**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 June 30,
                2008





or


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




For
                the transition period from __________________ to
                __________________________Commission
                file number:000-30451





LOTUS
                PHARMACEUTICALS, INC.(Name
                of registrant as specified in its charter)





NEVADA
            
            20-0507918(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification No.)





16
                Cheng Zhuang Road, Feng Tai District, Beijing100071
              People’s
                Republic of China
            
            N/A(Address
                of principal executive offices)
            
            (Zip
                Code)





86-10-63899868(Registrant's
                telephone number, including area
                code)




**N/A**(Former
                name, former address and former fiscal year, if changed since last
                report)





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





Yes
xNo
o





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





Large
                accelerated filer o
            
            Accelerated
                filer oNon-accelerated
                filer o
              (Do
                not check if 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
oNo
x




Indicated
      the number of shares outstanding of each of the issuer's classes of common
      stock, as of the latest practicable date, 42,420,239  shares
      of
      common stock are issued and outstanding as of August 14, 2008.









**TABLE
      OF CONTENTS**





PageNo.**PART
                I. - FINANCIAL INFORMATION**Item
                1.
            
            Financial
                Statements
            
            3Item
                2.
            
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations.
            
            28Item
                3.
            
            Quantitative
                and Qualitative Disclosures About Market Risk.
            
            41Item
                4T
            
            Controls
                and Procedures.
            
            41**PART
                II - OTHER INFORMATION**Item
                1.
            
            Legal
                Proceedings.
            
            43Item
                1A.
            
            Risk
                Factors.
            
            43Item
                2.
            
            Unregistered
                Sales of Equity Securities and Use of Proceeds.
            
            43Item
                3.
            
            Defaults
                Upon Senior Securities.
            
            43Item
                4.
            
            Submission
                of Matters to a Vote of Security Holders.
            
            43Item
                5.
            
            Other
                Information.
            
            43Item
                6.
            
            Exhibits.
            
            43









**CAUTIONARY
      STATEMENT REGARDING FORWARD-LOOKING INFORMATION**





Certain
      statements in this report contain or may contain forward-looking statements
      that
      are subject to known and unknown risks, uncertainties and other factors which
      may cause actual results, performance or achievements to be materially different
      from any future results, performance or achievements expressed or implied by
      such forward-looking statements. These forward-looking statements were based
      on
      various factors and were derived utilizing numerous assumptions and other
      factors that could cause our actual results to differ materially from those
      in
      the forward-looking statements. These factors include, but are not limited
      to,
      our ability to enforce the Contractual Arrangements, Lotus East's strategic
      initiatives, economic, political and market conditions and fluctuations, U.S.
      and Chinese government and industry regulation, interest rate risk, U.S.,
      Chinese and global competition, and other factors. Most of these factors are
      difficult to predict accurately and are generally beyond our control. You should
      consider the areas of risk described in connection with any forward-looking
      statements that may be made herein. Readers are cautioned not to place undue
      reliance on these forward-looking statements and readers should carefully review
      this report in its entirety together with our Annual Report on Form 10-K for
      the
      year ended December 31, 2007 as filed with the SEC, including the risks
      described in Item 1A. Risk Factors. Except for our ongoing obligations to
      disclose material information under the Federal securities laws, we undertake
      no
      obligation to release publicly any revisions to any forward-looking statements,
      to report events or to report the occurrence of unanticipated events. These
      forward-looking statements speak only as of the date of this report, and you
      should not rely on these statements without also considering the risks and
      uncertainties associated with these statements and our business.




**OTHER
      PERTINENT INFORMATION**





We
      maintain a web site at www.lotuseast.com. Information on this web site is not
      a
      part of this report.





**CERTAIN
      DEFINED TERMS USED IN THIS PROSPECTUS**





Unless
      specifically set forth to the contrary, when used in this report the
      terms:


·
              "Lotus,"
                  "we,"
                  "us,"
                  "our,"
                  the "Company,"
                  and similar terms refer to Lotus Pharmaceuticals, Inc., a Nevada
                  corporation formerly known as S.E. Asia Trading Company, Inc.,
                  and its
                  subsidiary,
 
 ·
              "Lotus
                International"
                refers toLotus
                Pharmaceutical International, Inc., a Nevada corporation and a subsidiary
                of Lotus,
  1
  ·
              "Lotus
                Century"
                refers to Lotus Century Pharmaceutical (Beijing) Technology co.,
                Ltd., a
                wholly foreign-owned enterprise (WFOE) Chinese company which is a
                subsidiary of Lotus,
 
 ·
              "Liang
                Fang"
                refers to Beijing Liang Fang Pharmaceutical Co., Ltd., a Chinese
                limited
                liability company formed on June 21, 2000 and an affiliate of En
                Zhe
                Jia,
 
 ·
              "En
                Zhe Jia"
                refers to Beijing En Zhe Jia Shi Pharmaceutical Co., Ltd., a Chinese
                limited liability company formed on September 17, 1999 and an affiliate
                of
                Liang Fang,
 
 ·
              "Lotus
                East"
                collectively refers to Liang Fang and En Zhe
                Jia,
 
 ·
              "Consulting
                Services Agreements"
                refers to the Consulting Services Agreements dated September 20,
                2006
                between Lotus and Lotus East.
 
 ·
              "Operating
                Agreements"
                refers to the Operating Agreements dated September 20, 2006 between
                Lotus,
                Lotus East and the stockholders of Lotus
                East,
 
 ·
              "Equity
                Pledge Agreements"
                refers to the Equity Pledge Agreements dated September 20, 2006 between
                Lotus, Lotus East and the stockholders of Lotus
                East,
 
 ·
              "Option
                Agreements"
                refers to the Option Agreements dated September 20, 2006 between
                Lotus,
                Lotus East and the stockholders of Lotus
                East,
 
 ·
              "Proxy
                Agreements"
                refers to the Proxy Agreements dated September 20, 2006 between Lotus,
                Lotus East and the stockholders of Lotus
                East,
 
 ·
              "Contractual
                Arrangements"
                collectively refers to the Consulting Services Agreements, Operating
                Agreements, Equity Pledge Agreements, Option Agreements and the Proxy
                Agreements,
 
 ·
              "China"
                or the "PRC"
                refers to the People's Republic of China,
                and
 
 ·
              "RMB"
                refers to the renminbi which is the currency of mainland PRC of which
                the
                yuan is the principal currency.





2





**PART
      1. - FINANCIAL INFORMATION**





Item
      1.  Financial
      Statements.





LOTUS
                PHARMACEUTICALS, INC. AND SUBSIDIARIESCONSOLIDATED
                BALANCE SHEETS




June
                30,
            
            December
                312008
            
            2007ASSETS
            
            (Unaudited)CURRENT
                ASSETS:Cash
            
            $
            3,401,444
            
            $
            4,557,957Accounts
                receivable, net of allowance for doubtful accounts and sale
                returns
            
            
            20,786,631
            
            
            20,430,827Inventories,
                net of reserve for obsolete inventory
            
            
            7,086,895
            
            
            3,410,739Prepaid
                expenses
            
            
            284,819
            
            
            1,009,382Deferred
                debt costs
            
            
            398,067
            
            
            29,340Total
                Current Assets
            
            
            31,957,856
            
            
            29,438,245PROPERTY
                AND EQUIPMENT - Net
            
            
            6,551,138
            
            
            6,169,966OTHER
                ASSETSDeposit
                on patent license
            
            
            2,910,446
            
            
            -Deposit
                on land use right
            
            
            6,033,353
            
            
            -Intangible
                assets, net of accumulated amortization
            
            
            1,298,038
            
            
            1,291,322Deferred
                debt costs
            
            
            265,377
            
            
            -Total
                Assets
            
            $
            49,016,208
            
            $
            36,899,533LIABILITIES
                AND SHAREHOLDERS' EQUITYCURRENT
                LIABILITIES:Convertible
                debt, net of debt discount
            
            $
            -
            
            $
            2,561,645Accounts
                payable and accrued expenses
            
            
            1,027,999
            
            
            764,491Value-added
                and service taxes payable
            
            
            2,030,543
            
            
            572,200Advances
                from customers
            
            
            -
            
            
            34,531Unearned
                revenue
            
            
            641,162
            
            
            530,063Due
                to related parties
            
            
            1,272,153
            
            
            323,178Total
                Current Liabilities
            
            
            4,971,857
            
            
            4,786,108LONG-TERM
                LIABILITIES:Due
                to related parties
            
            
            654,850
            
            
            738,300Notes
                payable - related parties
            
            
            5,043,500
            
            
            4,738,508Series
                A convertible redeemable preferred stock, $.001 par value; 10,000,000
                sharesauthorized;
                5,747,118 and -0- shares issued and outstanding at June 31,
                2008and
                December 31, 2007, respectively
            
            
            3,305,813
            
            
            -Total
                Liabilities
            
            
            13,976,020
            
            
            10,262,916SHAREHOLDERS'
                EQUITY:Common
                stock ($.001 par value; 200,000,000 shares authorized;42,420,239
                and 41,794,200 shares issued and outstandingat
                June 30, 2008 and December 31, 2007, respectively)
            
            
            42,420
            
            
            41,794Additional
                paid-in capital
            
            
            11,277,143
            
            
            8,095,848Statutory
                reserves
            
            
            2,616,019
            
            
            2,161,505Retained
                earnings
            
            
            16,081,308
            
            
            14,355,913Other
                comprehensive gain - cumulative foreign currency translation
                adjustment
            
            
            5,023,298
            
            
            1,981,557Total
                Shareholders' Equity
            
            
            35,040,188
            
            
            26,636,617Total
                Liabilities and Shareholders' Equity
            
            $
            49,016,208
            
            $
            36,899,533




See
                notes to unaudited consolidated financial
                statements





3





LOTUS
                PHARMACEUTICALS, INC. AND SUBSIDIARIESCONSOLIDATED
                STATEMENTS OF OPERATIONS(UNAUDITED)




For
                the Three Months Ended
            
            For
                the Six Months EndedJune
                30,
            
            June
                30,2008
            
            2007
            
            2008
            
            2007(As
                Restated)
            
            
            
            (As
                Restated)NET
                REVENUES:Wholesale
            
            $
            17,161,230
            
            $
            9,819,373
            
            $
            26,931,327
            
            $
            14,993,316Retail
            
            
            718,645
            
            
            516,594
            
            
            1,402,393
            
            
            893,014Other
                revenues
            
            
            1,505,737
            
            
            2,469,485
            
            
            2,761,069
            
            
            5,208,657Total
                Net Revenues
            
            
            19,385,612
            
            
            12,805,452
            
            
            31,094,789
            
            
            21,094,987COST
                OF SALES
            
            
            9,696,718
            
            
            7,311,471
            
            
            17,465,143
            
            
            12,974,387GROSS
                PROFIT
            
            
            9,688,894
            
            
            5,493,981
            
            
            13,629,646
            
            
            8,120,600OPERATING
                EXPENSES:Selling
                expenses
            
            
            5,875,549
            
            
            791,784
            
            
            6,997,886
            
            
            1,422,796Research
                and development
            
            
            471,243
            
            
            109,153
            
            
            1,181,468
            
            
            200,975General
                and administrative
            
            
            542,043
            
            
            988,233
            
            
            1,168,460
            
            
            1,718,810Total
                Operating Expenses
            
            
            6,888,835
            
            
            1,889,170
            
            
            9,347,814
            
            
            3,342,581INCOME
                FROM OPERATIONS
            
            
            2,800,059
            
            
            3,604,811
            
            
            4,281,832
            
            
            4,778,019OTHER
                INCOME (EXPENSE):Debt
                issuance costs
            
            
            (99,517
            )
            
            (58,680
            )
            
            (162,403
            )
            
            (88,020
            )Registration
                rights penalty
            
            
            -
            
            
            (56,000
            )
            
            
            
            
            (110,000
            )Interest
                income
            
            
            2,027
            
            
            -
            
            
            2,588
            
            
            -Interest
                expense
            
            
            (522,660
            )
            
            (448,606
            )
            
            (946,009
            )
            
            (701,173
            )Total
                Other Income (Expense)
            
            
            (620,150
            )
            
            (563,286
            )
            
            (1,105,824
            )
            
            (899,193
            )INCOME
                BEFORE INCOME TAXES
            
            
            2,179,909
            
            
            3,041,525
            
            
            3,176,008
            
            
            3,878,826INCOME
                TAXES
            
            
            -
            
            
            -
            
            
            -
            
            
            -NET
                INCOME
            
            $
            2,179,909
            
            $
            3,041,525
            
            $
            3,176,008
            
            $
            3,878,826COMPREHENSIVE
                INCOME:NET
                INCOME
            
            $
            2,179,909
            
            $
            3,041,525
            
            $
            3,176,008
            
            
            3,878,826OTHER
                COMPREHENSIVE INCOME:Unrealized
                foreign currency translation gain
            
            
            1,587,538
            
            
            248,403
            
            $
            3,041,741
            
            
            371,920COMPREHENSIVE
                INCOME
            
            $
            3,767,447
            
            $
            3,289,928
            
            $
            6,217,749
            
            $
            4,250,746NET
                INCOME PER COMMON SHARE:Basic
            
            $
            0.05
            
            $
            0.07
            
            $
            0.08
            
            $
            0.09Diluted
            
            $
            0.05
            
            $
            0.07
            
            $
            0.07
            
            $
            0.09WEIGHTED
                AVERAGE COMMON SHARES
              OUTSTANDING:Basic
            
            
            42,352,139
            
            
            41,389,362
            
            
            42,194,048
            
            
            41,297,531Diluted
            
            
            48,099,257
            
            
            44,389,262
            
            
            47,941,166
            
            
            44,297,531




See
                notes to unaudited consolidated financial
                statements





4





LOTUS
                PHARMACEUTICALS, INC. AND SUBSIDIARIESCONSOLIDATED
                STATEMENTS OF CASH FLOWS(UNAUDITED)




For
                the Six Month EndedJune
                30,2008
            
            2007(As
                Restated)CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            3,176,008
            
            $
            3,878,826Adjustments
                to reconcile net income from operations to net cashprovided
                by (used in) operating activities:Depreciation
                and amortization
            
            
            307,713
            
            
            275,197Amortization
                of deferred debt issuance costs
            
            
            162,029
            
            
            88,020Amortization
                of debt discount
            
            
            208,355
            
            
            433,735Amortization
                of discount on convertible redeemable preferred stock
            
            
            338,838
            
            
            -Stock
                base compensation
            
            
            270,245
            
            
            55,650Warrant
                repricing
            
            
            74,593
            
            
            -Decrease
                in allowance for doubtful accounts and sales returns
            
            
            (14,101
            )
            
            (1,567,166
            )Changes
                in assets and liabilities:Accounts
                receivable
            
            
            946,083
            
            
            (524,467
            )Inventories
            
            
            (3,358,488
            )
            
            1,201,912Prepaid
                expenses and other current assets
            
            
            986,132
            
            
            113,540Other
                receivable
            
            
            -
            
            
            -Accounts
                payable and accrued expenses
            
            
            224,627
            
            
            78,398Value-added
                and service taxes payable
            
            
            1,381,155
            
            
            921,996Unearned
                revenue
            
            
            74,796
            
            
            132,461Advances
                from customers
            
            
            (35,710
            )
            
            (145,138
            )NET
                CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            4,742,275
            
            
            4,942,964CASH
                FLOWS FROM INVESTING ACTIVITIES:Collections
                from related party advances
            
            
            -
            
            
            521,930Deposit
                on patent right
            
            
            (2,827,814
            )
            
            -Deposit
                on land use right
            
            
            (5,862,059
            )
            
            -Purchase
                of property and equipment
            
            
            (217,982
            )
            
            (376,201
            )NET
                CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
            
            
            (8,907,855
            )
            
            145,729CASH
                FLOWS FROM FINANCING ACTIVITIES:Net
                proceeds (payments) from convertible debt
            
            
            (2,520,000
            )
            
            2,950,000Proceeds
                from sale of convertible redeemable peferred stocks
            
            
            5,000,000
            
            
            -Payment
                of debt issuance costs
            
            
            (468,568
            )
            
            (231,526
            )Proceeds
                from related party advances
            
            
            774,571
            
            
            2,866Repayments
                of related party advances
            
            
            -
            
            
            (719,302
            )Repayments
                of notes payable - related parties
            
            
            -
            
            
            (846,781
            )NET
                CASH PROVIDED BY FINANCING ACTIVITIES
            
            
            2,786,003
            
            
            1,155,257EFFECT
                OF EXCHANGE RATE ON CASH
            
            
            223,064
            
            
            107,929NET
                (DECREASE) INCREASE IN CASH
            
            
            (1,156,513
            )
            
            6,351,879CASH
                - beginning of period
            
            
            4,557,957
            
            
            2,089,156CASH
                - end of period
            
            $
            3,401,444
            
            $
            8,441,035SUPPLEMENTAL
                DISCLOSURE OF CASH FLOW INFORMATION:Cash
                paid for:Interest
            
            $
            56,557
            
            $
            267,438Income
                taxes
            
            $
            -
            
            $
            -Non-cash
                operting, investing and financing activities:Warrants
                issued for prepaid financing costs
            
            $
            327,565
            
            $
            -Warrants
                issued for prepaid consulting
            
            $
            178,187
            
            
            -Common
                stock issued for compensation
            
            $
            318,551
            
            
            -Common
                stock issued for conversion of convertible debt
            
            $
            250,000
            
            $
            -Debt
                discount for grant of warrants and beneficial conversion
                feature
            
            $
            2,033,025
            
            $
            -




See
                notes to unaudited consolidated financial
                statements.





5





NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





Lotus
      Pharmaceuticals, Inc. (“Lotus” or the “Company”), formerly S.E. Asia Trading
      Company, Inc. (“SEAA”), was incorporated on January 28, 2004 under the laws of
      the State of Nevada. SEAA operated as a retailer of jewelry, framed art and
      home
      accessories. In December 2006, SEAA changed its name to Lotus Pharmaceuticals,
      Inc.




On
      September 6, 2006, the Company entered into a definitive Share Exchange
      Agreement with Lotus Pharmaceutical International, Inc. (“Lotus International”),
      whereby the Company acquired all of the outstanding common stock of Lotus
      International in exchange for newly-issued stock of the Company to Lotus
      International’s shareholders. On September 28, 2006 (the closing date), Lotus
      International became a wholly-owned subsidiary of the Company and Lotus
      International’s shareholders became the owners of the majority of the Company’s
      voting stock. The acquisition of Lotus International by the Company was
      accounted for as a reverse merger because on a post-merger basis, the former
      shareholders of Lotus International hold a majority of the outstanding
      common stock of the Company on a voting and fully-diluted basis. As a result,
      Lotus International is deemed to be the acquirer for accounting
      purposes.




Lotus
      International was incorporated under the laws the State of Nevada on August
      28, 2006 to develop and market pharmaceutical products in the People’s Republic
      of China (“PRC” or “China”). PRC law currently has limits on foreign ownership
      of certain companies. To comply with these foreign ownership restrictions,
      Lotus
      operates its pharmaceutical business in China through Beijing Liang Fang
      Pharmaceutical Co., Ltd. (“Liang Fang”) and an affiliate of Liang Fang, Beijing
      En Zhe Jia Shi Pharmaceutical Co., Ltd. (“En Zhe Jia”), both of which are
      pharmaceutical companies headquartered in the PRC and organized under the laws
      of the PRC (hereinafter, referred to together as “Lotus East”). Lotus
      International has contractual arrangements with Lotus East and its shareholders
      pursuant to which Lotus International will provide technology consulting and
      other general business operation services to Lotus East. Through these
      contractual arrangements, Lotus International also has the ability to
      substantially influence Lotus East’s daily operations and financial affairs,
      appoint its senior executives and approve all matters requiring shareholder
      approval. As a result of these contractual arrangements, which enable Lotus
      International to control Lotus East, Lotus International is considered
      the primary beneficiary of Lotus East. Accordingly, the consolidated financial
      statements include the accounts of Lotus Pharmaceuticals, Inc. and its
      wholly-owned subsidiary, Lotus International and companies under its control
      (Lotus East).




On
      September 6, 2006, Lotus International entered into the following
      contractual arrangements:




Operating
      Agreement .
      Pursuant to the operating agreement among Lotus, Lotus East and the shareholders
      of Lotus East, (collectively “Lotus East’s Shareholders”), Lotus provides
      guidance and instructions on Lotus East’s daily operations, financial management
      and employment issues. The shareholders of Lotus East must designate the
      candidates recommended by Lotus as their representatives on Lotus East’s Board
      of Directors. Lotus has the right to appoint senior executives of Lotus East.
      In
      addition, Lotus agreed to guarantee Lotus East’s performance under any
      agreements or arrangements relating to Lotus East’s business arrangements with
      any third party. Lotus East, in return, agreed to pledge its accounts receivable
      and all of its assets to Lotus. Moreover, Lotus East agreed that without the
      prior consent of Lotus, Lotus East would not engage in any transaction that
      could materially affect the assets, liabilities, rights or operations of Lotus
      East, including, without limitation, incurrence or assumption of any
      indebtedness, sale or purchase of any assets or rights, incurrence of any
      encumbrance on any of its assets or intellectual property rights in favor of
      a
      third party or transfer of any agreements relating to its business operation
      to
      any third party. The term of this agreement is ten (10) years from September
      6,
      2006 and may be extended only upon Lotus’s written confirmation prior to the
      expiration of the this agreement, with the extended term to be mutually agreed
      upon by the parties.




6




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Organization
      (continued)





Consulting
      Services Agreement .
      Pursuant to the exclusive consulting services agreements between Lotus and
      Lotus
      East, Lotus has the exclusive right to provide to Lotus East general
      pharmaceutical business operations services as well as consulting services
      related to the technological research and development of pharmaceutical products
      as well as general business operation advice and strategic planning (the
“Services”). Under this agreement, Lotus owns the intellectual property rights
      developed or discovered through research and development, in the course of
      providing the Services, or derived from the provision of the Services. Lotus
      East is required to pay quarterly consulting service fees in Renminbi (“RMB”),
      the functional currency of the PRC, to Lotus that is equal to Lotus East’s
      profits, as defined, for such quarter. To date, no consulting fees have been
      paid by Lotus East.




Equity
      Pledge Agreement *.* Under
      the
      equity pledge agreement between the shareholders of Lotus East and Lotus, the
      shareholders of Lotus East pledged all of their equity interests in Lotus East
      to Lotus to guarantee Lotus East’s performance of its obligations under the
      technology consulting agreement. If Lotus East or Lotus East’s Shareholders
      breaches its respective contractual obligations, Lotus, as pledgee, will be
      entitled to certain rights, including the right to sell the pledged equity
      interests. Lotus East’s Shareholders also agreed that upon occurrence of any
      event of default, Lotus shall be granted an exclusive, irrevocable power of
      attorney to take actions in the place and stead of Lotus East’s
      Shareholders to carry out the security provisions of the equity pledge agreement
      and take any action and execute any instrument that Lotus may deem necessary
      or
      advisable to accomplish the purposes of the equity pledge agreement. The
      shareholders of Lotus East agreed not to dispose of the pledged equity interests
      or take any actions that would prejudice Lotus’ interest. The equity pledge
      agreement will expire two (2) years after Lotus East’s obligations under the
      exclusive consulting services agreements have been fulfilled.




Option
      Agreement *.* Under
      the
      option agreement between the shareholders of Lotus East and Lotus, the
      shareholders of Lotus East irrevocably granted Lotus or its designated person
      an
      exclusive option to purchase, to the extent permitted under PRC law, all or
      part
      of the equity interests in Lotus East for the cost of the initial contributions
      to the registered capital or the minimum amount of consideration permitted
      by
      applicable PRC law. Lotus or its designated person has sole discretion to decide
      when to exercise the option, whether in part or in full. The term of this
      agreement is 10 years from September 6, 2006 and may be extended prior to its
      expiration by written agreement of the parties.




Proxy
      Agreement *.* Pursuant
      to the proxy agreement among Lotus and Lotus East’s Shareholders, Lotus East’s
      Shareholders agreed to irrevocably grant a person to be designated by Lotus
      with
      the right to exercise Lotus East’s Shareholders’ voting rights and their other
      rights, including the attendance at and the voting of Lotus East’s Shareholders’
shares at the shareholders’ meetings (or by written consent in lieu of such
      meetings) in accordance with applicable laws and its Article of Association,
      including but not limited to the rights to sell or transfer all or any of his
      equity interests of Lotus East, and appoint and vote for the directors and
      Chairman as the authorized representative of the shareholders of Lotus East.
      The
      term of this Proxy Agreement is ten (10) years from September 6, 2006 and may
      be
      extended prior to its expiration by written agreement of the
      parties.




Liang
      Fang is a Chinese limited liability company and was formed under laws of the
      People’s Republic of China on June 21, 2000. Liang Fang is engaged in the
      production, trade and retailing of pharmaceuticals. Further, Liang Fang is
      focused on development of innovative medicines and investing strategic growth
      to
      address various medical needs for patients worldwide. Liang Fang’s operations
      are based in Beijing, China.




As
      of
      June 30, 2008, Liang Fang owns and operates 10 drug stores throughout Beijing,
      China. These drugstores sell Western and traditional Chinese medicines, and
      medical treatment accessories.




7




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Organization
      (continued)





Liang
      Fang’s affiliate, En Zhe Jia is a Chinese limited liability company and was
      formed under laws of the People’s Republic of China on September 17, 1999. En
      Zhe Jia is the sole manufacturer for Liang Fang and maintains facilities for
      the
      production of medicines, patented Chinese medicine, as well as the research
      and
      production of other new medicines.





As
      a
      result of the management agreements between Lotus International and Lotus East,
      Lotus East was deemed to be the acquirer of Lotus International for
      accounting purposes. Accordingly, the financial statement data presented are
      those of Lotus East for all periods prior to the Company’s acquisition of Lotus
      International on September 28, 2006, and the financial statements of the
      consolidated companies from the acquisition date forward.




On
      May
      29, 2007, the Company formed a new entity, Lotus Century Pharmaceutical
      (Beijing) Technology Co., Ltd. (‘‘Lotus Century’’), a wholly
      foreign-owned enterprise (“WFOE”) organized under the laws of the Peoples’
Republic of China .
      Lotus
      Century is a Chinese limited liability company and a wholly-owned subsidiary
      of
      Lotus Pharmaceutical International, Inc. Lotus Century intends to be engaged
      in
      development of innovative medicines, medical technology consulting and
      outsourcing services, and related training services.





Basis
      of presentation




The
      interim consolidated financial statements included herein have been prepared
      by
      the Company, pursuant to the rules and regulations of the Securities and
      Exchange Commission (the “SEC”). Certain information and footnote disclosures
      normally included in an annual financial statement prepared in accordance with
      generally accepted accounting principles in the United States (“GAAP”) have been
      condensed or omitted pursuant to such rules and regulations. In the opinion
      of
      management, the interim consolidated financial statements reflect all
      adjustments (consisting only of normal recurring adjustments) necessary for
      a
      fair presentation of the statement of the results for the interim periods
      presented. These interim consolidated financial statements should be read in
      conjunction with the audited consolidated financial statements and notes
      thereto, as well as the accompanying Management’s Discussion and Analysis of
      Financial Condition and Results of Operations for the year ended December 31,
      2007 included in its Annual Report on Form 10-K. Interim financial results
      are
      not necessarily indicative of the results that may be expected for a full
      year.





The
      accompanying unaudited consolidated financial statements are prepared in
      accordance with generally accepted accounting principles in the United States
      of
      America (“US GAAP”). The consolidated statements include the accounts of Lotus
      Pharmaceuticals, Inc. and its wholly-owned subsidiaries, Lotus and Lotus Century
      and variable
      interest entities under
      its control (Liang Fang and En Zhe Jia). All significant inter-company balances
      and transactions have been eliminated.





The
      Company has adopted FASB Interpretation No. 46R "Consolidation of Variable
      Interest Entities" ("FIN 46R"), an Interpretation of Accounting Research
      Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be
      consolidated by a company if that company is subject to a majority of the risk
      of loss for the VIE or is entitled to receive a majority of the VIE's residual
      returns. VIEs are those entities in which the Company, through contractual
      arrangements, bears the risks of, and enjoys the rewards normally associated
      with ownership of the entities, and therefore the Company is the primary
      beneficiary of these entities.  As
      a VIE, Lotus
      East’s revenues are included in the Company’s total revenues, its income from
      operations is consolidated with the Company’s, and the Company’s net income
      includes all of Lotus
      East’s net income.




8




NOTE
      1 - BASIS
      OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
      (continued)





Use
      of
      estimates




The
      preparation of financial statements in conformity with US GAAP requires
      management to make estimates and assumptions that affect certain reported
      amounts and disclosures. Accordingly, actual results could differ from those
      estimates. Significant estimates in 2008 and 2007 include the allowance for
      doubtful accounts, the allowance for obsolete inventory, the useful life of
      property and equipment and intangible assets, and accruals for taxes
      due.





Fair
      value of financial instruments




The
      carrying amounts reported in the balance sheet for cash, accounts receivable,
      accounts payable and accrued expenses, convertible debt, customer advances,
      and
      amounts due to related parties approximate their fair market value based on
      the
      short-term maturity of these instruments.




Cash
      and cash equivalents




For
      purposes of the consolidated statements of cash flows, the Company considers
      all
      highly liquid instruments purchased with a maturity of three months or less
      and
      money market accounts to be cash equivalents. The
      Company maintains cash and cash equivalents with various financial institutions
      mainly in the PRC and the United States. Balances in the United States are
      insured up to $100,000 at each bank.





Accounts
      receivable





The
      Company records accounts receivable, net of an allowance for doubtful accounts
      and sales returns. The Company maintains allowances for doubtful accounts for
      estimated losses. The Company reviews the accounts receivable on a periodic
      basis and makes general and specific allowances when there is doubt as to the
      collectability of individual balances. In evaluating the collectability of
      individual receivable balances, the Company considers many factors, including
      the age of the balance, customer’s historical payment history, its current
      credit-worthiness and current economic trends. The amount of the provision,
      if
      any is recognized in the consolidated statement of operations within “General
      and administrative expenses”. Accounts are written off after exhaustive efforts
      at collection. The Company policy regarding sales returns is discussed below.
      The activity in the allowance for doubtful accounts and sales returns accounts
      for accounts receivable for the periods ended June 30, 2008 and December 31,
      2007 are as follows:





Allowance
                for doubtful accounts
            
            Allowance
                for sales returns
            
            TotalBalance
                - December 31, 2006
            
            $
            539,627
            
            $
            2,297,399
            
            $
            2,837,026Reductions
            
            
            (26,617
            )
            
            (2,354,720
            )
            
            (2,381,337
            )Foreign
                currency translation adjustments
            
            
            35,073
            
            
            57,321
            
            
            92,394Balance
                - December 31, 2007
            
            
            548,083
            
            
            -
            
            
            548,083Reductions
            
            
            (14,101
            )
            
            -
            
            
            (14,101
            )Foreign
                currency translation adjustments
            
            
            34,865
            
            
            -
            
            
            34,865Balance
                - June 30, 2008
            
            $
            568,847
            
            $
            -
            
            $
            568,847





9




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Inventories





Inventories,
      consisting of raw materials and finished goods related to the Company’s products
      are stated at the lower of cost or market utilizing the weighted average method.
      An allowance is established when management determines that certain inventories
      may not be saleable. If inventory costs exceed expected market value due to
      obsolescence or quantities in excess of expected demand, the Company will record
      reserves for the difference between the cost and the market value. These
      reserves are recorded based on estimates and reflected in cost of sales.





Property
      and equipment





Property
      and equipment are carried at cost and are depreciated on a straight-line basis
      over the estimated useful lives of the assets. The cost of repairs and
      maintenance is expensed as incurred; major replacements and improvements are
      capitalized. When assets are retired or disposed of, the cost and accumulated
      depreciation are removed from the accounts, and any resulting gains or losses
      are included in income in the year of disposition. In accordance with Statement
      of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment
      or Disposal of Long-Lived Assets”, the Company examines the possibility of
      decreases in the value of fixed assets when events or changes in circumstances
      reflect the fact that their recorded value may not be recoverable.





I mpairment
      of long-lived assets





In
      accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
      “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company
      periodically reviews its long-lived assets for impairment whenever events or
      changes in circumstances indicate that the carrying amount of the assets may
      not
      be fully recoverable. The Company recognizes an impairment loss when the sum
      of
      expected undiscounted future cash flows is less than the carrying amount of
      the
      asset. The amount of impairment is measured as the difference between the
      asset’s estimated fair value and its book value. The
      Company did not consider it necessary to record any impairment charges during
      the year ended December 31, 2007 and during the six months ended June 30, 2008.





Advances
      from customers





Advances
      from customers at June 30, 2008 and December 31, 2007 of $0 and $34,531,
      respectively,consist
      of prepayments from third party customers to the Company for merchandise
      that had not yet shipped. The Company will recognize the deposits as revenue
      as
      customers take delivery of the goods, in compliance with its revenue recognition
      policy.





Income
      taxes





The
      Company is governed by the Income Tax Law of the People’s Republic of China and
      the United States. Income taxes are accounted for under Statement of Financial
      Accounting Standards No. 109, “Accounting for Income Taxes,” which is an asset
      and liability approach that requires the recognition of deferred tax assets
      and
      liabilities for the expected future tax consequences of events that have been
      recognized in the Company’s financial statements or tax returns.




10




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Earnings
      per common share




Basic
      earnings per share is computed by dividing net earnings by the weighted average
      number of shares of common stock outstanding during the period. Diluted income
      per share is computed by dividing net income by the weighted average number
      of
      shares of common stock, common stock equivalents and potentially dilutive
      securities outstanding during each period. Potentially dilutive common shares
      consist of the common shares issuable upon the conversion of convertible debt
      (using the if-converted method). The following table presents a reconciliation
      of basic and diluted earnings per share:




**For
                the Three Months Ended**
              **June
                30,****2008**
            
            **2007**Net
                income for basic and diluted earnings per share
            
            $
            2,179,909
            
            $
            3,041,525Weighted
                average shares outstanding - basic
            
            
            42,352,139
            
            
            41,389,362Effect
                of dilutive securities:Unexercised
                warrants
            
            
            —
            
            
            —Convertible
                debentures
            
            
            —
            
            
            3,000,000Convertible
                redeemable preferred shares
            
            
            5,747,118
            
            
            —Weighted
                average shares outstanding- diluted
            
            
            48,099,257
            
            
            44,389,362Earnings
                per share - basic
            
            $
            0.05
            
            $
            0.07Earnings
                per share - diluted
            
            $
            0.05
            
            $
            0.07




**For
                the Six Months Ended**
              **June
                30,****2008**
            
            **2007**Net
                income for basic and diluted earnings per share
            
            $
            3,176,008
            
            $
            3,878,826Weighted
                average shares outstanding - basic
            
            
            42,194,048
            
            
            41,297,531Effect
                of dilutive securities:Unexercised
                warrants
            
            
            —
            
            
            —Convertible
                debentures
            
            
            —
            
            
            3,000,000Convertible
                redeemable preferred shares
            
            
            5,747,118
            
            
            —Weighted
                average shares outstanding- diluted
            
            
            47,941,166
            
            
            44,297,531Earnings
                per share - basic
            
            $
            0.08
            
            $
            0.09Earnings
                per share - diluted
            
            $
            0.07
            
            $
            0.09





At
      June
      30, 2008 and 2007, 5,166,999 and 1,500,000 outstanding warrants have not been
      included in the calculation of diluted earnings per shares as the effect would
      be anti-dilutive. The closing market price of the Company on June 30, 2008
      and
      2007 was lower than the exercise price of all outstanding warrants. Because
      of
      that, the Company assumes that none of the outstanding warrants at that date
      would have been exercised and therefore none were included in the computation
      of
      the diluted earnings per share for period ended June 30, 2008 and 2007.
      Accordingly, the Company has excluded any effect of outstanding warrants as
      their effect would be anti-dilutive.




11




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Revenue
      recognition





*Product
      sales*




Product
      sales are generally recognized when title to the product has transferred to
      customers in accordance with the terms of the sale. The Company recognizes
      revenue in accordance with the Securities and Exchange Commission’s (SEC) Staff
      Accounting Bulletin (SAB) No. 101, “ *Revenue
      Recognition in Financial Statements*” as
      amended by SAB No. 104 (together, “SAB 104”), and Statement of
      Financial Accounting Standards (SFAS) No. 48 “ *Revenue
      Recognition When Right of Return Exists.*” SAB 104 states
      that revenue should not be recognized until it is realized or realizable and
      earned. In general, the Company records revenue when persuasive evidence of
      an
      arrangement exists, services have been rendered or product delivery has
      occurred, the sales price to the customer is fixed or determinable, and
      collectability is reasonably assured.




SFAS No. 48 states
      that revenue from sales transactions where the buyer has the right to return
      the
      product shall be recognized at the time of sale only if the seller’s price to
      the buyer is substantially fixed or determinable at the date of sale, the buyer
      has paid the seller, or the buyer is obligated to pay the seller and the
      obligation is not contingent on resale of the product, the buyer’s obligation to
      the seller would not be changed in the event of theft or physical destruction
      or
      damage of the product, the buyer acquiring the product for resale has economic
      substance apart from that provided by the seller, the seller does not have
      significant obligations for future performance to directly bring about resale
      of
      the product by the buyer, and the amount of future returns can be
      reasonably estimated.




The
      Company’s net product revenues represent total product revenues less allowances
      for returns.




*Allowance
      for returns*





The
      Company accounts for sales returns in accordance with Statements of Financial
      Accounting Standards (SFAS) No. 48, *Revenue
      Recognition When Right of Return Exists* ,
      by
      establishing an accrual in an amount equal to its estimate of sales recorded
      for
      which the related products are expected to be returned. The Company determines
      the estimate of the sales return accrual primarily based on historical
      experience regarding sales returns, but also by considering other factors that
      could impact sales returns. These factors include levels of inventory in the
      distribution channel, estimated shelf life, product discontinuances, and price
      changes of competitive products, introductions of generic products and
      introductions of competitive new products. In general, for wholesale sales,
      the
      Company provides credit for product returns that are returned six months prior
      to and up to six months after the product expiration date. Upon sale, the
      Company estimates an allowance for future product returns. The Company provides
      additional reserves for contemporaneous events that were not known and knowable
      at the time of shipment. In order to reasonably estimate future returns, the
      Company analyzed both quantitative and qualitative information including, but
      not limited to, actual return rates, the level of product manufactured by the
      Company, the level of product in the distribution channel, expected shelf life
      of the product, current and projected product demand, the introduction of new
      or
      generic products that may erode current demand, and general economic and
      industry wide indicators. The Company also utilizes the guidance provided in
      SAB 104 in establishing its return estimates. At June 30, 2008 and December
      31, 2007, the Company’s allowance for returns was $0 and $0, respectively.




12




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





*Other
      revenues*




Other
      revenues consist of (i) leasing revenues received for the lease of retail space
      to various retail merchants; (ii) advertising revenues from the lease of counter
      space at the Company’s retail locations; (iii) leasing revenue from the lease of
      retail space to licensed medical practitioners; (iv) revenues received by the
      Company for research and development projects and lab testing jobs conducted
      on
      behalf of third party companies, and; (v) revenues received for performing
      third
      party contract manufacturing projects. In connection with third-party
      manufacturing, the customer supplies the raw materials and the Company is paid
      a
      fee for manufacturing their product and revenue is recognized at the completion
      of the manufacturing job. The Company recognizes revenues from leasing of space
      and advertising revenues as earned from contracting third parties. The Company
      recognizes revenues upon performance of any research or lab testing jobs.
      Revenues received in advance are reflected as deferred revenue on the
      accompanying balance sheet. Additionally, the Company receives income from
      the
      sale of developed drug formulas. Income from the sale of drug formulas are
      recognized upon performance of all of the Company’s obligations under the
      respective sales contract and are included in other income on the accompanying
      consolidated statement of operations.




Concentrations
      of credit risk




Financial
      instruments which potentially subject the Company to concentrations of credit
      risk consist principally of cash and trade accounts receivable. Substantially
      all of the Company’s cash is maintained with state-owned banks within the
      People’s Republic of China of which no deposits are covered by insurance. The
      Company has not experienced any losses in such accounts and believes it is
      not
      exposed to any risks on its cash in bank accounts. A significant portion of
      the
      Company’s sales are credit sales which are primarily to customers whose ability
      to pay is dependent upon the industry economics prevailing in these areas;
      however, concentrations of credit risk with respect to trade accounts
      receivables is limited due to generally short payment terms. The Company also
      performs ongoing credit evaluations of its customers to help further reduce
      credit risk.





Shipping
      costs





Shipping
      costs are included in cost of sales and totaled $206,818 and $505,697 for the
      six months ended June 30, 2008 and 2007, respectively.





A dvertising





Advertising
      is expensed as incurred. Advertising expenses amounted to $155,530 and $263,529
      for the six months ended June 30, 2008 and 2007, respectively.





Research
      and development





Research
      and development costs are expensed as incurred. These costs primarily consist
      of
      cost of material used and salaries paid for the development of the Company’s
      products and fees paid to third parties. For the six months ended June 30,
      2008
      and 2007, the Company expensed $1,181,468 and $200,975 as research and
      development expense, respectively, and paid for future research and development
      services in the amount of $0 and $769,742 at June 30, 2008 and December 31,
      2007, respectively, which has been included in prepaid expenses on the
      accompanying balance sheets. The December 31, 2007 prepaid research and
      development expense has been fully expensed during the period ended June 30,
      2008.




13




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Foreign
      currency translation





The
      reporting currency of the Company is the U.S. dollar. The functional currency
      of
      the Company is the local currency, the Chinese Renminbi (“RMB”). Results of
      operations and cash flows are translated at average exchange rates during the
      period, assets and liabilities are translated at the unified exchange rate
      at
      the end of the period, and equity is translated at historical exchange rates.
      Translation adjustments resulting from the process of translating the local
      currency financial statements into U.S. dollars are included in determining
      comprehensive income. The cumulative translation adjustment and effect of
      exchange rate changes on cash for the six months ended June 30, 2008 and 2007
      was $223,064 and $107,929, 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.





Asset
      and
      liability accounts at June 30, 2008 and December 31, 2007 were translated at
      6.8718 RMB to $1.00 USD and at 7.3141 RMB to $1.00 USD, respectively. Equity
      accounts were stated at their historical rate. The average translation rates
      applied to income statements for the six months ended June 30, 2008 and 2007
      were 7.0726 RMB and 7.7300 RMB to $1.00 USD, respectively. In accordance with
      Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows,"
      cash flows from the Company's operations is calculated based upon the local
      currencies using the average translation rate. As a result, amounts related
      to
      assets and liabilities reported on the statement of cash flows will not
      necessarily agree with changes in the corresponding balances on the balance
      sheet.





Accumulated
      other comprehensive income




Accumulated
      other comprehensive income consisted of unrealized gains on currency translation
      adjustments from the translation of financial statements from Chinese RMB to
      US
      dollars. As of June 30, 2008 and December 31, 2007, accumulated other
      comprehensive income was $5,023,298 and $1,981,557, respectively.





Reclassifications





Certain
      accounts and amounts in the period ended June 30, 2007 financial statements
      have
      been reclassified in order to conform with the period ended June 30, 2008
      presentation. These reclassifications have no effect on net income.





Recent
      Accounting Pronouncements





In
      February 2007, the FASB issued SFAS No. 159, *“The
      Fair Value Option for Financial Assets and Financial Liabilities, Including
      an
      Amendment of FASB Statement No. 115”* , under
      which entities will now be permitted to measure many financial instruments
      and
      certain other assets and liabilities at fair value on an
      instrument-by-instrument basis. This Statement is effective as of the beginning
      of an entity’s first fiscal year that begins after November 15, 2007. Early
      adoption is permitted as of the beginning of a fiscal year that begins on or
      before November 15, 2007, provided the entity also elects to apply the
      provisions of SFAS 157. The adoption of this interpretation did not have an
      impact on the Company’s financial position, results of operations, or cash
      flows.





14




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





In
      December 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      141R, Business Combinations (SFAS 141R) and Statement of Financial Accounting
      Standards No. 160, Accounting and Reporting of Non-controlling Interests in
      Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). These
      two standards must be adopted in conjunction with each other on a prospective
      basis. The most significant changes to business combination accounting pursuant
      to SFAS 141R and SFAS 160 are the following: (a) recognize, with certain
      exceptions, 100 percent of the fair values of assets acquired, liabilities
      assumed and non-controlling interests in acquisitions of less than a 100 percent
      controlling interest when the acquisition constitutes a change in control of
      the
      acquired entity, (b) acquirers’ shares issued in consideration for a business
      combination will be measured at fair value on the closing date, not the
      announcement date, (c) recognize contingent consideration arrangements at their
      acquisition date fair values, with subsequent changes in fair value generally
      reflected in earnings, (d) the expensing of all transaction costs as incurred
      and most restructuring costs, (e) recognition of pre-acquisition loss and gain
      contingencies at their acquisition date fair values, with certain exceptions,
      (f) capitalization of acquired in-process research and development rather than
      expense recognition, (g) earn-out arrangements may be required to be re-measured
      at fair value and (h) recognize changes that result from a business combination
      transaction in an acquirer’s existing income tax valuation allowances and tax
      uncertainty accruals as adjustments to income tax expense. Should we decide
      to
      enter future business combinations, these new standards will significantly
      affect the Company’s accounting for future business combinations following
      adoption on January 1, 2009.





In
      March
      2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and Hedging Activities* (“SFAS 161”). This statement requires companies to provide enhanced
      disclosures about (a) how and why they use derivative instruments,
      (b) how derivative instruments and related hedged items are accounted for
      under Statement 133 and its related interpretations, and (c) how derivative
      instruments and related hedged items affect a company’s financial position,
      financial performance, and cash flows. SFAS 161 is effective for financial
      statements issued for fiscal years and interim periods beginning after
      November 15, 2008. The Company will adopt the new disclosure requirements
      on or before the required effective date and thus will provide additional
      disclosures in its consolidated financial statements when adopted.





In
      April
      2008, FASB Staff Position No. 142-3, Determination of the Useful Life of
      Intangible Assets (FSP 142-3) was issued. This standard amends the factors
      that
      should be considered in developing renewal or extension assumptions used to
      determine the useful life of a recognized intangible asset under FASB Statement
      No. 142, Goodwill and Other Intangible Assets. FSP 142-3 is effective for
      financial statements issued for fiscal years beginning after December 15,
      2008, and interim periods within those fiscal years. Early adoption is
      prohibited. The Company has not determined the impact on its financial
      statements of this accounting standard.





In
      May
      2008, the Financial Accounting Standards Board (FASB”) issued FASB Staff
      Position (FSP”) APB 14-1, *Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
      Conversion (Including Partial Cash Settlement)* . FSP
      APB 14-1 clarifies that convertible debt instruments that may be settled in
      cash
      upon either mandatory or optional conversion (including partial cash settlement)
      are not addressed by paragraph 12 of APB Opinion No. 14, *Accounting for Convertible Debt and Debt issued with Stock Purchase
      Warrants* .
      Additionally, FSP APB 14-1 specifies that issuers of such instruments should
      separately account for the liability and equity components in a manner that
      will
      reflect the entity’s nonconvertible debt borrowing rate when interest cost is
      recognized in subsequent periods. FSP APB 14-1 is effective for financial
      statements issued for fiscal years beginning after December 15, 2008, and
      interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning
      in the first quarter of fiscal 2010, and this standard must be applied on a
      retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1
      will have on our consolidated financial position and results of
      operations.




15




NOTE
      1 - ORGANIZATION
      AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





In
      May
      2008, the FASB issued Statement of Financial Accounting Standards (SFAS”) No.
      162, *The
      Hierarchy of Generally Accepted Accounting Principles* . This
      standard is intended to improve financial reporting by identifying a consistent
      framework, or hierarchy, for selecting accounting principles to be used in
      preparing financial statements that are presented in conformity with generally
      accepted accounting principles in the United States for non-governmental
      entities. SFAS No. 162 is effective 60 days following approval by the U.S.
      Securities and Exchange Commission (SEC”) of the Public Company Accounting
      Oversight Board’s amendments to AU Section 411, *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles* . We do
      not expect SFAS No. 162 to have a material impact on the preparation of our
      consolidated financial statements.





On
      June
      16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, *Determining
      Whether Instruments Granted in Share-Based Payment Transactions Are
      Participating Securities”* to
      address the question of whether instruments granted in share-based payment
      transactions are participating securities prior to vesting. The FSP determines
      that unvested share-based payment awards that contain rights to dividend
      payments should be included in earnings per share calculations. The guidance
      will be effective for fiscal years beginning after December 15, 2008. We are
      currently evaluating the requirements of (FSP) No. EITF 03-6-1.





NOTE
      2 - ACCOUNTS
      RECEIVABLE





At
      June
      30, 2008 and December 31, 2007, accounts receivable consisted of the
      following:





June
                30,
              2008
            
            December
                31,
              2007Accounts
                receivable
            
            $
            21,355,478
            
            $
            20,978,910Less:
                allowance for doubtful accounts
            
            
            (568,847
            )
            
            (548,083
            )$
            20,786,631
            
            $
            20,430,827




NOTE
      3 - INVENTORIES





At
      June
      30, 2008 and December 31, 2007, inventories consisted of the
      following:





June
                30,
              2008
            
            December
                31,
              2007Raw
                materials
            
            $
            2,231,592
            
            $
            2,312,111Work
                in process
            
            
            310,768
            
            
            279,759Packaging
                materials
            
            
            24,721
            
            
            52,967Finished
                goods
            
            
            4,565,107
            
            
            808,4567,132,188
            
            
            3,453,293Less:
                reserve for obsolete inventory
            
            
            (45,293
            )
            
            (42,554
            )$
            7,086,895
            
            $
            3
                ,410,739





16




NOTE
      4 - PROPERTY
      AND EQUIPMENT





At
      June
      30, 2008 and December 31, 2007, property and equipment consist of the
      following:





Useful
                Life
            
            June
                30,
              2008
            
            December
                31,
              2007Office
                equipment and furniture
            
            
            5-8
                Years
            
            $
            170,500
            
            $
            154,488Manufacturing
                equipment
            
            
            10
                - 15 Years
            
            
            5,574,805
            
            5,032,601Building
                and building improvements
            
            
            20
                - 40 Years
            
            
            3,128,131
            
            2,938,9668,873,436
            
            8,126,055Less:
                accumulated depreciation
            
            
            
            
            
            (2,322,298
            )
            (1,956,089)$
            6,551,138
            
            $
                6,169,966





For
      the
      six months ended June 30, 2008 and 2007, depreciation expense amounted to $233,483 and
      $209,512, of which $226,593 and
      $188,209 is included in cost of sales, respectively.




NOTE
      5 - Deposit
      on patent





The
      Company has made a deposit to acquire a Chinese Class I drug patent in
      accordance with a technoloy transfer agreement the Company’ entered into in
      April 2008. The Company will need to make additional installment payments to
      obtain the patent. Accordingly, the Company recorded $2,910,446 as deposit
      on
      patent as of June 30, 2008.





NOTE
      6 - Deposit
      on land use right





The
      Company has recorded as a deposit on land use rights for the amounts paid to
      a
      local government agency in Cha You to acquire a long-term interest to utilize
      certain land to construct a new manufacture facility. The Company will need
      to
      make additional payments to obtain the full land use right and construct the
      new
      facility. Accordingly, the Company has not received the full land use right
      title and has reflected amounts paid of $6,033,353 as of June 30, 2008 as a
      deposit on land use rights. The deposit is non-refundable in the event the
      Company decides not to construct the manufacture facility.




NOTE
      7 - INTANGIBLE
      ASSETS





The
      Company’s intangible assets included two approved drugs’ manufacturing rights.
      The manufacturing rights issued are in connection with the Company’s products
      Valsartan and Brimonidine. The manufacturing rights for Valsartan became
      effective in November 2000 and had a life of 6.5 years, which expired in 2007.
      The manufacturing rights for Brimonidine became effective on August 27, 2005
      and
      have a life of 5 years.





On
      October 9, 2006, the Company entered into a five-year loan agreement and a
      contract with Wu Lan Cha Bu Emergency Hospital (“Wu Lan”), whereby the Company
      agreed to lend to Wu Lan approximately $3,840,000 for the construction of a
      hospital ward in Inner Mongolia, China. In exchange for agreeing to lend to
      Wu
      Lan the funds, Wu Lan agreed that
      the
      Company will be the exclusive provider for all medicines and disposable medical
      treatment apparatus to Wu Lan for a period of twenty (20) years. In October
      2006, the Company’s chief executive officer, Mr. Liu, lent these funds to Wu Lan
      on behalf of the Company. The Company entered into an assignment agreement
      whereby the Company assigned all of its rights, obligations, and receipts under
      the Loan Agreement to Mr. Liu, except for the rights to revenues from the sale
      of medical and disposable medical treatment apparatus which will remain with
      the
      Company. As compensation to Mr. Liu for accepting the assignment under the
      loan
      agreement including all of the risks and obligations and for Liu not accepting
      the rights to revenues from the sale of medical and disposable medical treatment
      apparatus which will remain with the Company, the Company agreed to pay Mr.
      Liu
      an aggregate of approximately $1,150,000 in 5 equal annual installments of
      approximately $230,000. Accordingly, the Company recorded an intangible asset
      of
      $1,151,263 related to exclusive rights to provide all medicines and disposable
      medical treatment apparatus to Wu Lan for a period of twenty (20) years. The
      Company will amortize this exclusive right over a term of 20 years.





17




NOTE
      7 - INTANGIBLE
      ASSETS (continued)





At
      June
      30, 2008 and December 31, 2007, intangible assets consist of the
      following:





June
                30,
              2008
            
            December
                31,
              2007Manufacturing
                rights
            
            $
            1,263,969
            
            $
            1,187,569Revenue
                rights
            
            
            1,309,738
            
            
            1,230,5002,573,707
            
            
            2,418,069Less:
                accumulated amortization
            
            
            (1,275,669
            )
            
            (1,126,747
            )$
            1,298,038
            
            $
            1,291,322





Amortization
      expense amounted to approximately $74,230 and $65,685 for six months ended
      June
      30, 2008 and 2007, respectively. The projected amortization for the next five
      calendar years and thereafter is:





2008
            
            $
            76,3992009
            
            
            124,7652010
            
            
            65,4852011
            
            
            65,4862012
                and thereafter
            
            
            965,904Total
            
            
            1,298,038





NOTE
      8 - RELATED
      PARTY TRANSACTIONS




**Notes
      payable - related parties**





Notes
      payable - related parties consisted of the following at June 30, 2008 and
      December 31, 2007:





June
                30,
              2008
            
            December
                31, 2007Note
                to Song Guoan, father of Song Zheng Hong, director and spouse of
                Liu Zhong
                Yi, due on December 30, 2015 with variable annual interest at 80%
                of
                current bank rate (6.26% at June 30, 2008 and December 31, 2007),
                and
                unsecured
            
            $
            759,943
            
            $
            1,895,424Note
                to Zheng Gui Xin, employee, due on December 30, 2015 with with variable
                annual interest at 80% of current bank rate (6.26% at June 30, 2008
                and
                December 31, 2007), and unsecured
            
            
            1,645,129
            
            
            1,545,645Note
                to Ma Zhao Zhao, employee, due on December 30, 2015 with variable
                annual
                interest at 80% of current bank rate (6.26% at June 30, 2008 and
                December
                31, 2007), and unsecured
            
            
            658,870
            
            
            619,027Note
                to Liu Zhong Yi, officer and director, due on December 30, 2015 with
                variable annual interest at 80% of current bank rate (6.26% at June
                30,
                2008 and December 31, 2007), and unsecured
            
            
            1,402,492
            
            
            136,244Note
                to Song Zheng Hong, director and spouse of the Company chief executive
                officer, Liu Zhong Yi, due on December 30, 2015 with variable annual
                interest at 80% of current bank rate (6.26% at June 30, 2008 and
                December
                31, 2007), and unsecured
            
            
            577,066
            
            
            542,168Total
                notes payable - related parties, long term
            
            $
            5,043,500
            
            $
            4,738,508




18




NOTE
      8 - RELATED
      PARTY TRANSACTIONS (continued)





For
      the
      six months ended June 30, 2008 and 2007, interest expense related to these
      related loans amounted to $153,898 and $107,605, respectively.





**Due
      to related parties**





Several
      employees of the Company, from time to time, provided advances to the Company
      for operating expenses. During the six months ended June 30, 2008 and 2007,
      the
      Company repaid approximately
      $0 and $118,800
      of these advances, respectively. At June 30, 2008 and December 31, 2007, the
      Company had a payable to these employees amounting to $ 440,204 and
      $323,178, respectively. These advances are short-term in nature and non-interest
      bearing.





The
      chief
      executive officer of the Company and his spouse, from time to time, provided
      advances to the Company for operating expenses. During
      the six months ended June 30, 2008 and 2007, the Company repaid approximately$0
      and $489,500 of these advances, respectively.  At
      June
      30, 2008 and December 31, 2007, the Company had a payable to the chief executive
      officer and his spouse amounting to $831,949 and $0, respectively. These
      advances are short-term in nature and non-interest bearing.





On
      October 9, 2006, the Company entered into a five-year loan agreement and a
      contract with Wu Lan Cha Bu Emergency Hospital (“Wu Lan”), whereby the Company
      agreed to lend to Wu Lan approximately $3,840,000 for the construction of a
      hospital ward in Inner Mongolia, China. In exchange for agreeing to lend to
      Wu
      Lan the funds, Wu Lan agreed that the Company will be the exclusive provider
      for
      all medicines and disposable medical treatment apparatus to Wu Lan for a period
      of twenty (20) years. In October 2006, the Company’s chief executive officer,
      Mr. Liu, lent these funds to Wu Lan on behalf of the Company. Accordingly,
      the
      Company entered into an assignment agreement whereby the Company assigned all
      of
      its rights, obligations, and receipts under the Loan Agreement to Mr. Liu,
      except for the rights to revenues from the sale of medical and disposable
      medical treatment apparatus which will remain with the Company. As compensation
      to Mr. Liu for accepting the assignment under the loan agreement including
      all
      of the risks and obligations and for Mr. Liu not accepting the rights to
      revenues from the sale of medical and disposable medical treatment apparatus
      which will remain with the Company, the Company agreed to pay Mr. Liu an
      aggregate of approximately $1,137,000 to be paid in 5 equal annual installments
      of approximately $230,000. Accordingly, the Company recorded an intangible
      asset
      of approximately $1,137,000 related to exclusive rights to provide all medicines
      and disposable medical treatment apparatus to Wu Lan for a period of twenty
      (20)
      years and a corresponding related party liability. For the six months ended
      June
      30, 2008 and for the year ended December 31, 2007, the Company paid approximately
      $0 and
      $195,000 of this related party liability, respectively. At June 30, 2008 and
      December 31, 2007, amounts due under this assignment agreement amounted to
      $1,047,760 and $966,198 of which $ 654,850 and $
      738,300 is included in long-term liabilities and has been included in due to
      related parties on the accompanying balance sheet, respectively.





At
      June
      30, 2008 and December 31, 2007, the Company has recorded accrued interest
      relating to notes payable - related parties of $158,395 and $61,208,
      respectively which has been included in due to related parties on the
      accompanying balance sheets.




19




NOTE
      9 - CONVERTIBLE
      DEBT





The
      convertible debenture liability is as follows at December 31, 2007:





Convertible
                debentures payable
            
            $
            2,770,000Less:
                unamortized discount on debentures
            
            
            (208,355
            )Convertible
                debentures, net
            
            $
            2,561,645




In
      January 2008, the Company issued 250,000 shares of its common stock in
      connection with the conversion of $250,000 of convertible debt. In
      February 2008, in connection with a private placement (See Note 10), the
      remaining $2,520,000 of convertible debt and any unpaid interest was repaid
      in
      full. The Company amortized the remaining $208,355 in discount on debentures
      in
      the six months ended June 30, 2008. As of June 30, 2008, the balance of the
      convertible debt is $0.





NOTE
      10 - CONVERTIBLE
      REDEEMABLE PREFERRED STOCKS




On
      February 25, 2008, the Company entered into a Convertible Redeemable Preferred
      Share and Warrant Purchase Agreement (the "Purchase Agreement") by and among
      the
      Company, Dr. Liu Zhong Yi and Mrs. Song Zhenghong (the "Founders"), and
      accredited investors (each a "Purchaser" and collectively, the "Purchasers"),
      pursuant to which the Company sold to the Purchasers 5,747,118 shares of the
      Company's series A convertible redeemable preferred stock and warrants
      to purchase 2,873,553 shares of the Company's common stock, in a private
      placement ( the
      “February 2008 Private Placement”) pursuant
      to Regulation D under the Securities Act of 1933, for the aggregate purchase
      price of $5 million (the "Transaction"). The Transaction closed on February
      25,
      2008 (the "Closing Date"). Net proceeds, exclusive of expenses of the
      Transaction, from the sale to the Company were $4.6 million, after the Company
      paid fees of  approximately
      $469,000 of which $400,000 was paid to Maxim Group, LLC, its placement agent
      for
      the Transaction. The Company recorded the approximately $469,000 in fees as
      a
      deferred debt cost and amortized approximately $99,500 of the deferred cost
      during the six months ended June 30, 2008. The Company has presented the
      convertible redeembable preferred stocks as long term debt due to the mandatory
      redeemable feature of the preferred stocks.





The
      Company used $2,576,556 of the net proceeds of the Transaction to repay in
      full
      all of its outstanding principal obligations including accrued interest under
      the 14% Secured Convertible Notes due February 2008 and the Company will use
      the
      remainder of the net proceeds for working capital and general corporate
      purposes.





The
      Purchase Agreement includes customary representations and warranties by each
      party thereto. The following is a brief description of the terms and conditions
      of the Purchase Agreement and the transactions contemplated there under that
      are
      material to the Company:





Pursuant
      to the Purchase Agreement, the Company issued to the Purchasers an aggregate
      of
      5,747,118 shares of the Company's series A convertible redeemable preferred
      stock, par value $0.001 per share, at a price equal to $0.87 per share (the
      "Preferred Shares"). Each of these Preferred Shares may be converted into one
      share of the Company's common stock, par value $0.001 per share (as adjusted
      for
      stock splits, stock dividends, reclassification and the like). The Preferred Shares
      pay an 8% dividend annually, which is payable in additional Preferred Shares.
      Preferred Shares also pay any dividend paid on the common shares on an as
      converted basis. For a period of 90 days after February 25, 2010, these Preferred
      Shares may also be redeemed at the option of the Purchasers at the redemption
      price of $0.87 per share (as adjusted for stock splits, stock dividends,
      reclassification and the like), and no other capital stock of the Company may
      be
      redeemable prior to the Preferred Shares. Holders of Preferred Shares may not
      convert Preferred Shares to common shares if the conversion would result in
      the
      holder beneficially owning more than 4.99% of the Company's outstanding common
      shares. That limitation may be waived by a holder of Preferred Shares on not
      less than 61 days written notice to the Company. In addition, the Company issued
      to the Purchasers warrants to purchase up to 2,873,553 shares of the Company's
      common stock in the aggregate. The warrants have an initial exercise price
      of
      $1.20 (subject to adjustment pursuant to the terms of the warrants). The
      warrants are exercisable for a period of five (5) years from the Closing Date.
      Holders of the warrants may not exercise the warrants if the exercise would
      result in the holder beneficially owning more than 4.99% of the Company's
      outstanding common shares. That limitation may be waived by a holder of the
      warrants on not less than 61 days written notice to the Company.




20





NOTE
      10 - CONVERTIBLE
      REDEEMABLE PREFERRED STOCKS (continued)





Other
      key
      provisions of the February 2008 Private Placement:





·
            The
                Preferred Shares vote with the common stock on an as converted basis,
                except that the Preferred Shares are not entitled to vote for directors.
                The Company is prohibited from taking certain corporate actions,
                including, without limitation, issuing securities senior to the Preferred
                Shares, selling substantially all assets, repurchasing securities
                and
                declaring or paying dividends, without the approval of the holders
                of a
                majority of the Preferred Shares
                outstanding.





·
            The
                Company agreed to undertake to file a registration statement within
                60
                days following the Closing Date in order to register the maximum
                number of
                common stock issuable from conversion of the Preferred Shares and
                underlying the warrants that is allowable under applicable federal
                securities regulations. The Company is also obligated to have the
                registration statement declared effective within 120 days following
                the
                Closing Date. If the Company is informed by the SEC that there are
                no
                comments to the registration statement, then the registration statement
                must be effective within five (5) business days thereafter or on
                the 60th
                day after the filing date, whichever is sooner. The registration
                statement
                must be declared effective by the 120th day after its filing if the
                SEC
                has comments. Otherwise, the Company is subject to liquidated damages,
                equal to 1% of the total conversion price and exercise price for
                the
                common stock being registered under the registration statement, for
                every
                30-day period following the date that the registration statement
                should
                have been effective, prorated for any period less than 30 days, until
                either all of common shares registered under the registration statement
                have been sold or all such common shares may be sold in any three
                (3)
                month period pursuant to Rule 144 promulgated under the Securities
                Act,
                whichever is earlier. The Company must also pay the liquidated damages
                if
                sales cannot be made pursuant to the registration statement for any
                reason
                (excepting market conditions). The maximum amount of liquidated damages
                is
                $500,000.





·
            The
                Founders delivered in the aggregate 7,500,000 shares of the Company's
                common stock owned by them (the "Escrow Shares") to an escrow account.
                Portions of the Escrow Shares are being held in escrow subject to
                the
                Company meeting certain earning targets in fiscal years 2007, 2008
                and
                2009. The target for 2007 is $8.5 million in net income. The target
                for
                2008 is 95% of $13.8 million in net income after eliminating the
                effect of
                non-cash charges associated with the Transaction and adjusting for
                differences in the exchange rate between Chinese. The Company successfully
                met the 2007 earning target.





Renminbi
      and US dollars used in the Company's 2008 financial statements and an exchange
      rate of RMB 7.30 to USD 1.00. The target for 2009 is 95% of $17.5 million in
      net
      income after eliminating the effect of non-cash charges associated with the
      Transaction and adjusting for differences in the exchange rate between Chinese
      Renminbi and US dollars used in the Company's 2009 financial statements and
      an
      exchange rate of RMB 7.30 to USD 1.00. These Escrow Shares will be transferred
      to the Purchasers if the Company does not meet the earning targets, and released
      back to the Founders if the Company does. Another portion of the Escrow Shares
      is being held in escrow subject to the Company listing on the NASDAQ Stock
      Market within 18 months following the Closing Date. These Escrow Shares will
      be
      transferred to the Purchasers if the listing is not completed within that time
      period, and released back to the Founders if it is. Finally, two-thirds of
      the
      Escrow Shares are held in escrow to ensure that the Purchasers receive their
      full redemption payments if they choose to redeem their Preferred Shares. Each
      Preferred Share may be redeemed for $0.87 per share (adjusted for stock splits,
      stock dividends, reclassification and the like). If a Purchaser receives less
      than the full redemption amount for each Preferred Share being redeemed, the
      Purchaser will receive a number of Escrow Shares to make up the difference,
      based on the then-current market price of the common shares. Following the
      end
      of the redemption period, these Escrow Shares, less those transferred to any
      Purchasers that redeemed their Preferred Shares, will be released back to the
      Founders.





In
      connection with the issuance of the series  A
      convertible redeemable preferred stock and warrants to purchase 2,873,553 shares
      of the Company's common stock, the Company recorded a total debt discount of
      $2,033,025 to be amortized over the term of this Purchase Agreement. For the
      six
      months ended June 30, 2008, amortization of debt discount amounted to $338,838
      and has been included in interest expense.





21




NOTE
      10 - CONVERTIBLE
      REDEEMABLE PREFERRED STOCKS (continued)





For
      the
      six months ended June 30, 2008, the Company evaluated whether or not the series
      A convertible redeemable preferred stock contain embedded conversion options,
      which meet the definition of derivatives under SFAS 133 “Accounting for
      Derivative Instruments and Hedging Activities” and related interpretations. The
      Company concluded that since the series A convertible redeemable preferred
      stock
      had a fixed redemption price of $0.87, the convertible redeemable preferred
      stock was not a derivative instrument. The Company analyzed this provision
      under
      EITF 05-04 and therefore it qualified as equity under EITF 00-19.





The series
      A
      convertible redeemable preferred stock is as
      follows at June 30, 2008:





Series
                A convertible redeemable preferred stock
            
            $
            5,000,000Less:
                unamortized discount
            
            
            (1,694,187
            )Series
                A convertible redeemable preferred stock, net
            
            $
            3,305,813





NOTE
      11
      - SHAREHOLDERS’
      EQUITY




In
      January 2008, the Company issued 250,000 shares of its common in connection
      with
      the conversion of $250,000 of convertible debt.





In
      April
      2008, the Company issued in aggregate 331,668 shares of restricted common stock
      to the several directors, consultants and officers of the Company for services
      rendered. The Company valued these common shares at
      the
      fair market value on the date of grant at $0.87 per
      share or $288,551 in total. In
      connection with issuance of these shares, the Company recorded prepaid
      stock-based expenses of $288,551. As of June 30, 2008, the Company recorded
      amortization on prepaid stock-based expenses of approximately $166,000 related
      to those issuances.





In
      April
      2008, in connection with a cashless exercise of 60,000 warrants, the Company
      issued 9,077 shares of common stock accordingly.





In
      June 2008, the Company issued 35,294 shares of restricted common stock to a
      consultant for services rendered to the Company. The Company valued these common
      shares at the fair market value on the date of the grant at $0.85 per share
      or
      $30,000 in total. The Company recorded stock-based compensation expenses of
      $30,000 for the six months ended June 30, 2008 accordingly.





Stock
      warrants





In
      January, 2008, the Company granted 250,000 stock warrants to a consulting
      company at an exercise price of $1.50 per share in connection with a one year
      contract. The warrants are not vested
      until January 2009. The Company valued these warrants utilizing the
      Black-Scholes options pricing model at approximately $0.71 per warrant or
      $178,187 in total and recorded a prepaid consulting expense of $178,187 for
      the
      period ended June 30,
      2008. Those warrants will expire in January 2012. For the six months ended
      June
      30, 2008, the Company recorded amortization expenses of $74,245 related to
      the
      consulting contract.





In
      connection with the preferred share financing (See Note 10), the Company granted
      2,873,553 warrants to investors purchase up to 2,873,553 shares of common stock
      of the Company at an exercise price of $1.20 per share. The Warrants have a
      term
      of 5 years after the issue date of February 12, 2007. Additionally, the
      Company granted 603,446 stock warrants to an investment banking firm at an
      exercise price of $1.21 per share. The Company valued these warrants utilizing
      the Black-Scholes options pricing model at approximately $0.54 per warrant
      or
      $327,565 in total and recorded a deferred financing costs of $327,565. The
      Company amortized approximately $55,000 of this deferred cost during the six
      months ended June 30, 2008. Those warrants will expire in February
      2013.





On
      February 25, 2008, pursuant to a Convertible Redeemable Preferred Share and
      Warrant Purchase Agreement (See Note
      10),
      the exercise price of the 1,500,000 warrants granted in February 2007 were
      reduced and repriced to $0.87 per share. As
      a
      result of the repricing, the Company recorded an interest expense of $74,593
      for
      the six months ended June 30, 2008.




22




NOTE
      11
      - SHAREHOLDERS’
      EQUITY (continued)





Stock
      warrants issued, terminated/forfeited and outstanding during the six months
      ended June 30, 2008 (unaudited) are as follows:


**Shares**
            
            **Average
                Exercise price per share**Warrants
                outstanding December 31, 2007
            
            
            1,500,000
            
            
            0.87Warrants
                issued
            
            
            3,726,999
            
            
            1.22Warrants
                terminated/forfeited
            
            
            -
            
            
            -Warrants
                exercised
            
            
            (60,000
            )
            
            0.87Warrants
                outstanding, June 30, 2008
            
            
            5,166,999
            
            
            1.13




NOTE
      12 - SEGMENT
      INFORMATION





The
      following information is presented in accordance with SFAS No. 131, Disclosure
      about Segments of an Enterprise and Related Information. For the six months
      ended June 30, 2008 and 2007, the Company operated in two reportable business
      segments - (1) the manufacture and distribution of pharmaceutical products
      and
      (2) the retailing of traditional and Chinese medicines and supplies through
      ten
      drug stores located in Beijing China and other ancillary revenues generated
      from
      retail location such as advertising income, rental income, and examination
      income. The Company's reportable segments are strategic business units that
      offer different products. They are managed separately based on the fundamental
      differences in their operations.




Information
      with respect to these reportable business segments for the three months ended
      June 30, 2008 and 2007 is as follows:




**2008**
            
            **Wholesale
                and third-party manufacturing**
            
            **Retail
                Operations**
            
            **Unallocated**
            
            **Total****Net
                Revenues**
            
            $
            18,382,332
            
            $
            903,404
            
            $
            99,876
            
            $
            19,385,612**Cost
                of Sales (excluding depreciation)**
            
            
            9,003,234
            
            
            551,612
            
            
            6,337
            
            
            9,561,183**Operating
                expenses (excluding depreciation and
                amortization)**
            
            
            -
            
            
            -
            
            
            6,866,102
            
            
            6,866,102**Depreciation
                and Amortization**
            
            
            126,492
            
            
            9,043
            
            
            23,294
            
            
            158,829**Other
                Expense**
            
            
            -
            
            
            -
            
            
            96,929
            
            
            96,929**Interest
                Expense**
            
            
            -
            
            
            -
            
            
            522,660
            
            
            522,660**Net
                Income**
            
            $
            9,252,606
            
            $
            342,749
            
            $
            (7,415,446
            )
            $
            2,179,909




**2007**
            
            **Wholesale
                  and third-party manufacturing**
            
            **Retail
                  Operations**
            
            **Unallocated**
            
            **Total****Net
                Revenues**
            
            $
            11,845,544
            
            $
            701,421
            
            $
            258,487
            
            $
            12,805,452**Cost
                of Sales (excluding depreciation)**
            
            
            6,702,701
            
            
            498,391
            
            
            7,173
            
            
            7,208,265**Operating
                expenses (excluding depreciation and
                amortization)**
            
            
            -
            
            
            -
            
            
            1,841,813
            
            
            1,841,813**Depreciation
                and Amortization**
            
            
            98,044
            
            
            5,162
            
            
            47,357
            
            
            150,563**Other
                Expense**
            
            
            -
            
            
            -
            
            
            114,680
            
            
            114,680**Interest
                Expense**
            
            
            -
            
            
            -
            
            
            448,606
            
            
            448,606**Net
                Income**
            
            $
            5,044,799
            
            $
            197,868
            
            
            ($
                2,201,142
            )
            $
            3,041,525





23




NOTE
      12 - SEGMENT
      INFORMATION (continued)




Information
      with respect to these reportable business segments for the six months ended
      June
      30, 2008 and 2007 is as follows:




**2008**
            
            **Wholesale
                and third-party manufacturing**
            
            **Retail
                Operations**
            
            **Unallocated**
            
            **Total****Net
                Revenues**
            
            $
            29,061,319
            
            $
            1,766,887
            
            $
            266,583
            
            $
            31,094,789**Cost
                of Sales (excluding depreciation)**
            
            
            16,193,198
            
            
            1,033,608
            
            
            11,744
            
            
            17,238,550**Operating
                expenses (excluding depreciation and
                amortization)**
            
            
            -
            
            
            -
            
            
            9,266,694
            
            
            9,266,694**Depreciation
                and Amortization**
            
            
            212,997
            
            
            13,596
            
            
            81,120
            
            
            307,713**Other
                Expense**
            
            
            -
            
            
            -
            
            
            159,815
            
            
            159,815**Interest
                Expense**
            
            
            -
            
            
            -
            
            
            946,009
            
            
            946,009**Net
                Income**
            
            $
            12,655,124
            
            $
            719,683
            
            $
            (10,198,799
            )
            $
            3,176008




**2007**
            
            **Wholesale
                  and third-party manufacturing**
            
            **Retail
                  Operations**
            
            **Unallocated**
            
            **Total****Net
                Revenues**
            
            $
            19,130,594
            
            $
            1,627,972
            
            $
            336,421
            
            $
            21,094,987**Cost
                of Sales (excluding depreciation)**
            
            
            11,843,631
            
            
            928,364
            
            
            14,202
            
            
            12,786,197**Operating
                expenses (excluding depreciation and
                amortization)**
            
            
            -
            
            
            -
            
            
            3,255,574
            
            
            3,255,574**Depreciation
                and Amortization**
            
            
            178,779
            
            
            9,411
            
            
            87,007
            
            
            275,197**Other
                Expense**
            
            
            -
            
            
            -
            
            
            198,020
            
            
            198,020**Interest
                Expense**
            
            
            -
            
            
            -
            
            
            701,173
            
            
            701,173**Net
                Income**
            
            $
            7,108,184
            
            $
            690,197
            
            
            ($
                3,919,555
            )
            $
            3,878,826




The
      Company does not allocate all of its operating expenses to its reportable
      segments, because these activities are managed at a corporate
      level.





Asset
      information by reportable segment is not reported to or reviewed by the chief
      operating decision maker and, therefore, the Company has not disclosed asset
      information for each reportable segment. Substantially all of the Company’s
      assets are located in China.





NOTE
      13 -
      RESTATEMENT




For
      the
      six months ending June 30, 2007, the Company revised certain accounting
      treatment related to the recording of an intangible asset and a corresponding
      related party liability associated with an assignment agreement and exclusive
      revenue rights as described in Note 7. The Company initially did not record
      the
      value of the intangible asset and corresponding liability and treated payment
      due under the assignment agreement as a periodic payment of interest expense
      to
      the Company’s chief executive officer. Subsequently, the Company determined that
      an intangible asset and a corresponding related party liability should have
      been
      recorded. Accordingly, the adjustments to the financial statements for this
      adjustment were as follows:





24




NOTE
      13 -
      RESTATEMENT (continued)




1.
      Balance Sheet:




a)
      Intangible assets increased by $1,136,096 to $1,309,551 from $173,455 and total
      assets increased by $1,136,096. This increase reflects the addition of an
      intangible asset of approximately $1,165,000 offset by an increase in
      accumulated amortization of approximately $29,000.




b)
      Due to
      related parties increased by $1,003,304 which increased total current
      liabilities by $236,071 and long-term liabilities by $767,233. This increase
      reflects the addition of a related party payable of approximately $1,119,000
      offset by the repayment of this payable of approximately $116,000. Stockholders’
equity increased $87,198 which reflect the changes made to the balance sheet
      and
      statement of operations as well as an increase in comprehensive income of
      $1,486.




2.
      Statement of Operations:




a)
      For
      the six months ended June 30, 2007, general and administrative expenses
      decreased by $87,323 which reflects an increase in depreciation and amortization
      expenses of $29,108 offset by a decrease in assignment fee expenses of $116,431
      due to the reversal of the periodic assignment fee expense previously
      recorded.




3.
      Statement of Cash Flows:




a)
      For
      the six months ended June 30, 2007, net cash flows provided by operating
      activities increased by $116,431 and net cash provided by financing activities
      decreased by $116,431.




NOTE
      14—COMMITMENTS AND CONTINGENCIES




Technology
      Transfer Agreement




In
      April
      2008, one of the Company’s affiliates, En Ze Jia, entered into a Technology
      Transfer Agreement with Dong Guan Kai Fa Biologicals Medicine LTD (“Dong Guan”)
      pursuant to which Dong Guan agreed to transfer the technology material, new
      medicine research and rights to the Chinese patent of the anti-asthma new
      medicine R-BM to En Ze Jia on an exclusive basis in exchange for a transfer
      technology fee of approximately $7 million (RMB 48 million) to be paid at
      various intervals. Under the terms of the agreement, En Ze Jia is obligated
      to:




·
            complete
                the filing with the Chinese State Food and Drug Administration (SFDA)
                of
                the medicine’s clinical research ratification document,·
            complete
                the clinical research,·
            complete
                the medicine’s trial production, and·
            providing
                raw materials and formulation related documentation and apply for
                the new
                medicine certification and production
                approval.




In
      addition to the payment of the technology transfer fee, En Ze Jia is responsible
      for paying all costs associated with its responsibility under the agreement
      which are presently estimated at $2.3 million (RMB 16 million). Lotus East
      intends to use its working capital to fund the project costs.




Dong
      Guan
      is responsible for preparing and transferring the clinical research and
      application documents as well as assisting En Ze Jia in the completing the
      clinical research and applying for the new medicine certification and production
      approval documents.




25




NOTE
      14—COMMITMENTS AND CONTINGENCIES (continued)





Under
      the
      terms of the agreement, the technology transfer fee is to be paid upon the
      following schedule:




·
            Approximately
                $1.5 million is due by the 15th business day following the receipt
                of the
                processing notice of the receipt of the clinical application and
                all
                related material from SFDA is
                received,




·
            Approximately
                $1.2 million (RMB 8 million) is due by the 10th business day after
                the
                receipt of the medicine’s clinical ratification
                document,




·
            Approximately
                $1.5 million (RMB 10 million) is due by the 15th business day after
                the
                medicine’s Phase I clinical study is completed and ratification from the
                SFDA is obtained, and




·
            Approximately
                $2.9 million (RMB 20 million) is due by the 10th business day after
                the
                medicine’s Phase II clinical study is completed and ratification from the
                SFDA is obtained.





En
      Ze Jia
      paid Dong Guan a deposit of approximately $2.9 million(RMB 20 million) which
      is
      returned to En Ze Jia with 10 days after the transfer technology fee is paid.
      In
      the event Dong Guan should be unable to timely return the deposit, it will
      pay
      En Ze Jia a late fee and En Ze Jia is entitled to damages for Dong Guan’s
      failure to timely return the deposit.




The
      intellectual property arising from the agreement will be jointly shared by
      the
      parties. In addition, En Ze Jia has guaranteed that both parties must jointly
      apply for related government grants prior to when the new medicine is marketed.
      Upon receipt of the government grants En Ze Jia guaranteed that the grant monies
      will be shared equally by both parties. The agreement can be terminated by
      Dong
      Guan if En Ze Jia should fail to make any of the aforedescribed payments in
      which event the patent rights would revert to Dong Guan and it is entitled
      to
      transfer the project rights to a third party.




**New
      Manufacturing Facility**




In
      June
      2008, one of the Company’s affiliates, Liang Fang, entered into an
      agreement with Cha You Qian Qi Economy Commission, a governmental agency (“Cha
      You”) related to the construction of a pharmaceutical plant in Cha You's Cha Ha
      Er Industrial Garden District. The new facility, which will be comprised
      approximately 40,000 square meters situated on 600 MU of land (approximately
      400,200 square meters), will be used to expand Liang Fang's current
      manufacturing capacity. The new facility, which will manufacture medical
      injection products, including 0.9% physiological saline injection, hydroxyethyl
      starch 130/0.4 injection and hydroxyethyl starch 200/0.5 injection, Qiang Yi
      Ji
      starch, a medical corn starch commonly known as O-2-hydeoxyethyl starch, dextran
      and additional pharmaceuticals, will require a total investment of RMB 500
      million, or approximately $72.8 million. It anticipated that construction will
      begin on the project in September 2008 and that it will take between 12 to
      30
      months to complete the facility.




Included
      in the total cost of the project is land cost of approximately $15.7 million
      (RMB 108 million) which is paid to Cha You. Other components of the project
      include construction costs of approximately $23.3 million (RMB 160 million)
      costs associated with the various production lines estimated at approximately
      $26.5 million (RMB 182 million) and working capital of approximately $7.3
      million (RMB 50 million).





Liang
      Fang intends to use its present working capital together with bank loans and
      government grants to fund the project. The funds are required to be invested
      over the next 18 months under a specified schedule ending in December 2010.
      As
      of June 30, 2008, Liang Fang has paid approximately $6 million (approximately
      RMB 39 million) of the total investment. Liang Fang, however, has not secured
      either the bank loans or government grants and does not have sufficient working
      capital to complete this project without securing substantial funds from those
      third party sources.




Under
      the
      terms of the agreement, Cha You agreed to abate fees associated with water
      resources, waste and other relative supplies for a period of 30 years and agreed
      to ensure that the land use tax to be paid by Liang Fang after it begins normal
      production will be at the lowest tax rate imposed for five years. Once the
      project is completed, for a period of eight years the local reserved portion
      of
      the imposed corporation income tax will be returned to Liang Fang. Liang Fang
      is
      required to commence construction by September 3, 2008. If for any reason Liang
      Fang should fail to begin construction within 90 days from the date of the
      agreement, Cha You has the right to restore the land use rights to it and Liang
      Fang will forfeit any funds invested to date. In addition, Liang Fang is
      prohibited from changing the land use designation.




26





NOTE
      15 - OPERATING
      RISK





(a)
      Country risk





Currently,
      the Company’s revenues are primarily derived from the sale of pharmaceutical
      products to customers in the Peoples Republic of China (PRC). The Company hopes
      to expand its operations to countries outside the PRC, however, such expansion
      has not been commenced and there are no assurances that the Company will be
      able
      to achieve such an expansion successfully. Therefore, a downturn or stagnation
      in the economic environment of the PRC could have a material adverse effect
      on
      the Company’s financial condition.





(b)
      Products risk





In
      addition to competing with other manufacturers of pharmaceutical product
      offerings, the Company competes with larger Chinese and International companies
      who may have greater funds available for expansion, marketing, research and
      development and the ability to attract more qualified personnel. These Chinese
      companies may be able to offer products at a lower price. There can be no
      assurance that the Company will remain competitive.





(c)
      Political risk





Currently,
      PRC is in a period of growth and is openly promoting business development in
      order to bring more business into PRC. Additionally PRC allows a Chinese
      corporation to be owned by a United States corporation. If the laws or
      regulations are changed by the PRC government, the Company's ability to operate
      the PRC subsidiaries could be affected.




27




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





**Overview**





We
      operate, control and beneficially own the pharmaceutical businesses in China
      of
      Lotus East under the terms of the Contractual Arrangements. Other than the
      Contractual Arrangements with Lotus East, we do not have any business or
      operations. Pursuant to the Contractual Arrangements we provide business
      consulting and other general business operation services to Lotus East. Through
      these Contractual Arrangements, we have the ability to control the daily
      operations and financial affairs of Lotus East, appoint each of their senior
      executives and approve all matters requiring stockholder approval. As a result
      of these Contractual Arrangements, which enable us to control Lotus East, we
      are
      considered the primary beneficiary of Lotus East. Accordingly, we consolidate
      Lotus East's results, assets and liabilities in our financial statements. The
      creditors of Lotus East, however, do not have recourse to any assets we may
      have.





PRC
      law
      currently places certain limitations on foreign ownership of Chinese companies.
      To comply with these foreign ownership restrictions, we operate our business
      in
      China through the Contractual Arrangements with Lotus East. The contractual
      relationship among the above companies as follows:





chart




Based
      in
      Beijing, China, Lotus East is engaged in the production, trade and retailing
      of
      pharmaceuticals, focusing on the development of innovative medicines and
      investing in strategic growth to address various medical needs. Lotus East
      owns
      and operates 10 drug stores throughout Beijing, China that sell Western and
      traditional Chinese medications, lease medical treatment facilities to licensed
      physicians, and generate revenues from the leasing of retail space to third
      party vendors and the leasing of advertising locations at its retail stores.





When
      used
      in this section, and except as may be set forth otherwise, the terms "we,"
      "us,"
      "ours," and similar terms includes Lotus and its subsidiary Lotus International
      as well as Lotus East.




CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES





Our
      discussion and analysis of our financial condition and results of operations
      are
      based on our financial statements, which have been prepared in accordance with
      accounting principles generally accepted in the United States of America. The
      preparation of these financial statements requires us to make estimates and
      judgments that affect the reported amounts of assets, liabilities and expenses.
      On an ongoing basis, we evaluate our estimates and judgments, including those
      related to accrued expenses, fair valuation of stock related to stock-based
      compensation and income taxes. We based our estimates on historical experience
      and on various other assumptions that we believe to be reasonable under the
      circumstances, the results of which form the basis for making judgments about
      the carrying values of assets and liabilities that are not readily apparent
      from
      other sources. Actual results may differ from these estimates under different
      assumptions or conditions.




28




REVENUE
      RECOGNITION





Product
      sales. Product sales are generally recognized when title to the product has
      transferred to customers in accordance with the terms of the sale. We recognize
      revenue in accordance with the Securities and Exchange Commission's (SEC) Staff
      Accounting Bulletin (SAB) No. 101, " Revenue Recognition in Financial Statements
      " as amended by SAB No. 104 (together, "SAB 104"), and Statement of Financial
      Accounting Standards (SFAS) No. 48 " Revenue Recognition When Right of Return
      Exists. " SAB 104 states that revenue should not be recognized until it is
      realized or realizable and earned. In general, we record revenue when persuasive
      evidence of an arrangement exists, services have been rendered or product
      delivery has occurred, the sales price to the customer is fixed or determinable,
      and collectability is reasonably assured.





SFAS
      No.
      48 states that revenue from sales transactions where the buyer has the right
      to
      return the product shall be recognized at the time of sale only if the seller's
      price to the buyer is substantially fixed or determinable at the date of sale,
      the buyer has paid the seller, or the buyer is obligated to pay the seller
      and
      the obligation is not contingent on resale of the product, the buyer's
      obligation to the seller would not be changed in the event of theft or physical
      destruction or damage of the product, the buyer acquiring the product for resale
      has economic substance apart from that provided by the seller, the seller does
      not have significant obligations for future performance to directly bring about
      resale of the product by the buyer, and the amount of future returns can be
      reasonably estimated.





We
      recognize revenue for the sale of pharmaceutical products and for payments
      received, if any, under reimbursement of development costs as follows:





*Product
      Sales* .
      Revenue
      from product sales, net of estimated provisions, is recognized when there is
      persuasive evidence that an arrangement exists, delivery has occurred, the
      selling price is fixed or determinable, and collectability is reasonably
      probable. Our customers consist of pharmaceutical wholesalers who sell directly
      into the retail channel, hospitals, and retail customers. Provisions for sales
      discounts, and estimates for chargebacks, and product returns are established
      as
      a reduction of product sales revenue at the time revenues are recognized, based
      on historical experience adjusted to reflect known changes in the factors that
      impact these reserves. Factors include current contract prices and terms,
      estimated wholesaler inventory levels, remaining shelf life of product, and
      historical information for similar products in the same distribution channel.
      These revenue reductions are generally reflected either as a direct reduction
      to
      accounts receivable through an allowance, or as an addition to accrued expenses
      if the payment is due to a party other than the customer.





PRODUCT
      RETURNS.





We
      account for sales returns in accordance with Statements of Financial Accounting
      Standards (SFAS) No. 48, Revenue Recognition When Right of Return Exists, by
      establishing an accrual in an amount equal to its estimate of sales recorded
      for
      which the related products are expected to be returned. We determine the
      estimate of the sales return accrual primarily based on historical experience
      regarding sales returns, but also by considering other factors that could impact
      sales returns. These factors include levels of inventory in the distribution
      channel, estimated shelf life, product discontinuances, and price changes of
      competitive products, introductions of generic products and introductions of
      competitive new products. In general, for wholesale sales, we provide credit
      for
      product returns that are returned six months prior to and up to six months
      after
      the product expiration date. Upon sale, we estimate an allowance for future
      product returns. We provide additional reserves for contemporaneous events
      that
      were not known and knowable at the time of shipment.





In
      order
      to reasonably estimate future returns, we analyzed both quantitative and
      qualitative information including, but not limited to, actual return rates,
      the
      level of product manufactured by us, the level of product in the distribution
      channel, expected shelf life of the product, current and projected product
      demand, the introduction of new or generic products that may erode current
      demand, and general economic and industry wide indicators. We also utilize
      the
      guidance provided in SAB 104 in establishing our return estimates.





Other
      revenues. Other revenues consist of (i) rental income received for the lease
      of
      retail space to various retail merchants; (ii) advertising revenues from the
      lease of counter space at our retail locations; (iii) rental income from the
      lease of retail space to licensed medical practitioners; and (iv) revenues
      received by us for research and development projects. We recognize revenues
      upon
      performance of such funded research. We recognize revenues from leasing of
      space
      as earned from contracting third parties. Revenues received in advance are
      reflected as deferred revenue on the accompanying balance sheets. Additionally,
      we receive income from the sale of developed drug formulas. Income from the
      sale
      of drug formulas are recognized upon performance of all of our obligations
      under
      the respective sales contract and are included in other income on the
      accompanying consolidated statement of operations.




29




ACCOUNTS
      RECEIVABLE





Accounts
      receivable are carried at original invoice amount less an estimate made for
      doubtful receivables based on a review of all outstanding amounts on a monthly
      basis. Management judgment and estimates are made in connection with
      establishing the allowance for doubtful accounts. Specifically, we analyze
      the
      aging of accounts receivable balances, historical bad debts, customer
      concentrations, customer credit-worthiness, current economic trends and changes
      in our customer payment terms. Significant changes in customer concentration
      or
      payment terms, deterioration of customer credit-worthiness or weakening in
      economic trends could have a significant impact on the collectability of
      receivables and our operating results. If the financial condition of our
      customers were to deteriorate, resulting in an impairment of their ability
      to
      make payments, additional allowances may be required.





INVENTORIES





Inventories
      are stated at the lower of cost or market with cost determined under the
      weighted-average method. Inventory consists of finished capsules, liquids,
      finished oral suspension powder and other western and traditional Chinese
      medicines and medical equipment. At least on a quarterly basis, we review our
      inventory levels and write down inventory that has become obsolete or has a
      cost
      basis in excess of its expected net realizable value or is in excess of expected
      requirements. Inventory levels are evaluated by management relative to product
      demand, remaining shelf life, future marketing plans and other factors, and
      reserves for obsolete and slow-moving inventories are recorded for amounts
      which
      may not be realizable.





PROPERTY
      AND EQUIPMENT





Property
      and equipment are carried at cost. The cost of repairs and maintenance is
      expensed as incurred; major replacements and improvements are capitalized.
      When
      assets are retired or disposed of, the cost and accumulated depreciation are
      removed from the accounts, and any resulting gains or losses are included in
      income in the year of disposition. In accordance with Statement of Financial
      Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal
      of Long-Lived Assets", we examine the possibility of decreases in the value
      of
      fixed assets when events or changes in circumstances reflect the fact that
      their
      recorded value may not be recoverable.





Depreciation
      is calculated on a straight-line basis over the estimated useful lives of the
      assets. The useful lives for property and equipment are as follows:


Buildings
                  and leasehold improvement
              
              
              20
                  to 40 yearsManufacturing
                  equipment
              
              
              10
                  to 15 yearsOffice
                  equipment and furniture
              
              
              5
                  to 8 years





INCOME
      TAXES





Taxes
      are
      calculated in accordance with taxation principles currently effective in the
      United States and PRC. We account for income taxes using the liability method.
      Deferred tax assets and liabilities are recognized for the future tax
      consequences attributable to differences between the financial statement
      carrying amounts of existing assets and liabilities and their respective tax
      bases. Deferred tax assets and liabilities are measured using enacted tax rates
      expected to apply to taxable income in the years in which those temporary
      differences are expected to be recovered or settled. The effect on deferred
      tax
      assets and liabilities of a change in tax rates is recognized as income in
      the
      period that includes the enactment date. A valuation allowance is provided
      for
      the amount of deferred tax assets that, based on available evidence, are not
      expected to be realized.





RECENT
      ACCOUNTING PRONOUNCEMENTS





In
      February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
      Financial Assets and Financial Liabilities, Including an Amendment of FASB
      Statement No.115", under which entities will now be permitted to measure many
      financial instruments and certain other assets and liabilities at fair value
      on
      an instrument-by-instrument basis. This Statement is effective as of the
      beginning of an entity's first fiscal year that begins after November 15, 2007.
      Early adoption is permitted as of the beginning of a fiscal year that begins
      on
      or before November 15, 2007, provided the entity also elects to apply the
      provisions of SFAS 157. The adoption of SFAS 159 did not have a material impact
      on our financial statements.





30




In
      December 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      141R, Business Combinations (SFAS 141R) and Statement of Financial Accounting
      Standards No. 160, Accounting and Reporting of Non-controlling Interests in
      Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). These
      two standards must be adopted in conjunction with each other on a prospective
      basis. The most significant changes to business combination accounting pursuant
      to SFAS 141R and SFAS 160 are the following: (a) recognize, with certain
      exceptions, 100 percent of the fair values of assets acquired, liabilities
      assumed and non-controlling interests in acquisitions of less than a 100 percent
      controlling interest when the acquisition constitutes a change in control of
      the
      acquired entity, (b) acquirers' shares issued in consideration for a business
      combination will be measured at fair value on the closing date, not the
      announcement date, (c) recognize contingent consideration arrangements at their
      acquisition date fair values, with subsequent changes in fair value generally
      reflected in earnings, (d) the expensing of all transaction costs as incurred
      and most restructuring costs, (e) recognition of pre-acquisition loss and gain
      contingencies at their acquisition date fair values, with certain exceptions,
      (f) capitalization of acquired in-process research and development rather than
      expense recognition, (g) earn-out arrangements may be required to be re-measured
      at fair value and (h) recognize changes that result from a business combination
      transaction in an acquirer's existing income tax valuation allowances and tax
      uncertainty accruals as adjustments to income tax expense. Should we decide
      to
      enter into future business combinations, these new standards will significantly
      affect our accounting for future business combinations following adoption on
      January 1, 2009.





In
      March
      2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments
      and Hedging Activities-- an amendment of FASB Statement No. 133" ("FAS 161").
      FAS 161 changes the disclosure requirements for derivative instruments and
      hedging activities. Entities are required to provide enhanced disclosures about
      (a) how and why an entity uses derivative instruments, (b) how derivative
      instruments and related hedged items are accounted for under Statement 133
      and
      its related interpretations, and (c) how derivative instruments and related
      hedged items affect an entity's financial position, financial performance,
      and
      cash flows. The guidance in FAS 161 is effective for financial statements issued
      for fiscal years and interim periods beginning after November 15, 2008, with
      early application encouraged. This Statement encourages, but does not require,
      comparative disclosures for earlier periods at initial adoption. We are
      currently assessing the impact of FAS 161.





In
      May
      2008, the Financial Accounting Standards Board (FASB”) issued FASB Staff
      Position (FSP”) APB 14-1, *Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
      Conversion (Including Partial Cash Settlement)* . FSP
      APB 14-1 clarifies that convertible debt instruments that may be settled in
      cash
      upon either mandatory or optional conversion (including partial cash settlement)
      are not addressed by paragraph 12 of APB Opinion No. 14, *Accounting for Convertible Debt and Debt issued with Stock Purchase
      Warrants* .
      Additionally, FSP APB 14-1 specifies that issuers of such instruments should
      separately account for the liability and equity components in a manner that
      will
      reflect the entity’s nonconvertible debt borrowing rate when interest cost is
      recognized in subsequent periods. FSP APB 14-1 is effective for financial
      statements issued for fiscal years beginning after December 15, 2008, and
      interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning
      in the first quarter of fiscal 2010, and this standard must be applied on a
      retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1
      will have on our consolidated financial position and results of
      operations.





In
      May
      2008, the FASB issued Statement of Financial Accounting Standards (SFAS”) No.
      162, *The
      Hierarchy of Generally Accepted Accounting Principles* . This
      standard is intended to improve financial reporting by identifying a consistent
      framework, or hierarchy, for selecting accounting principles to be used in
      preparing financial statements that are presented in conformity with generally
      accepted accounting principles in the United States for non-governmental
      entities. SFAS No. 162 is effective 60 days following approval by the U.S.
      Securities and Exchange Commission (SEC”) of the Public Company Accounting
      Oversight Board’s amendments to AU Section 411, *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles* . We do
      not expect SFAS No. 162 to have a material impact on the preparation of our
      consolidated financial statements.





On
      June
      16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, *Determining
      Whether Instruments Granted in Share-Based Payment Transactions Are
      Participating Securities”* to
      address the question of whether instruments granted in share-based payment
      transactions are participating securities prior to vesting. The FSP determines
      that unvested share-based payment awards that contain rights to dividend
      payments should be included in earnings per share calculations. The guidance
      will be effective for fiscal years beginning after December 15, 2008. We are
      currently evaluating the requirements of (FSP) No. EITF 03-6-1.




31




**Results
      of Operations**





***For
      the Six Months and Three Months Ended June 30, 2008 and Ended June 30,
      2007***





**Six
      Months ended June 30, 2008 compared to six months ended June 30,
      2007**





**Total
      Net Revenues**





Total
      revenues for the six months ended June 30, 2008 were $31,094,789 as compared
      to
      total revenues of $21,094,987 for the six months ended June 30, 2007, an
      increase of $9,999,802 or approximately 47.40%. For the
      six months ended June 30, 2008 and 2007, net revenues consisted of the
      following:





2008
            
            2007Wholesale
            
            $
            26,931,327
            
            $
            14,993,316Retail
            
            
            1,402,393
            
            
            893,014Other
                revenues
            
            
            2,761,069
            
            
            5,208,657Total
                net revenues
            
            $
            31,094,789
            
            $
            21,094,987





·
            For
                the six months ended June 30, 2008, wholesale revenues increased
                by
                $11,938,011or
                79.62%.The significant increase in tangible product revenues is mainly attributed
                to strong sales in Brimonidine Tartrate Eye Drops, a drug used to
                constrict adrenaline receptors, an important step in treating glaucoma
                and
                significant increase in third party manufactured pharmaceutical products
                and partially offset by the decrease in sales in Levofloxacin, an
                anti-bacterial drug used for the treatment of mild, moderate, and
                severe
                infections and Nicergoline for Injection, an a-receptor blockage
                system
                blood-brain medicine, and revenue recorded from collection of our
                previous
                reversed allowance for sales returned in the six months ended June
                30,
                2007. The decrease in sales in Levofloxacin and Nicergoline for Injection
                was due to more competitors entered into the market. During the six
                months
                ended June 30, 2007, the Company collected approximately $1.8 million
                that
                was previously recorded as allowance for sales returns at December
                31,
                2006. The collection of sales return allowance had the effect of
                increasing the Company’s net revenues for the six months ended June 30,
                2007 by approximately $1.8 million, even though the sales of these
                products were actually made during the fourth quarter of fiscal 2006.
                The
                significant increased sales in Brimonidine Tartrate Eye Drops was
                primarily due to our strong marketing, heavy advertising spending
                in 2007
                and sales effort on promoting this drug since it was first introduced
                in
                late 2006. We also have few domestic competitors in this drug market
                in
                China. In late 2007, we also obtained exclusive distribution rights
                from a
                third party Beijing based pharmaceutical company for four drugs:
                Octreotide Acetate Injection, Recombinant Human Erythropoietin Injection,
                Recombinant Human Granulocyte Colony-stimulating Factor Injection,
                and
                Recombinant Human Interleukin-2 for Injection. As a result, we experienced
                a significant increase in our third party manufactured drug sales
                during
                the six months ended June 30, 2008. We expect the sales in Brimonidien
                Tartrate Eye Drops and third party manufactured drugs will continue
                to
                have steady growths in the remaining of 2008.·
            For
                the six months ended June 30, 2008, retail revenues increased by$509,379
                or 57%. Theincrease is attributable to our continuous efforts to diversify products
                carried by our retail stores to provide more varieties as well as
                better
                quality products and the favorable RMB currency appreciation which
                converted our revenue in RMB into higher US dollar amounts. As a
                result,
                our retail revenue increased.·
            For
                the six months ended June 30, 2008, other revenues decreased by$2,447,588
                or 47%.The decrease in other revenues is attributed to the
                following:





2008
            
            2007Leasing
                revenues
            
            $
            364,279
            
            $
            439,615Third-party
                manufacturing
            
            
            2,129,992
            
            
            4,137,278Advertising
                revenues
            
            
            215
            
            
            295,343Research
                and development and lab testing services
            
            
            266,583
            
            
            336,421Total
                other revenues
            
            $
            2,761,069
            
            $
            5,208,657




·
            We
                sublease certain portion our retail stores and counter spaces to
                various
                other vendors and generate leasing revenue. The
                decrease was primarily due to less counter spaces were leased to
                third
                parties due to less demand for our counter spaces during the first
                quarter
                of 2008 and partially offset by the increase in second quarter of
                2008 as
                we were able to lease more counter spaces to third party vendors
                in the
                second quarter of 2008.




32




·
            For
                third-party manufacturing, customers supply the raw materials and
                we are
                paid a fee for manufacturing their products. We had less large
                manufacturing contracts during the six months ended June 30, 2008as
                the demand for the third-party manufacturing decreasedas
                compared to the same period in 2007. Several of our old large third
                party
                manufacturing customers have built their own facilities and started
                manufacturing products on their own in 2008 and we were unable to
                find new
                customers to replace them. As a result, our third-party manufacturing
                revenue decreased. We anticipate the third-party manufacturing revenue
                will continue to decrease for the remainder of fiscal 2008 as we
                do not
                expect to have new customers with large third party manufacturing
                contracts.·
            A
                large advertisement contract whereby we receive approximately $50,000
                per
                month for the lease of counter and other space at our retail locations
                ended in December 2007. Accordingly, our advertising revenuesdecreasedduring
                the six months ended June 30, 2008 as compared to the same period
                in 2007.
                As the local government tightens the advertising rules and regulations
                in
                the pharmaceutical industry, we do not anticipate signing similar
                advertisement contracts in the near future.·
            We
                performed research and development and lab testing projects for various
                third parties and performed drug testing and analysis. We preformed
                less
                R&D testing services and drug testing and analysis work for third
                parties during the six months ended June 30, 2008as
                compared
                to the same period in 2007. Some of our old customers were able to
                find
                other companies that provide similar R&D and lab testing serves at a
                lower price and decided not to use our services in 2008. We expect
                the
                revenue from R&D and lab testing will maintain at its current level
                with minimal growth in the remaining of 2008.





**Cost
      of Sales**





Cost
      of
      sales includes raw materials, packing materials, shipping, and manufacturing
      costs, which includes allocated portion of overhead expenses such as utilities
      and depreciation directly related to product production. For the six months
      ended June 30, 2008, cost of sales amounted to $17,465,143 or approximately
      56.17% of total revenues as compared to cost of sales of $12,974,387 or
      approximately 61.5% of total revenues for the six months ended June 30, 2007.
      The collections on the previously reserved allowance for sales return of
      approximately $1.8 million in 2007 mentioned above had the effect of decreasing
      the Company’s cost of sales as a percentage of total revenue by 5.7% for the six
      months ended June 30, 2007as the Company recorded the costs associated with
      these products in its cost of sales during fiscal 2006 and the revenue was
      recognized in the second quarter of 2007. The decrease in cost of sales as
      a
      percentage of total revenue was primarily due to better purchase pricing
      management and more efficient production cost controls.





**Gross
      Profit**





Gross
      profit for the six months ended June 30, 2008 was $13,629,646
      or 43.83% of total
      revenues, as compared to $8,120,600 or 38.5% of revenues for the six months
      ended June 30, 2007. The collections on the previously reserved allowance for
      sales return of approximately $1.8 million in 2007 mentioned above had the
      effect of increasing the Company’s profit margin by approximately $1.8 million
      for the six months ended June 30, 2007, even though the sales of these products
      were actually made during the fourth quarter of fiscal 2006. As the costs
      associated with these products was recorded in our cost of sales during fiscal
      2006, both the Company’s gross profit margin and income from operations for the
      six months ended June 30, 2007 increased by approximately $1.8 million. The
      increase in gross profit was attributable to the decrease in cost of sales
      as a
      percentage of revenue. Although we recognized higher than average gross profits
      during the six months ended June 30, 2008, there could be no assurance that
      we
      will continue to recognize similar gross profit margin in the
      future.





**Operating
      Expenses**





Total
      operating expenses for the six months ended June 30, 2008 were $9,347,814 ,
      an
      increase of $6,005,233  or
      179.66%, from
      total operating expenses in the six months ended June 30, 2007 of $3,342,581.
      This increase included the following:





For
      the
      six months ended June 30, 2008, selling expenses amounted to $6,997,886 as
      compared to $1,422,796 for the six months ended June 30, 2007, an increase
      of $5,575,090
      or 391.84%. This
      increase is primarily attributable to an increase of approximately $3.7 million
      in commission paid on sales generated to our sales representatives to provide
      better incentives. **** Additionally,
      we paid bonuses of approximately $2.5 million to improve our collections on
      accounts receivables and cash flows. We expect our selling expenses to increase
      as our revenues increase and we continue to pay out commission and bonuses
      to
      our sales representatives to increase sales and collections. As a result, the
      significant increase in the selling expenses negatively impacted of our net
      income. We expect to continue paying commission on sales to increase our sales
      and provide bonuses based on the collection personnel’s performance to generate
      sufficient cash to meet our near term capital commitments such as new facility
      construction project and acquiring Chinese Class I drug patent.





33




For
      the
      six months ended June 30, 2008, research and development costs amounted to
      $1,181,468 as compared to $200,975 for the six months ended June 30, 2007,
      an
      increase of $980,493  or
      487.87%. In late
      2007, we entered into several research and development agreements with third
      parties for the design, research and development of designated pharmaceutical
      projects and as a result, expenses related to those research and development
      projects increased during the six months ended June 30, 2008.





For
      the
      six months ended June 30, 2008, general and administrative expenses were $1,168,460 as
      compared to $1,718,810 for the six months ended June 30, 2007, a decrease of
      $550,350  or
      32% as
      summarized below:




Six
                months ended
              June
                30,2008
            
            2007Salaries
                and related benefits
            
            $
            544,454
            
            $
            826,963Amortization
                and depreciation expenses
            
            
            81,120
            
            
            50,117Rent
            
            
            149,443
            
            
            133,512Travel
                and entertainment
            
            
            37,039
            
            
            94,029Professional
                fees
            
            
            185,618
            
            
            148,260Other
            
            
            170,786
            
            
            465,929Total
            
            $
            1,168,460
            
            $
            1,718,810





The
      changes in these expenses from the six months ended June 30, 2008 as compared
      to
      the six months ended June 30, 2007 included the following:





·
            Salaries
                and related benefitsdecreased
                $282,509 or 34.16%primarily due to decrease bonuses paid to administrative personnel
                as we
                are in an effort of controlling corporate spending and decreased
                use of
                part time employees. Additionally, starting in 2008, we no longer
                provided
                certain benefits that were provided to employees in the 2007 including
                insurance, car allowances and other fringe benefits. The related
                benefit
                costs reduced approximately $120,000 accordingly. As a result, the
                salaries and related benefits costs decreased accordingly.·
            Amortization
                of our intangible assets and depreciation on our fixed assetsincreased
                by $31,003orapproximately
                61.86%which is primarily attributable to additional fixed assets purchased
                and
                started depreciating. As such, there was an increase in depreciation
                for
                the six months ended June 30, 2008.·
            Rentincreased
                by $15,931 or approximately 11.93% primarily due to appreciation
                in RMB
                currency exchange rate.·
            Travel
                and entertainment expensesdecreased
                by $56,990 or 60.61%as
                a result of corporate spending control effort.·
            Professional
                feesincreased
                $37,358 or 25.2%due to increase in compensations paid to consultants.·
            Other
                selling, general and administrative expenses, which includes utilities,
                office supplies and training and other office expensesdecreased
                by $295,143 or approximately 63.35% as an effort of reducing non-sales
                related corporate training and other activities as well as stricter
                controls on corporate spending.





**Income
      from Operations**





We
      reported income from operations of $4,281,832 for the
      six months ended June 30, 2008 as compared to income from operations of
      $4,778,019 for the six months ended June 30, 2007, a decrease
      of $496,187 or approximately 10.38%.





**Other
      Expense**





For
      the
      six months ended June 30, 2008, total other expense amounted to $1,105,824 as
      compared to other expense of $899,193 for the six months ended June 30, 2007,
      an
      increase of $206,631
      or 22.98%. This
      change is primarily attributable to:




34




·
            For
                the six months ended June 30, 2008, we recorded debt issuance costs
                of$162,403compared to $88,020 for the six months ended June 30, 2007 due to
                our
                recent funding during thesix
                monthsof
                2008.·
            For
                the six months ended June 30, 2007, we recorded registration rights
                penalties of $110,000 related to the late filing of our registration
                statement on Form SB-2 for which there wasno
                comparableexpense in the 2008 period.·
            For
                the six months ended June 30, 2008, interest expense was$946,009as
                compared to $701,173 for the six months ended June 30, 2007, an increaseof
                $244,836.
                This increase is primarily attributable to the amortization of discount
                on
                convertible redeemable preferred stock and repricing expense of previously
                issued warrants in connection with our February 2008 private placement
                financing.




**NET
      INCOME, OTHER COMPREHENSIVE INCOME AND COMPREHENSIVE
      INCOME**





As
      a
      result of these factors, we reported net income of $3,176,008 for the six months
      ended June 30, 2008 as compared to net income of $3,878,826 for the six months
      ended June 30, 2007. This translates to basic and diluted net income per common
      share of $0.08,
      $0.07 and $0.09,
      $0.09 for the six months ended June 30, 2008 and 2007,
      respectively.





During
      the six months ended June 30, 2008, we reported an unrealized gain on foreign
      currency translation of $3,041,741, an increase of
      $2,669,821, or approximately 717.85 % ,
      from
      the same period in 2007. We report in U.S. dollars, but the functional currency
      of Lotus East is the RMB. Translation adjustments result from the process of
      translating the local currency financial statements into U.S. dollars, with
      the
      average translation rates applied to our income statement of 7.0726 RMB to
      $1.00
      during the six months ended June 30, 2008. As a result of this non-cash gain,
      we
      reported comprehensive income of $6,217,749 for the
      six months ended June 30, 2008 as compared to $4,250,746 for the same period
      in
      2007.





**Three
      Months ended June 30, 2008 compared to three months ended June 30,
      2007**





**Total
      Net Revenues**





Total
      revenues for the three months ended June 30, 2008 were $19,385,612 as compared
      to total revenues of $12,805,452 for the three months ended June 30, 2007,
      an
      increase of $6,580,160 or approximately 51.39%. For the
      three months ended June 30, 2008 and 2007, net revenues consisted of the
      following:





2008
            
            2007Wholesale
            
            $
            17,161,230
            
            $
            9,819,373Retail
            
            
            718,645
            
            
            516,594Other
                revenues
            
            
            1,505,737
            
            
            2,469,485Total
                net revenues
            
            $
            19,385,612
            
            $
            12,805,452





·
            For
                the three months ended June 30, 2008, wholesale revenues increased
                by
                $7,341,857 or 74.77%. The significant increase in tangible product
                revenues is mainly attributed to strong sales in Brimonidine Tartrate
                Eyes
                Drops, a drug used to constrict adrenaline receptors, an important
                step in
                treating glaucoma and significant increase in third party manufactured
                pharmaceutical products and partially offset by the decrease in sales
                in
                Levofloxacin, an anti-bacterial drug used for the treatment of mild,
                moderate, and severe infections and Nicergoline for Injection, an
                a-receptor blockage system blood-brain medicine, and revenue recorded
                from
                collection of our previous reversed allowance for sales returned
                in the
                three months ended June 30, 2007. The decrease in sales in Levofloxacin
                and Nicergoline for Injection was due to more competitors entered
                into the
                market. During the three months ended June 30, 2007, the Company
                collected
                approximately $1.8 million that was previously recorded as allowance
                for
                sales returns at December 31, 2006. The collection of sales return
                allowance had the effect of increasing the Company’s net revenues for the
                three months ended June 30, 2007 by approximately $1.8 million, even
                though the sales of these products were actually made during the
                fourth
                quarter of fiscal 2006. The significant increased sales in Brimonidine
                Tartrate Eye Drops was primarily due to our strong marketing, heavy
                advertising spending in 2007 and sales effort on promoting this drug
                since
                it was first introduced in late 2006. We also have few domestic
                competitors in this drug market in China. In late 2007, we also obtained
                exclusive distribution rights from a third party Beijing based
                pharmaceutical company for four drugs: Octreotide Acetate Injection,
                Recombinant Human Erythropoietin Injection, Recombinant Human Granulocyte
                Colony-stimulating Factor Injection, and Recombinant Human Interleukin-2
                for Injection. As a result, we experienced a significant increase
                in our
                third party manufactured drug sales during the three months ended
                June 30,
                2008. We expect the sales in Brimonidien Tartrate Eye Drops and third
                party manufactured drugs will continue to have steady growth in the
                remaining of 2008.




35




·
            For
                the three months ended June 30, 2008, retail revenues increased by$202,051
                or 39.11%. Theincrease is attributable to our continuous efforts to diversify products
                carried by our retail stores to provide more varieties as well as
                better
                quality products and the favorable RMB currency appreciation which
                converted our revenue in RMB into higher US dollar amounts.**A**s
                a
                result, our average per retail store increased.·
            For
                the three months ended June 30, 2008, other revenues decreased by$963,748
                or 39.03%.The decrease in other revenues is attributed to the
                following:





2008
            
            2007Leasing
                revenues
            
            $
            184,756
            
            $
            160,998Third-party
                manufacturing
            
            
            1,221,102
            
            
            1,901,349Advertising
                revenues
            
            
            -
            
            
            148,651Research
                and development and lab testing services
            
            
            99,879
            
            
            258,487Total
                other revenues
            
            $
            1,505,737
            
            $
            2,469,485




·
            We
                sublease certain portion our retail stores and counter spaces to
                various
                other vendors and generate leasing revenue.The
                increase was primarily due to the favorable RMB currency application
                which
                converted our leasing revenue in RMB into higher US dollar amounts
                and
                slightly more counter spaces being leased to third party vendors
                during
                the three months ended June 30, 2008.·
            For
                third-party manufacturing, customers supply the raw materials and
                we are
                paid a fee for manufacturing their products. We had less large
                manufacturing contracts during the three months ended June 30, 2008as
                the demand for the third-party manufacturing decreasedas
                compared to the same period in 2007. Several of our old large third
                party
                manufacturing customers have built their own facilities and started
                manufacturing products on their own in 2008 and we were unable to
                find new
                customers to replace them. As a result, our third-party manufacturing
                revenue decreased. We anticipate the third-party manufacturing revenue
                will continue to decrease for the remainder of fiscal 2008 as we
                do not
                expect to have new customers with large third party manufacturing
                contracts.·
            A
                large advertisement contract whereby we receive approximately $50,000
                per
                month for the lease of counter and other space at our retail locations
                ended in December 2007. Accordingly, our advertising revenuesdecreasedduring
                the three months ended June 30, 2008 as compared to the same period
                in
                2007. As the local government tightens the advertising rules and
                regulations in the pharmaceutical industry, we do not anticipate
                signing
                similar advertisement contracts in the near future.·
            We
                performed research and development and lab testing projects for various
                third parties and performed drug testing and analysis. We preformed
                less
                R&D testing services and drug testing and analysis work for third
                parties during the three months ended June 30, 2008as
                compared
                to the same period in 2007. Some of our old customers were able to
                find
                other companies that provide similar R&D and lab testing serves at a
                lower price and decided not to use our services in 2008. We expect
                the
                revenue from R&D and lab testing will maintain at its current level
                with minimal growth in the remaining of 2008.




**Cost
      of Sales**





Cost
      of
      sales includes raw materials, packing materials, shipping, and manufacturing
      costs, which includes allocated portion of overhead expenses such as utilities
      and depreciation directly related to product production. For the three months
      ended June 30, 2008, cost of sales amounted to $9,696,718 or approximately
      50.02% of total revenues as compared to cost of sales of $7,311,471 or
      approximately 57.10% of total revenues for the three months ended June 30,
      2007.
      The collections on the previously reserved allowance for sales return of
      approximately $1.8 million in 2007 mentioned above had the effect of decreasing
      the Company’s cost of sales as a percentage of total revenue by 9.33% for the
      six months ended June 30, 2007as the Company recorded the costs associated
      with
      these products in its cost of sales during fiscal 2006 and the revenue was
      recognized in the second quarter of 2007. The decrease in cost of sales as
      a
      percentage of total revenue was primarily due to better purchase pricing
      management and more efficient production cost controls.





36




**Gross
      Profit**





Gross
      profit for the three months ended June 30, 2008 was $9,688,894
      or 49.98% of total
      revenues, as compared to $5,493,981 or 42.90% of revenues for the three months
      ended June 30, 2007. The collections on the previously reserved allowance for
      sales return of approximately $1.8 million in 2007 mentioned above had the
      effect of increasing the Company’s profit margin by approximately $1.8 million
      for the three months ended June 30, 2007, even though the sales of these
      products were actually made during the fourth quarter of fiscal 2006. As the
      costs associated with these products was recorded in our cost of sales during
      fiscal 2006, both the Company’s gross profit margin and income from operations
      for the three months ended June 30, 2007 increased by approximately $1.8
      million. The increase in gross profit was attributable to the decrease in cost
      of sales as a percentage of revenue. Although we recognized higher than average
      gross profits during the three months ended June 30, 2008, there could be no
      assurance that we will continue to recognize similar gross profit margin in
      the
      future.





**Operating
      Expenses**





Total
      operating expenses for the three months ended June 30, 2008 were $6,888,835 ,
      an
      increase of $4,999,665  or
      264.65%, from
      total operating expenses in the three months ended June 30, 2007 of $1,889,170.
      This increase included the following:





For
      the
      three months ended June 30, 2008, selling expenses amounted to $5,875,549 as
      compared to $791,784 for the three months ended June 30, 2007, an increase
      of $5,083,765
      or 642.06%. This
      increase is primarily attributable to an increase of approximately $3.0 million
      in commission paid on sales to our sales representatives to provide better
      incentives. Additionally, we paid bonuses of approximately $2.4 million to
      improve our collections on accounts receivables and cash flows. We expect our
      selling expenses to increase as our revenues increase and we continue to pay
      out
      commission and bonuses to our sales representatives to increase sales and
      collections. As a result, the significant increase in the selling expenses
      negatively impacted of our net income. We expect to continue paying commission
      on sales to increase our sales and provide bonuses based on the collection
      personnel’s performance to generate sufficient cash to meet our near term
      capital commitments such as new facility construction project and acquiring
      Chinese Class I drug patent.





For
      the
      three months ended June 30, 2008, research and development costs amounted to
      $471,243 as compared to $109,153 for the three months ended June 30, 2007,
      an
      increase of $362,090  or
      331.73%. In late
      2007, we entered into several research and development agreements with third
      parties for the design, research and development of designated pharmaceutical
      projects and as a result, expenses related to those research and development
      projects increased during the three months ended June 30, 2008.




For
      the
      three months ended June 30, 2008, general and administrative expenses were $542,043 as
      compared to $988,233 for the three months ended June 30, 2007, a decrease of
      $446,190  or
      45.15% as
      summarized below:




Three
                months
              ended
                June 30,2008
            
            2007Salaries
                and related benefits
            
            $
            274,986
            
            $
            437,482Amortization
                and depreciation expenses
            
            
            23,294
            
            
            6,301Rent
            
            
            78,275
            
            
            66,235Travel
                and entertainment
            
            
            17,277
            
            
            42,525Professional
                fees
            
            
            130,638
            
            
            95,160Other
            
            
            17,573
            
            
            340,530Total
            
            $
            542,043
            
            $
            988,233





The
      changes in these expenses from the three months ended June 30, 2008 as compared
      to the three months ended June 30, 2007 included the following:





·
            Salaries
                and related benefitsdecreased
                $162,496 or 37.14%primarily due to decrease bonuses paid to administrative personnel
                and
                decreased use of part time employees as we are in an effort of controlling
                corporate expenses. Additionally, starting in 2008, we no longer
                provided
                certain benefits such as insurance and car allowance and other fringe
                benefits that were provided to employees in the 2007. The related
                benefit
                costs for the three months ended June 30, 2008 reduced approximately
                $55,000 as compared to the same period in 2007.As a result, the salaries
                and related benefits costs decreased accordingly.




37




·
            Amortization
                of our intangible assets and depreciation on our fixed assetsincreased
                by $16,993orapproximately
                269.69%which is primarily attributable to additional fixed assets purchased
                and
                started depreciating. As such, there was an increase in depreciation
                for
                the three months ended June 30, 2008.·
            Rentincreased
                by $12,040 or approximately 18.18% primarily due to slight increase
                in
                rent rate and appreciation in RMB currency exchange
                rate.·
            Travel
                and entertainment expensesdecreased
                by $25,248 or 59.37%as
                a result of corporate spending control effort.·
            Professional
                feesincreased
                $35,478 or 37.28%due to increase in compensations paid to consultants.·
            Other
                selling, general and administrative expenses, which includes utilities,
                office supplies and training and other office expensesdecreased
                by $322,957 or approximately 94.84% as an effort of reducing non-sales
                related corporate training and other activities as well as stricter
                controls on corporate spending.





**Income
      from Operations**





We
      reported income from operations of $2,800,059 for the
      three months ended June 30, 2008 as compared to income from operations of
      $3,604,811 for the three months ended June 30, 2007, a decrease
      of $804,752 or approximately 22.32%.





**Other
      Expense**





For
      the
      three months ended June 30, 2008, total other expense amounted to $620,150 as
      compared to other expense of $563,286 for the three months ended June 30, 2007,
      an increase of $56,864
      or 10.10%. This
      change is primarily attributable to:


·
              For
                    the three months ended June 30, 2008, we recorded debt issuance
                    costs
                    related to amortization on debt issuance costs of$99,517compared to $58,680 for the three months ended June 30, 2007
                    due to our
                    recent funding during thethree
                    monthsof
                    2008.·
              For
                    the three months ended June 30, 2007, we recorded registration
                    rights
                    penalties of $56,000 related to the late filing of our registration
                    statement on Form SB-2 for which there wasno
                    comparableexpense in the 2008 period.·
              For
                    the three months ended June 30, 2008, interest expense was$522,660as
                    compared to $448,606 for the three months ended June 30, 2007,
                    an increase
                    of $74,054 primarily due to the 2007 warrant repricing expense.




**NET
      INCOME, OTHER COMPREHENSIVE INCOME AND COMPREHENSIVE
      INCOME**





As
      a
      result of these factors, we reported net income of $2,179,909 for the three
      months ended June 30, 2008 as compared to net income of $3,041,525 for the
      three
      months ended June 30, 2007. This translates to basic and diluted net income
      per
      common share of $0.05,
      $0.05 and $0.07,
      $0.07 for the three months ended June 30, 2008 and 2007,
      respectively.





During
      the three months ended June 30, 2008, we reported an unrealized gain on foreign
      currency translation of $1,587,538, an increase of
      $1,339,135 or approximately 539.10 % ,
      from
      the same period in 2007. These gains are non-cash items. As described elsewhere
      herein, our functional currency is the Chinese Renminbi; however the
      accompanying consolidated financial statements have been translated and
      presented in U.S. dollars using period-end rates of exchange for assets and
      liabilities, and average rates of exchange for the period for revenues, costs,
      and expenses. Net gains and losses resulting from foreign exchange transactions
      are included in the consolidated statements of operations and can have a
      significant effect on our financial statements. As a result of this non-cash
      gain, we reported comprehensive income of $3,767,447 for the
      three months ended June 30, 2008 as compared to $3,289,928 for the same period
      in 2007.




**Liquidity
      and Capital Resources**





Liquidity
      is the ability of a company to generate funds to support its current and future
      operations, satisfy its obligations and otherwise operate on an ongoing basis.





At
      June
      30, 2008, we had a cash balance of $3,401,444 .
      These
      funds are located in financial institutions located as follows:





China
            
            $
            3,285,478USA
            
            
            115,966Total
            
            $
            3,401,444




38




Our
      working capital position
      increased  $2,333,862
      to $26,985,999 at June
      30, 2008 from $24,652,137 at December 31, 2007. This increase in working capital
      is primarily attributable to an increase in accounts receivable net of allowance
      of approximately $355,804, and an
      increase of approximately
      $3,676,156 in inventories, a decrease in convertible debt of $2,561,645, in crease
      in
      accounts payable and accrued expenses of $263,508 offset
      by decrease in cash of approximately $1.2 million,
      a decrease in prepaid expense of $724,563, increase
      in unearned revenue of approximately $111,000 and
      increase in due to related parties of approximately $949,000 .





At
      June
      30, 2008, our inventories of raw materials, work in progress, packaging
      materials and finished goods totaled
      $7,086,895 ,
      an
      increase of approximately $3.7 million, or
      107.78%, from
      December 31, 2007. We expect to maintain higher inventory levels to accommodate
      for anticipated future sales growth, new products development and productions
      as
      well as a wider variety of products.




At
      June
      30, 2008, we maintain an allowance for doubtful accounts and sales return on
      accounts receivable balances of $568,847 as
      compared to $548,083 at December 31, 2007, an increase
      of $20,764  ($14,108
      reflects as a reduction to allowance for doubtful accounts and sales return
      and
      $34,872 as foreign currency translation adj ustment)
      and reflects our best estimate of probable losses. In determining the allowance
      for doubtful accounts, our management reviews our accounts receivable aging
      as
      well as the facts and circumstances of specific customers which may indicate
      the
      collection of specific amounts are at risk. As is customary in the PRC, we
      extend relatively long payment terms to our customers. Our terms of sale
      generally require payment within four months to a year, which is considerably
      longer than customary terms offered in the United States, however, we believe
      that our terms of sale are customary among our competitors for a company in
      our
      size within our industry. We also occasionally offer established customers
      longer payment terms on new products as an incentive to purchase these products,
      which has served to further increase the average days outstanding for accounts
      receivable. As the market for these new products is established, we will
      discontinue offering this sales incentive. Occasionally we will request a
      customer to prepay an order prior to shipment. At June 30, 2008, our balance
      sheet reflected advances from customers of $0,
      a
      decrease of $34,531, or 100%, from
      December 31, 2007.





At
      June
      30, 2008, we have a deposit on patent of $2,910,446 to acquire a new Chinese
      Class I anti-asthma
      medicine drug
      patent in accordance with a technoloy transfer agreement the Company entered
      into in April 2008. Additionally, in accordance with the agreement we entered
      into in June 2008, we also have a deposit on land use right of $6,033,353 for
      the
      amounts paid to a local government agency in Cha You to acquire a long-term
      interest to utilize certain land to construct a new manufacture facility. We
      did
      not have the two deposit amounts at December 31, 2007. We will need to make
      additional payments totaling approximately $73.7 million in the future.





At
      June
      30, 2008, we have a value-added and services taxes payable of $2,030,543 as
      compared to $572,200 at December 31, 2007. The amounts are related to accrued
      but unpaid value added and services taxes for the six months ended June 30,
      2008. The increase in the taxes payable is primarily due to increase in our
      revenues during the six months ended June 30, 2008 and the tax payment timing
      differences.





Our
      balance sheet at June 30, 2008, also reflects a balance due to related parties
      of $1,272,153 which was a working capital advances made to us by our president,
      vice-president and an officer of the Company and a Board member as well as
      an
      amount payable of approximately
      $654,850 related to an assignment agreement as discussed elsewhere in this
      report. These advances are non-interest bearing and are due on
      demand .
      We are
      currently repaying these balances as operating cash become
      available.





Our
      balance sheet at June 30, 2008 also reflects notes payable to related parties
      of
      approximately $5 million
      due on December 30, 2015 which is a working capital loan made to us by the
      Company’s Chief Executive Officer, two employees of the Company and a Board
      member. These loans bear a variable annual interest at 80% of current bank
      rate
      and are unsecured. During the three months ended June 30, 2008, we did not
      repay
      any portion of these loan balances.





The
      changes in asset and liabilities discussed above is based on a comparison of
      amounts on our balance sheets at June 30, 2008 and December 31, 2007 and does
      necessarily reflect changes in assets and liabilities reflected on our cash
      flow
      statement, which we use the average foreign exchange rate during the period
      to
      calculate these changes.





39




Net
      cash
      provided by operating activities for the six months ended June 30, 2008 was
      $4,742,275 as compared to net cash provided by operating activities of
      $4,942,964 for the six months ended June 30, 2007. For the six months ended
      June
      30, 2008, net cash provided by operating activities was attributable primarily
      to decrease in accounts receivable of $946,083, increase in inventories of $3,358,488 ,
      increase in value-added and service taxes payable of 1,381,155 offset by the
      net
      income of $3,176,008, the add back of depreciation and amortization of $307,713,
      amortization of debt discount of $ 208,355 ,
      amortization of debt issuance costs of $162,029, stock based compensation of
      $270,245 and the amortization of discount on convertible redeemable preferred
      stock of $338,838, and decrease in allowance for doubtful accounts and sales
      return of $14,101, a decrease in prepaid and other current assets of $986,132,
      and an increase in unearned revenue of $74,796. Net cash provided by operating
      activities for the six months ended June 30, 2007 was $4,942,964. For the six
      months ended June 30, 2007, net cash provided by operating activities was
      attributable primarily to our net income of $3,878,826, the add back of
      depreciation and amortization of $275,197, amortization of debt issuance costs
      of $88,020 and the amortization of debt discount of $433,735, a increase in
      accounts receivable of $524,467, an increase in accounts payable and accrued
      expenses of $78,398, an increase in value-added and service taxes payable of
      $921,996, and an increase in unearned revenues of $132,461 offset by an decrease
      in inventory balance of $1,201,912, an decrease in prepaid expenses and other
      current assets of $113,540, and a decrease in advances from customers of
      $145,138.





Net
      cash
      used in investing activities for the six months ended June 30, 2008 amounted
      to $8,907,855 .
      For the
      six months ended June 30, 2008, net cash used in investing activities was
      attributable to the deposit on patent right of $2,827,814, the deposit on land
      use right of $5,862,059 and the purchase of property and equipment of $217,982.
      Net cash provided by investing activities for the six months ended June 30,
      2007
      was $145,729 attributable to the purchase of property and equipment of $376,201
      offset by payment received on due from related parties of
      $521,930.





Net
      cash
      provided by financing activities was $2,786,003 for the
      six months ended June 30, 2008 and was attributable to the receipt of net
      proceeds of $5,000,000 from our
      private financing and proceeds from related party advances of $774,571 offset
      by payments on convertible debt of $2,520,000 and debt
      issuance costs of $ 468,568 .
      Net
      cash provided by financing activities was $1,155,257 for the six months ended
      June 30, 2007 and was primarily attributable to the receipt of net proceeds
      of
      $2,950,000 from our debt financing offset by payments on related party advances
      and loans of $1,566,083 and the payment of debt issuance costs of $231,526.





We
      reported a net decrease in cash for the six months ended June 30, 2008 of $1,156,513 as
      compared to a net increase in cash of $6,351,879 for the six months ended June
      30, 2007.




In
      2007,
      we lent approximately $2 million of the net proceeds received from the sale
      of
      $3 million principal amount convertible debt to Lotus East, which they used
      as
      working capital. These advances are unsecured and interest free. During the
      first quarter of 2008, we used a portion of the proceeds from the sale of equity
      to satisfy these notes, lent Lotus East an additional $1.6 million and retained
      the balance to fund our operating expenses. We have no operations other than
      the
      Contractual Arrangements with Lotus East and, accordingly, we are dependent
      upon
      the quarterly service fees due us to provide cash to pay our operating expenses.
      Such payments have not been tendered to us and those funds are being retained
      by
      Lotus East to fund their operations. At June 30, 2008, Lotus East owned us
      approximately $13.5million for such fees and we do not know when such funds
      will
      be paid to us. Our CEO is also the CEO and principal shareholder of Lotus East.
      Accordingly, we are solely reliant upon his judgment to ensure that the funds
      advanced to Lotus East are repaid to us. If these funds should not be repaid,
      or
      if Lotus East should continue to withhold payment of the quarterly service
      fee
      due us under the Contractual Arrangement, it is possible that we will not have
      sufficient funds to pay our operating expenses in future periods.




Other
      than our existing cash we presently have no other alternative source of working
      capital. We believe that our working capital may not be sufficient to fund
      our
      current operations for the next 12 months unless Lotus East pays us the amounts
      due to us. Lotus East has historically funded its capital expenditures from
      their working capital and has advised us that they believe this capital is
      sufficient for their current needs. Lotus
      East has contractual commitments for approximately $80.6 million related to
      a
      Technology Transfer Agreement and the construction of the new manufacturing
      facility. While it intends to fund the costs associated with the Technology
      Transfer Agreement and a portion of the construction of the new manufacturing
      facility with its existing working capital, it is dependent upon the continued
      growth of its operations and prompt payment of outstanding accounts receivables
      by its customers to ensure that it has sufficient cash for these commitments.
      In
      addition, its ability to fully fund the costs associated with the new
      manufacturing facility is materially dependent upon its ability to secured
      bank
      financing and/or government grants. As it has no firm commitments for either,
      while its management believes the company will be successful in securing the
      necessary funding based upon its preliminary discussions with various commercial
      banks, there are no assurances the funding will be available in the amounts
      or
      at the time required to meet Liang Fang's commitment.





However,
      the ability of Lotus East to raise any significant capital to expand their
      operations is very limited. We believe that it is in our best long term
      interests to assist Lotus East in their growth plans. Accordingly, it is likely
      that we will seek to raise working capital not only for our operating expense
      but to provide capital to Lotus East for these projects as well as providing
      working capital necessary for its ongoing operations and obligations. No
      assurances can be given that we will be successful in obtaining additional
      capital, or that such capital will be available in terms acceptable to our
      company. If we are unable to raise capital as necessary for our operations,
      and
      we were no longer able to timely file our reports with the Securities and
      Exchange Commission, our common stock would be removed from quotation on the
      OTC
      Bulletin Board. In this event, the ability of our stockholders to liquidate
      their investment in our company would be adversely impacted and it is possible
      that an event of default would occur under various agreements we are a party
      to
      with the purchases of our Series A Convertible Redeemable Preferred Stock and
      common stock purchase warrants.





40




**Contractual
      Obligations and Off-Balance Sheet Arrangements**




***Contractual
      Obligations***




We
      have
      certain fixed contractual obligations and commitments that include future
      estimated payments. Changes in our business needs, cancellation provisions,
      changing interest rates, and other factors may result in actual payments
      differing from the estimates. We cannot provide certainty regarding the timing
      and amounts of payments. We have presented below a summary of the most
      significant assumptions used in our determination of amounts presented in the
      tables, in order to assist in the review of this information within the context
      of our consolidated financial position, results of operations, and cash
      flows.




The
      following tables summarize our contractual obligations as of June 30, 2008,
      and
      the effect these obligations are expected to have on our liquidity and cash
      flows in future periods.




**Payments
                Due by
                Period****Total**
            
            **Less
                than**
              **1
                year**
            
            **1-3**
              **Years**
            
            **3-5**
              **Years**
            
            **5
                Years****+****In
                Thousands**Contractual
                Obligations:Related
                Parties Indebtedness
            
            
            5,829,320
            
            
            130,970
            
            $
            654,850
            
            
            
            
            $
            5,043,500Patent
                Purchase Obligations
            
            $
            6,985,069
            
            $
            2,619,401
            
            $
            4,365,668
            
            
            
            
            $
            -Construction
                Obligations
            
            $
            66,727,786
            
            $
            16,483,309
            
            $
            50,244,477
            
            $
            -
            
            $
            -Total
                Contractual Obligations:
            
            $
            79,542,175
            
            $
            19,233,680
            
            $
            55,264,995
            
            $
            0
            
            $
            5,043,500






***Off-balance
      Sheet Arrangements***





As
      of the
      date of this report, we do not have any off-balance sheet arrangements that
      have
      or are reasonably likely to have a current or future effect on our financial
      condition, changes in financial condition, revenues or expenses, results of
      operations, liquidity, capital expenditures or capital resources that are
      material to investors, however
      we have agreed to guarantee loans for Lotus East, if required. As of the date
      of
      this report, we have not entered into any guarantee arrangements with Lotus
      East .
      The
      term "off-balance sheet arrangement" generally means any transaction, agreement
      or other contractual arrangement to which an entity unconsolidated with us
      is a
      party, under which we have: (i) any obligation arising under a guarantee
      contract, derivative instrument or variable interest; or (ii) a retained or
      contingent interest in assets transferred to such entity or similar arrangement
      that serves as credit, liquidity or market risk support for such
      assets.




**Item
      3.**  **Quantitative
      and Qualitative Disclosures About Market Risk.**





Not
      applicable for a smaller reporting company.





**Item
      4T.**  **Controls
      and Procedures.**





*Evaluation
      of Disclosure Controls and Procedures* .
      We
      maintain "disclosure controls and procedures" as such term is defined in Rule
      13a-15(e) under the Securities Exchange Act of 1934. In designing and evaluating
      our disclosure controls and procedures, our management recognized that
      disclosure controls and procedures, no matter how well conceived and operated,
      can provide only reasonable, not absolute, assurance that the objectives of
      disclosure controls and procedures are met. Additionally, in designing
      disclosure controls and procedures, our management necessarily was required
      to
      apply its judgment in evaluating the cost-benefit relationship of possible
      disclosure controls and procedures. The design of any disclosure controls and
      procedures also is based in part upon certain assumptions about the likelihood
      of future events, and there can be no assurance that any design will succeed
      in
      achieving its stated goals under all potential future conditions. Our
      management, including our Chief Executive Officer and Chief Financial Officer,
      has evaluated the effectiveness of our disclosure controls and procedures as
      of
      the end of the period covered by this report. Based on such evaluation, our
      Chief Executive Officer and Chief Financial Officer have concluded that, as
      of
      the end of the period covered by this report, our disclosure controls and
      procedures were not effective:




·
              to
                  give reasonable assurance that the information required to be disclosed
                  by
                  us in reports that we file under the Securities Exchange Act of
                  1934 is
                  recorded, processed, summarized and reported within the time periods
                  specified in the Securities and Exchange Commission's rules and
                  forms, and





41




·
                to
                    ensure that information required to be disclosed in the reports
                    that we
                    file or submit under the Securities Exchange Act of 1934 is accumulated
                    and communicated to our management, including our CEO and our
                    CFO, to
                    allow timely decisions regarding required disclosure.




Our
      internal accounting staff was primarily engaged in ensuring compliance with
      PRC
      accounting and reporting requirements for our operating affiliates and their
      U.S. GAAP knowledge was limited. As a result, majority of our internal
      accounting staff, on a consolidated basis, is relatively inexperienced with
      U.S.
      GAAP and the related internal control procedures required of U.S. public
      companies. Although our accounting staff is professional and experienced in
      accounting requirements and procedures generally accepted in the PRC, management
      has determined that they require additional training and assistance in U.S.
      GAAP
      matters. Management has determined that our internal audit function is also
      significantly deficient due to insufficient qualified resources to perform
      internal audit functions. Finally, management determined that the lack of an
      Audit Committee of our Board of Directors also contributed to insufficient
      oversight of our accounting and audit functions.





In
      order
      to correct the foregoing weaknesses, we have taken the following remediation
      measures:




·
            In
                first quarter of 2008, under our CEO and CFO's supervision, we have
                started a new accounting system implementation project to improve
                our
                financial reporting process. We intend to rely on our CFO, a senior
                financial executive from the U.S. with extensive experience in internal
                control and U.S. GAAP, and together with our CEO to oversee and manage
                the
                financial reporting process. In connection with the new accounting
                system
                implementation, we also plan to increase training of our accounting
                staff
                both accounting system and U.S. GAAP related knowledge. The new accounting
                system implementation project is currently in progress.




·
            We
                have started searching for an independent director qualified to serve
                on
                an audit committee to be established by our Board of Directors and
                we
                anticipate that our Board of Directors will also establish a compensation
                committee to be headed by one of an independent
                director.





Due
      to
      our size and nature, segregation of all conflicting duties may not always be
      possible and may not be economically feasible. However, to the extent possible,
      we will implement procedures to assure that the initiation of transactions,
      the
      custody of assets and the recording of transactions will be performed by
      separate individuals.





We
      believe that the foregoing steps will remediate the material weaknesses
      identified above, and we will continue to monitor the effectiveness of these
      steps and make any changes that our management deems appropriate. Due to the
      nature of these material weaknesses in our internal control over financial
      reporting, there is more than a remote likelihood that misstatement which
      could be material to our annual or interim financial statements could occur
      that
      would not be prevented or detected.




A
      material weakness (within the meaning of PCAOB Auditing Standard No. 5) is
      a
      deficiency, or a combination of deficiencies, in internal control over financial
      reporting, such that there is a reasonable possibility that a material
      misstatement of our annual or interim financial statements will not be prevented
      or detected on a timely basis. A significant deficiency is a deficiency, or
      a


combination
      of deficiencies, in internal control over financial reporting that is less
      severe than a material weakness, yet important enough to merit attention by
      those responsible for oversight of the company's financial
      reporting.





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





*Changes
      in Internal Control over Financial Reporting.* There
      have been no changes in our internal control over financial reporting during
      our
      last fiscal quarter that has materially affected, or is reasonably likely to
      materially affect, our internal control over financial reporting. **





42




PART
      II -
      OTHER INFORMATION




Item
        1.
        Legal Proceedings




None.




Item
        1A.
Risk
        Factors.




Not
      applicable to smaller reporting company.




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





In
      June
      30, 2008, we issued 35,294 shares of restricted common stock to a consultant
      for
      technical services rendered to us. We valued these common shares at the fair
      market value on the date of the grant at $0.85 per share or $30,000 in total.
      We
      recorded stock-based compensation expenses of $30,000 for the three months
      ended
      June 30, 2008 accordingly. The securities were issued in a transaction exempt
      from registration under the Securities Act of 1933 in reliance on an exemption
      provide by Section 4(2) of that act. The recipient was a sophisticated investor
      who had such knowledge and experiences in business matters that he was capable
      of evaluating the merits and risks of the prospective investment in our
      securities. The recipient had access to business and financial information
      concerning our company.




Item
        3.
Defaults
        Upon Senior Securities




None.


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





None.




Item
        5.
Other
        Information




None.


Item
        6.
Exhibits





**No.**
            
            **Description**31.1
            
            Rule
                13a-14(a)/ 15d-14(a) Certificationof
                Chief Executive Officer31.2
            
            Rule
                13a-14(a)/ 15d-14(a) Certificationof
                Chief Financial Officer32.1
            
            Section
                1350 Certification of Chief Executive Officer32.2
            
            Section
                1350 Certification of Chief Financial
                Officer




43





SIGNATURES




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


Lotus
                Pharmaceuticals, Inc.Date:  August
                14, 2008
            By:
            /s/
                Liu Zhong YiLiu
                Zhong YiChief
                Executive Officer




Date:  August
                14, 2008
            By:
            /s/
                Adam WassermanAdam
                WassermanChief
                Financial Officer




44