
Securities
 
 On July
15, 2010, we issued 666,667 shares of common stock to OEP CHME Holdings, LLC
upon the conversion of 66,666.7 shares of redeemable convertible preferred
stock.  This transaction was exempt from registration pursuant to
Section 3(a)(9) of the Securities Act of 1933, as amended (the “Securities
Act”.
 
 On
September 6, 2010, we issued 232,000 shares of common stock to Peak Capital
Advisory Limited as compensation for certain consulting
services.  This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act.
 
 Issuer Purchases of Equity
Securities
 
 The
following table sets forth information regarding shares of our common stock that
we repurchased during the three months ended September 30, 2010.
  Period
                  
                  (a)
                    Total Number of
                    Shares Purchased
                  
                  
                  (b)
                    Average Price Paid
                    per Share
                  
                  
                  (c)
                    Total Number of
                    Shares Purchased
                    as Part of Publicly
                    Announced Plans
                    or Programs
                  
                  
                  (d)
                    Maximum Number
                    (or Approximate
                    Dollar Value) of
                    Shares that May
                    Yet Be Purchased
                    Under the Plans or
                    Programs
                    (in thousands)July
      1 to July 31, 2010
                  
                  
                  47,462
                  
                  
                  
                  2.71
                  
                  
                  
                  47,462
                  
                  
                  $
                  2,000August
      1 to August 31, 2010
                  
                  
                  331,874
                  
                  
                  
                  2.49
                  
                  
                  
                  331,874
                  
                  
                  
                  1,872September
      1 to September 30, 2010
                  
                  
                  82,244
                  
                  
                  
                  2.25
                  
                  
                  
                  82,244
                  
                  
                  
                  1,046Total
                  
                  
                  461,580
                  
                  
                  
                  2.47
                  
                  
                  
                  461,580
                  
                  
                  
                  1,046
 
 (1)
              On
      July 9, 2010, we announced that our board of directors had authorized the
      repurchase and retirement of up to $2.0 million worth of our common stock
      in open market transactions or in privately negotiated
      transactions.
 
 Item
      6.
              Exhibits
 
 The
exhibits required by this item are set forth on the Exhibit Index attached
hereto.
  41
  SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 CHINA
      MEDICINE CORPORATIONDate:  November
      10, 2010
              By:
              /s/ Senshan YangSenshan
      YangPresident
      and Chief Executive Officer(Principal
      Executive Officer)Date:  November
      10, 2010
              By:
              /s/ Fred W. CheungFred
      W. CheungChief
      Financial Officer(Principal
      Financial Officer andAccounting
      officer)
  42
  Exhibit
Index
 
 Exhibit
                  Number
                
                Exhibit Title31.1
      *
                
                Certification
      of our Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
      *
                
                Certification
      of our Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
      *
                
                Certification
      of our Chief Executive Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32.2
      *
                
                Certification
      of our Chief Financial Officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.
  43