UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  Form 10-QSB/A (Amendment No. 1)  (Mark One)  x
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarter ended September 30, 2007  o
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from ________ to __________  Commission File Number: 001-32581  LOTUS PHARMACEUTICALS, INC. (Exact name of small business issuer as specified in charter)  NEVADA
        20-0507918(State or other jurisdiction ofincorporation or organization)
        (I.R.S. Employer I.D. No.)
  Boca Corporate Plaza, 7900 Glades Road. Suite 420 Boca Raton, FL 33434 (Address of principal executive offices)  (877) 801-0344 (Issuers telephone number, including area code)  N/A (Former name or former address, if changed since last report)  Check whether the Issuer (1) has filed all reports required to be filed by section 13 or 15(d) of the Exchange Act during the past 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. YesxNoo  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YesoNox  State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: 41,564,200 shares at November 19, 2007  Transitional Small Business Disclosure Format (Check one): YesoNox    EXPLANATORY PARAGRAPH



This Amendment No. 1 to Form 10-QSB for the Quarter Ended September 30, 2007 is being filed by Lotus Pharmaceuticals, Inc. to supplement certain disclosure contained in Part I, Item 2. Managements Discussion and Analysis or Plan of Operation in response to comments from the staff of the Securities and Exchange Commission.



We are amending our Form 10-QSB for the period ended September 30, 2007 to restate our Consolidated Balance Sheet at September 30, 2007 and Consolidated Statements of Operations, Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements for the periods ended September 30, 2007, and to revise disclosure related to same which appeared in our Form 10-QSB as filed on November 19, 2007. On February 11, 2008 based upon comments from the Securities and Exchange Commission we determined to revise 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 4. In summary, our total assets increased by $1,137,332, total liabilities increased by $957,752, and net income increased by $133,768. Please see Note 9 - Restatement
contained in the Notes to Consolidated Financial Statements appearing later in this Form 10-QSB/A which further describes the effect of this restatement.



Additionally,  this Amendment No. 1 to Form 10-QSB for the Quarter Ended September 30, 2007 is being filed to supplement certain disclosure contained in Part I, Item 2. Managements Discussion and Analysis or Plan of Operation in response to comments from the staff of the Securities and Exchange Commission.



The Items of this Form 10-QSB/A for the period ended September 30, 2007 which areamended and restated as a result of the restatement of our financial statements are as follows:





        Part II, Item 6. Managements Discussion and Analysis or Plan of Operations,






        Part II. Item 7. Financial Information, including:






        Consolidated Balance Sheet at September 30, 2007,






        Consolidated Statements of Operations for the three and nine months ended September 30, 2007,






        Consolidated Statement of Cash Flows for the period ended September 30, 2007, and






        Notes to Consolidated Financial Statements as of September 30, 2007,




In addition, Part II, Item 6. Exhibits of this Form 10-QSB/A includes currently dated certificates from our Chief Executive Officer and Principal Accounting and Financial Officer in Exhibits 31.1, 31.2, 32.1 and 32.2.



The remaining Items contained in this Form 10-QSB/A consist of all other Items originally contained in our Form 10-QSB for the period ended September 30, 2007 as filed on November 19, 2007. This Form 10-QSB/A does not reflect events occurring after the filing of the original Form 10-QSB and supersedes in its entirety the previously filed Form 10-QSB for the quarter ended September 30, 2007.



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

FORM 10-QSB/A

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007



INDEX




PagePART I - FINANCIAL INFORMATIONItem 1. Consolidated Financial StatementsConsolidated Balance Sheet (Unaudited) As of September 30, 2007
        3Consolidated Statements of Operations (Unaudited)For the Three and Nine Months Ended September 30, 2007 and 2006
        4Consolidated Statements of Cash Flows (Unaudited)For the Nine Months Ended September 30, 2007 and 2006
        5Notes to Unaudited Consolidated Financial Statements
        6Item 2. Managements Discussion and Analysis or Plan of Operation
        21Item 3. Controls and Procedures
        32PART II - OTHER INFORMATIONItem 1. Legal Proceedings
        33Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
        33Item 3. Default Upon Senior Securities
        33Item 4. Submission of Matters to a Vote of Security Holders
        33Item 5. Other Information
        33Item 6. Exhibits
        33



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION



Certain statements in this quarterly 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 increase our revenues, develop our brands, implement our strategic initiatives, economic, political and market conditions and fluctuations, government and industry regulation, Chinese, U.S. 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 in our annual report as filed with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements and readers should carefully review this quarterly report in its entirety, 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 quarterly report, and you should not rely on these statements without also considering the risks and uncertainties associated with these statements and our business.



When used in this quarterly report, the terms the Company, we, and us refers to Lotus Pharmaceuticals, Inc., a Nevada corporation, and our wholly-owned subsidiary Lotus Pharmaceutical International, Inc., a Nevada Corporation and its controlled companies.



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

September 30, 2007

(Unaudited)

(As Restated - See Note 10)




ASSETSCURRENT ASSETS:Cash
        
        $
        6,194,302Accounts receivable, net of allowance for doubtful accounts of $1,182,208and sales returns of $32,932
        
        
        15,673,542Inventories, net of reserve for obsolete inventory of $284,088
        
        
        852,263Prepaid expenses
        
        
        50,798Deferred debt costs
        
        
        88,020Total Current Assets
        
        
        22,858,925PROPERTY AND EQUIPMENT - net of accumulated depreciation
        
        
        6,115,170OTHER ASSETSIntangible assets, net of accumulated amortization
        
        
        1,291,285Due from related party
        
        
        1,092,769Total Assets
        
        $
        31,358,149LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Convertible debt, net of debt discount of $625,065
        
        $
        2,374,935Accounts payable and accrued expenses
        
        
        624,562VAT and service taxes payable
        
        
        3,436,784Advances from customers
        
        
        68,426Unearned revenue
        
        
        567,132Due to related parties
        
        
        272,588Total Current Liabilities
        
        
        7,344,427LONG-TERM LIABILITIES:Due to related parties - long-term
        
        
        718,314Notes payable - related parties
        
        
        2,933,290Total Liabilities
        
        
        10,996,031SHAREHOLDERS EQUITY:Preferred stock ($.001 par value; 10,000,000 shares authorized;No shares issued and outstanding)
        
        
        Common stock ($.001 par value; 200,000,000 shares authorized;41,564,200 shares issued and outstanding)
        
        
        41,564Additional paid-in capital
        
        
        7,866,078Retained earnings
        
        
        11,400,456Other comprehensive gain - cumulative foreign currency translation adjustment
        
        
        1,054,020Total Shareholders Equity
        
        
        20,362,118Total Liabilities and Shareholders Equity
        
        $
        31,358,149



See notes to unaudited consolidated financial statements



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(As Restated - See Note 10)




For the Three Months Ended
September 30,
        
        For the Nine Months Ended
September 30,2007
        
        2006
        
        2007
        
        2006NET REVENUES:Wholesale
        
        $
        11,429,926
        
        $
        6,376,182
        
        $
        25,715,018
        
        $
        18,863,467Retail
        
        
        1,643,501
        
        
        1,734,260
        
        
        3,244,739
        
        
        3,011,110Other revenues
        
        
        3,480,922
        
        
        921,565
        
        
        8,689,579
        
        
        3,205,112Total Revenues
        
        
        16,554,349
        
        
        9,032,007
        
        
        37,649,336
        
        
        25,079,689COST OF SALES
        
        
        9,856,382
        
        
        6,955,650
        
        
        22,738,456
        
        
        17,482,064GROSS PROFIT
        
        
        6,697,967
        
        
        2,076,357
        
        
        14,910,880
        
        
        7,597,625OPERATING EXPENSES:Selling expenses
        
        
        1,596,656
        
        
        160,322
        
        
        2,864,746
        
        
        1,191,170Research and development
        
        
        1,255,844
        
        
        106,898
        
        
        1,549,132
        
        
        290,503General and administrative
        
        
        757,840
        
        
        269,116
        
        
        2,631,356
        
        
        1,506,512Total Operating Expenses
        
        
        3,610,340
        
        
        536,336
        
        
        7,045,234
        
        
        2,988,185INCOME FROM OPERATIONS
        
        
        3,087,627
        
        
        1,540,021
        
        
        7,865,646
        
        
        4,609,440OTHER INCOME (EXPENSE):Debt issuance costs
        
        
        (58,679
        )
        
        
        
        
        (146,699
        )
        
        Registration rights penalty
        
        
        
        
        
        
        
        
        (110,000
        )
        
        Interest income (expense), net
        
        
        (807,608
        )
        
        (103,458
        )
        
        (1,508,781
        )
        
        (308,711
        )Total Other Income (Expense)
        
        
        (866,287
        )
        
        (103,458
        )
        
        (1,765,480
        )
        
        (308,711
        )INCOME BEFORE INCOME TAXES
        
        
        2,221,340
        
        
        1,436,563
        
        
        6,100,166
        
        
        4,300,729INCOME TAXES
        
        
        
        
        
        
        
        
        
        
        
        NET INCOME
        
        $
        2,221,340
        
        $
        1,436,563
        
        $
        6,100,166
        
        $
        4,300,729COMPREHENSIVE INCOME:NET INCOME
        
        $
        2,221,340
        
        $
        1,436,563
        
        $
        6,100,166
        
        $
        4,300,729OTHER COMPREHENSIVE INCOME:Unrealized foreign currency translation gain
        
        
        180,895
        
        
        127,386
        
        
        552,815
        
        
        197,345COMPREHENSIVE INCOME
        
        $
        2,402,235
        
        $
        1,563,949
        
        $
        6,652,981
        
        $
        4,498,074NET INCOME PER COMMON SHARE:Basic
        
        $
        0.05
        
        $
        0.04
        
        $
        0.15
        
        $
        0.11Diluted
        
        $
        0.05
        
        $
        0.04
        
        $
        0.14
        
        $
        0.11WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:Basic
        
        
        41,356,483
        
        
        40,041,600
        
        
        41,317,461
        
        
        40,041,600Diluted
        
        
        44,356,483
        
        
        40,041,600
        
        
        44,317,461
        
        
        40,041,600



See notes to unaudited consolidated financial statements



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(As Restated - See Note 10)





For the Nine Months EndedSeptember 30,2007
        
        2006CASH FLOWS FROM OPERATING ACTIVITIES:Net income
        
        $
        6,100,166
        
        $
        4,300,729Adjustments to reconcile net income from operations to net cashprovided by operating activities:Depreciation and amortization
        
        
        422,055
        
        
        433,158Amortization of deferred debt issuance costs
        
        
        146,699
        
        
        Amortization of debt discount
        
        
        1,041,774
        
        
        Stock issued for compensation
        
        
        239,200
        
        
        Increase (Decrease) in allowance for doubtful accounts and sales returns
        
        
        (1,723,258
        )
        
        114,368Changes in assets and liabilities:Accounts receivable
        
        
        (6,327,758
        )
        
        (2,218,221
        )Inventories
        
        
        2,390,052
        
        
        (2,687,949
        )Prepaid and other current assets
        
        
        251,225
        
        
        171,041Accounts payable and accrued expenses
        
        
        (101,796
        )
        
        742,332Other payable
        
        
        
        
        
        (67,346
        )VAT and service taxes payable
        
        
        1,298,344
        
        
        24,155Unearned revenue
        
        
        122,924
        
        
        53,445Advances from customers
        
        
        (170,971
        )
        
        (37,171
        )NET CASH PROVIDED BY OPERATING ACTIVITIES
        
        
        3,688,656
        
        
        828,541CASH FLOWS FROM INVESTING ACTIVITIES:Decrease in due from related parties
        
        
        801,238
        
        
        754,746Purchase of property and equipment
        
        
        (384,198
        )
        
        NET CASH PROVIDED BY INVESTING ACTIVITIES
        
        
        417,040
        
        
        754,746CASH FLOWS FROM FINANCING ACTIVITIES:Net proceeds from convertible debt
        
        
        2,950,000
        
        
        Payment of debt issuance costs
        
        
        (231,526
        )
        
        Repayments of related party advances
        
        
        (863,480
        )
        
        (508,366
        )Repayments of notes payable - related parties
        
        
        (1,971,772
        )
        
        NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
        
        
        (116,778
        )
        
        (508,366
        )EFFECT OF EXCHANGE RATE ON CASH
        
        
        116,228
        
        
        16,895NET INCREASE IN CASH
        
        
        4,105,146
        
        
        1,091,816CASH - beginning of year
        
        
        2,089,156
        
        
        160,934CASH - end of period
        
        $
        6,194,302
        
        $
        1,252,750SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid for:Interest
        
        $
        1,582,393
        
        $
        308,710Income taxes
        
        $
        
        
        $
        



See notes to unaudited consolidated financial statements.



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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.



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 1 -ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (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 a 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 September 30, 2007, Liang Fang owns and operates 10 drug stores throughout Beijing, China. These drugstores sell Western and traditional Chinese medicines, and medical treatment accessories.



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.



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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



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.



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.



On May 29, 2007, the Company formed a new entity, Lotus Century Pharmaceutical (Beijing) Technology Co., Ltd. (Lotus Century) under laws of the Peoples Republic of China. Lotus Century is a Chinese limited liability company and a wholly-owned subsidiary of Lotus Pharmaceutical International, Inc. Lotus Century is primarily engaged in development of innovative medicines, medical technology consulting and outsourcing services, and related training services.



Basis of presentation



The 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.



The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The accompanying consolidated financial statements for the interim periods are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the periods presented. These consolidated financial statements should be read in conjunction with the financial statements for the year ended December 31, 2006 and notes thereto contained on Form 10-KSB of the Company as filed with the Securities and Exchange Commission. The results of operations for the nine months ended September 30, 2007 are not necessarily indicative of the results for the full fiscal year ending December 31, 2007.



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 2007 and 2006 include the allowance for doubtful accounts and sales returns, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, and accruals for taxes due.



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LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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



Fair value of financial instruments



The carrying amounts reported in the balance sheet for cash, accounts receivable, accounts payable and accrued expenses, customer advances, and amounts due from 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.



Accounts receivable



The Company has a policy of reserving for uncollectible accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. The Company periodically reviews its accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. At September 30, 2007, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amount of $1,182,208.



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. At September 30, 2007, inventory reserve was $284,088.



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.



Impairment 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 nine months ended September 30, 2007 and 2006.



- 9 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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



Advances from customers



Advances from customers at September 30, 2007 of $68,426 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.



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 Nine Months Ended September 30,2007
        
        2006Net income
        
        $
        6,100,166
        
        $
        4,300,729Weighted average shares outstanding  basic
        
        
        41,317,461
        
        
        40,041,600EPS  basic
        
        $
        0.15
        
        $
        0.11Net income
        
        $
        6,100,166
        
        $
        4,300,729Weighted average shares outstanding  basic
        
        
        41,317,461
        
        
        40,041,600Effect of dilutive securitiesUnexercised options and warrants
        
        
        
        
        
        Convertible debentures
        
        
        3,000,000
        
        
        Weighted average shares outstanding diluted
        
        
        44,317,461
        
        
        40,041,600EPS  diluted
        
        $
        0.14
        
        $
        0.11



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.



- 10 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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



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. Historically, approximately 65% of our total revenues consist of sales of four principal products and product returns from these principal products, as well as the
Companys other products, have been immaterial. Accordingly, based upon the Companys experience, it historically does not record a reserve at the time of sale and there have been no accounting entries related to its product return policy which have reduced its gross revenues or had any material impact on its financial statements. However, during the fourth quarter of fiscal 2006, the Company sold approximately $2,300,000 of products which were either less popular products or products that were nearing their expiration dates to existing customers at reduced prices in a one-time transaction. The customers had the right to return these products pursuant to our product return policy. Because of the one-time nature of the transaction and the age of the products sold, the Company did not believe that the customary assumptions which it utilizes when determining the amount of reserve to establish for product returns were appropriate as it was more than remotely possible that all or
substantially all of the products would be returned by the customer and the Company would not collect any revenues from this transaction. During the nine months ended September 30, 2007 the Company collected substantially all of the amounts billed to these customers for the product.



Accordingly, the Company reduced its allowance for sales returns as of September 30, 2007 by $2,200,000 recorded as a reserve at December 31, 2006. The collection of this receivable had the effect of increasing the Companys net revenues for the nine months ended September 30, 2007 by $2,200,000, even though the sales of these products were actually made during the fourth quarter of fiscal 2006. Because the Company recorded the costs associated with these products in its cost of sales during fiscal 2006, both the Companys gross profit margin and income from operations for the nine months ended September 30, 2007 increased by $2,200,000. The allowance for product returns at September 30, 2007 was $32,932 and related to this 2006 sale. This allowance has been netted with accounts receivable on the Companys balance sheet.



- 11 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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 we are 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 approximately $590,000 and $196,000 for the nine months ended September 30, 2007 and 2006, respectively.



Advertising



Advertising is expensed as incurred. Advertising expenses amounted to $964,448 and $71,664 for the nine months ended September 30, 2007 and 2006, 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. Research and development costs for the nine months ended September 30, 2007 and 2006 were approximately $1,549,132 and $290,503 respectively, and are included in operating expenses.



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. For the nine months ended September 30, 2007 and 2006, accumulated other comprehensive income was $550,175 and $ 197,345, respectively.



- 12 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



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



Recent Accounting Pronouncements



In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (FIN 48),Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109 (SFAS 109). The interpretation clarifies the accounting for uncertainty in income taxes recognized in an entitys financial statements in accordance with SFAS 109,Accounting for Income Taxes.It prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of this interpretation did not have an impact on the Companys
consolidated financial statements.



In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(SFAS 157), which provides guidance for how companies should measure fair value when required to use a fair value measurement for recognition or disclosure purposes under generally accepted accounting principle (GAAP). SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact, if any, the adoption of SFAS 157 will have on its financial statements.



In December 2006, FASB Staff Position No. EITF 00-19-2,Accounting for Registration Payment Arrangements,was issued. The FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with SFAS No. 5,Accounting for Contingencies.The Company believes that its current accounting is consistent with the FSP.



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 Company is currently assessing the impact, if any, the adoption of SFAS 159 will have on its financial statements.



Reclassifications



Certain prior period balances have been reclassified to conform to the current periods financial statement presentation. These reclassifications had no impact on previously reported financial position, results of operations or cash flows.



NOTE 2 -INVENTORIES



At September 30, 2007, inventories consisted of the following:




Raw materials
        $
        754,544Packing materials
        
        35,876Finished goods
        
        345,9311,136,351Less: Reserve for obsolete inventory
        
        (284,088
        )$
        852,263



-13-

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 3 -PROPERTY AND EQUIPMENT



At September 30, 2007, property and equipment consist of the following:




Useful LifeOffice equipment and furniture
        
        3  8 Years
        
        $
        150,307Manufacturing equipment
        
        10 - 15 Years
        
        
        4,896,369Building and building improvements
        
        20 - 40 Years
        
        
        2,859,4097,906,085Less: accumulated depreciation
        
        
        
        
        (1,790,915
        )$
        6,115,170



For the nine months ended September 30, 2007 and 2006, depreciation expense amounted to approximately $315,000 and $295,000, respectively.



NOTE 4 -RELATED PARTY TRANSACTIONS



Due from related parties



At September 30, 2007, the Company had a receivable from an affiliated entity owned by the Companys chief executive officer. During the nine months ended September 30, 2007, this related party repaid approximately $800,000 of these advances and is currently repaying this balance monthly at approximately $89,000 per month until paid in full. At September 30, 2007, the Company has a receivable from this related party amounting to $1,092,769. These advances are payable on demand and were personally guaranteed by the officer. The Company is aware that the receivable from this related party may be in violation of the Sarbanes-Oxley Act of 2002. Through monthly payments, the Company intends on rectifying this situation during fiscal 2007 and 2008.



Notes payable - related parties



Notes payable - related parties consisted of the following at September 30, 2007:




Note 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 (5.1% at September 30, 2007), and unsecured
        
        $
        694,660Note to Zheng Gui Xin, employee, due on December 30, 2015 with variable annual interest at 80% of current bank rate (5.1% at September 30, 2007), and unsecured
        
        
        1,503,804Note to Ma Zhao Zhao, employee, due on December 30, 2015 with variable annual interest at 80% of current bank rate (5.1% at September 30, 2007), and unsecured
        
        
        602,270Note to Liu Zhong Yi, officer and director, due on December 30, 2015 with variable annual interest at 80% of current bank rate (5.1% at September 30, 2007), and unsecured
        
        
        132,556Total notes payable - related parties, long term
        
        $
        2,933,290



For the nine months ended September 30, 2007 and 2006, interest expense related to these related loans amounted to approximately $154,547 and $308,000, respectively.



- 14 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 4 -RELATED PARTY TRANSACTIONS (continued)



Due to related parties



Prior to fiscal 2006, an employee of the Company, from time to time, provided advances to the Company for operating expenses. During the nine months ended September 30, 2007, the Company repaid approximately $119,000 of these advances. At September 30, 2007, the Company had a payable to this employee amounting to $33,150. These advances are short-term in nature and non-interest bearing.



Other



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 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 $1,151,000 to be paid in 5 equal annual installments of approximately $230,000. Accordingly, the Company recorded an intangible asset of approximately $1,150,000 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 nine months ended September 30, 2007, the Company paid approximately $178,000 of this related party liability. At September 30, 2007, amounts due under this assignment agreement amounted to $957,752 of which $718,314 is included in long-term liabilities and has been included in due to
related parties on the accompanying balance sheet.



NOTE 5 -CONVERTIBLE DEBT



On February 12, 2007, the Company entered into Subscription Agreements with certain accredited investors (the Purchasers). Pursuant to the Agreements, the Company issued to the Purchasers Secured Convertible Notes, (Notes), with an aggregate principal value of $3,000,000, plus interest on the unpaid principal balance at a rate equal to 14.0% per annum. The maturity date of the Notes is February 12, 2008. Interest on the Notes commences accruing on February 12, 2007 and is payable on April 30, 2007 and on the last business day of each calendar quarter thereafter. Interest is payable in cash, except that upon notice to the Purchasers in writing not less than 15 trading days prior to the relevant interest payment date, the Company may deliver common stock that were registered exclusively for the purpose of satisfying the payment of interest and not principal (Interest Shares)
valued at 75% of the average of the three lowest closing bid prices of the common stock as report by Bloomberg L.P. for the 20 trading days ending on the trading day preceding the relevant interest payment date. In the event of default under the terms of the Notes, at the option of the Purchaser, all sums of principal and interest remaining unpaid will become immediately due and payable. The notes are convertible into shares of common stock of the Company a rate equal to $1.00 per share, subject to adjustment. The transaction closed on February 12, 2007.



In connection with the debt issuance on February 12, 2007, $50,000 was deducted from the gross proceeds, which was deferred as a debt discount and will be amortized over the life of the convertible debentures. Other fees incurred in connection with the debt issuance include $234,719 of legal fees and other costs, which were treated as a deferred debt issue costs and are being amortized to debt issue cost expense over the life of the debenture.



- 15 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 5 -CONVERTIBLE DEBT (continued)



In accordance with Emerging Issues Task Force (EITF) 98-5 and EITF 00-27, the convertible notes were considered to have an embedded beneficial conversion feature (BCF) because the effective conversion price was less than the fair value of the Companys common stock. This convertible notes were fully convertible at the issuance date, therefore the portion of proceeds allocated to the convertible notes of $808,420 was determined to be the value of the beneficial conversion feature and was recorded as a debt discount and is being amortized over the 12-months note term.



The Purchasers also received Common Stock Purchase Warrants (the Warrants). Pursuant to the terms of the Warrants, the Purchasers are entitled to purchase up to 1,500,000 shares of common stock of the Company at an exercise price of $1.50 per share. The Warrants have a term of 5 years after the issue date of February 12, 2007. These warrants were treated as a discount on the secured notes and were valued at $808,419 to be amortized over the 12-month note term. The fair market value of each stock warrant was estimated on the date of grant using the Black-Scholes option-pricing model in accordance with SFAS No. 123R using the following weighted-average assumptions: expected dividend yield 0%; risk-free interest rate of 4.62%; volatility of 105% and an expected term of one year.



During the nine months ended September 30, 2007, amortization of debt issue costs was $146,699. The remaining balance of debt issue costs at September 30, 2007 was $88,020. The amortization of debt discounts for the nine months ended September 30, 2007 was $1,041,774, which has been included in interest expense on the accompanying statement of operations. The balance of the debt discount is $625,065 at September 30, 2007.



The Notes are secured by a Security Agreement, a Pledge Agreement, a Guaranty, and Share Pledge Agreements (collectively, the Security Agreements). In the event of a default, the Security Agreements grant to S. Michael Rudolph, as collateral agent for the Purchasers, a security interest in all right, title and interest of Debtors, as that term is defined therein, to and in respect of all Accounts, Goods, real or personal property, all present and future books and records relating to the foregoing and all products and Proceeds of the foregoing, as set forth therein, and all security interests, as set forth therein, of the Company, Lotus Pharmaceutical International, Inc. Beijing Liang Fang Pharmaceutical Co., Ltd. and Beijing En Zhe Jia Shi Pharmaceutical Co., Ltd. In addition, Liu Zhong Yi, the Companys president and chief executive officer, pledged his 18,782,400 shares
of the Companys common stock, Song Zhenghong, a director of the Company and spouse of Liu Zhong Yi, pledged her 6,708,000 shares of the Companys common stock, and the Company pledged its 38,800 shares of Lotuss common stock in the event of a default under the Notes. Events of default include, but are not limited to, (i) the Companys failure to pay any installment of principal, interest or other sum due under the Notes when due and such failure continues for a period of 5 business days after the due date, (ii) the commencement of a voluntary or involuntary liquidation, or other relief with respect to the Company or its debts under bankruptcy, insolvency or other similar law, that is not dismissed with 45 days of initiation (iii) final judgments for the payment in excess of $100,000 are rendered against the Company, and remain unpaid, unvacated, unbonded or unstayed for a period of 45 days (iv) or any breach or failure to comply in any respect with the terms of
the Notes or any agreements entered into in connection with the transactions contemplated by the Agreements.



The Company evaluated whether or not the secured convertible debentures 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 secured convertible debentures had a fixed conversion rate of $1.00, the secured convertible debt was not a derivative instrument.



The Company granted registration rights to holders of the Securities. Generally, the Company shall file with the Commission a Form SB-2 registration statement (the Registration Statement) (or such other form that it is eligible to use) in order to register the Registrable Securities for resale and distribution under the 1933 Act within forty-five (45) calendar days after the Closing Date (the Filing Date), and cause the Registration Statement to be declared



- 16 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 5 -CONVERTIBLE DEBT (continued)



effective not later than one hundred and fifty (150) calendar days after the Closing Date (the Effective Date). If the Registration Statement is not filed on or before the Filing Date or is not declared effective on or before the Effective Date, then the Company shall deliver to the holder of Registrable Securities, as Liquidating Damages, an amount equal to two percent (2%) for the first day of such Non-Registration Event and two percent (2%) for each thirty (30) days (or such lesser pro-rata amount for any period of less than thirty (30) days) of the Purchase Price of the outstanding Notes. The Company must pay the Liquidated Damages in cash. The Liquidated Damages must be paid within ten (10) days after the end of each thirty (30) day period or shorter part thereof for which Liquidated Damages are payable. The Company files its registration on April 25, 2007 and it was declared effective on May
4, 2007. For the nine months ended September 30, 2007, the Company recorded registration rights penalty expense of $110,000.



The financing was completed through a private placement to accredited investors and is exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (Securities Act).



The convertible debenture liability is as follows at September 30, 2007:




Convertible debentures payable
        
        $
        3,000,000Less: unamortized discount on debentures
        
        
        (625,065
        )Convertible debentures, net
        
        $
        2,374,935



NOTE 6 -SHAREHOLDERS EQUITY



In February 2007, the Companys Board of Directors and its consenting majority stockholders have adopted and approved an amendment to increase the number of the Companys authorized shares of capital stock from 50,000,000 to 210,000,000 total authorized shares of capital stock. The capital stock shall consist of 200,000,000 authorized shares of Common Stock, $0.001 par value per share, and 10,000,000 authorized shares of Preferred Stock, with a par value $0.001 per share.



In May 2007, the Company issued 74,200 shares of common stock to an officer and a director of the Company for services rendered. The shares were issued at the fair values at the date of the issuance of $74,200 or $1.00 per share.



In September 2007, the Company issued 210,000 shares of common stock to seven directors of the Company for services rendered. The shares were issued at the fair values at the date of the issuance of $210,000 or $1.00 per share.



For the nine months ended September 30, 2007, the Company recorded stock-based compensation of $239,200 and as of September 30, 2007 recorded a prepaid assets of $45,000 which will be amortized over the remaining service period.



NOTE 7 -SEGMENT INFORMATION



The following information is presented in accordance with SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. During the nine months ended September 30, 2007 and 2006, 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.



- 17 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 7 -SEGMENT INFORMATION (continued)



Information with respect to these reportable business segments for the nine months ended September 30, 2007 and 2006 is as follows:




Wholesale and
third-party
manufacturing
        
        Retail
Operations
        
        Unallocated
        
        Total2007Net revenues
        
        $
        32,769,631
        
        $
        4,316,890
        
        $
        562,815
        
        $
        37,649,336Cost of sales (excluding depreciation)
        
        
        20,826,503
        
        
        1,592,348
        
        
        22,441
        
        
        22,441,292Operating expenses (excluding depreciation and amortization)
        
        
        -
        
        
        -
        
        
        6,920,343
        
        
        6,920,343Depreciation and amortization
        
        
        282,306
        
        
        14,858
        
        
        124,891
        
        
        422,055Other expenses
        
        
        -
        
        
        -
        
        
        256,699
        
        
        256,699Interest expense
        
        
        -
        
        
        -
        
        
        1,508,781
        
        
        1,508,781Net income (loss)
        
        $
        11,660,822
        
        $
        2,709,684
        
        $
        (8,270,340
        )
        $
        6.100,1662006Net revenues
        
        $
        20,755,333
        
        $
        3,967,422
        
        $
        356,934
        
        $
        25,079,689Cost of sales (excluding depreciation)
        
        
        15,314,736
        
        
        2,182,082
        
        
        -
        
        
        17,496,818Operating expenses (excluding depreciation and amortization)
        
        
        -
        
        
        -
        
        
        2,540,274
        
        
        2,540,274Depreciation and amortization
        
        
        267,491
        
        
        8,258
        
        
        157,409
        
        
        433,158Other Income
        
        
        -
        
        
        -
        
        
        -
        
        
        -Interest expense
        
        
        -
        
        
        -
        
        
        308,711
        
        
        308,711Net income (loss)
        
        $
        5,173,106
        
        $
        1,777,082
        
        $
        (2,649,459
        )
        $
        4,300,729




Total assets be geographical location:China
        
        $        31,180,038USA
        
        178,111Total assets
        
        $        31,358,149



The Company does not allocate research and development, selling and general and administrative 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.



- 18 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 8 -SUBSEQUENT EVENT



In October and November 2007, the Company issued 130,000 shares of its common in connection with the conversion of $130,000 of convertible debt.



NOTE 9 -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 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 should this occur.



(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.



- 19 -

LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

SEPTEMBER 30, 2007



NOTE 10 - RESTATEMENT



For the nine months ending September 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 4. 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:



1. Balance Sheet:



a) Intangible assets increased by $1,137,332 to $1,291,285 from $153,953 and total assets increased by $1,137,332. This increase reflects the addition of an intangible asset of approximately $1,092,000 offset by an increase in accumulated amortization of approximately $44,500.



b) Due to related parties increased by $957,752 which increased total current liabilities by $239,438 and long-term liabilities by $718,314. This increase reflects the addition of a related party payable of approximately $1,137,000 offset by the repayment of this payable of approximately $178,000. Stockholders equity increased $179,580 which reflects the changes made to the balance sheet and statement of operations as well as an increase in comprehensive income of $2,640.



2. Statement of Operations:



a) For the nine months ended September 30, 2007, general and administrative expenses decreased by $133,768 which reflects an increase in depreciation and amortization expenses of $44,589 offset by a decrease in assignment fee expenses of $178,357 due to the reversal of the periodic assignment fee expense previously recorded.



3. Statement of Cash Flows:



a) For the nine months ended September 30, 2007, net cash flows provided by operating activities increased by $178,357 and net cash provided by financing activities decreased by $178,357.



- 20 -

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION



Overview



The following discussion of the financial condition and results of operation of Lotus Pharmaceuticals, Inc. (Lotus) should be read in conjunction with the financial statements and the notes to those statements included herein. This discussion includes forward-looking statements that involve risk and uncertainties. Actual results may differ materially from those anticipated in the forward-looking statements.



Lotus revenues and results of operations could differ materially from those projected in the forward-looking statements as a result of numerous factors, including, but not limited to, the following: the risk of significant natural disaster, the inability of Lotus to insure against certain risks, inflationary and deflationary conditions and cycles, currency exchange rates, changing government regulations domestically and internationally affecting the pharmaceutical industry, competition and pricing, changes in external competitive market factors, termination of certain agreements, protocol, or inability to enter into strategic agreements, inability to satisfy anticipated working capital or other cash shortage requirements, changes in or developments under domestic or foreign laws, regulations, or changes in Lotus business strategy or an inability to execute its strategy due to unanticipated changes
in the market. In light of these risks and uncertainties, there can be no assurance that actual results, performance or achievements of Lotus will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. For purposes of the following discussion and analysis, references to we, our, us refers to Lotus.



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



Additionally, on September 6, 2006, Lotus International entered into various agreements with Liang Fang Pharmaceuticals Co. Ltd. (Liang Fang) and Beijing En Zhe Jia Pharmaceutical Co., Ltd. (En Zhe Jia) (herein referred to as Lotus East) whereby the shareholders of Lotus East transferred all operating and voting control of Lotus East to Lotus International. As a result of these agreements, 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 our acquisition of Lotus International on September 28, 2006, and the financial statements of the consolidated companies from the acquisition date forward.



Liang Fang is a Chinese limited liability company and was formed under laws of the Peoples Republic of China on June 21, 2000 and 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.



Liang Fang owns and operates several drug stores throughout Beijing, China. These drugstores sell Western and traditional Chinese medicine, and medical treatment equipment.



- 21 -

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



On May 29, 2007, we formed a new entity, Lotus Century Pharmaceutical (Beijing) Technology Co., Ltd. (Lotus Century) under laws of the Peoples Republic of China. Lotus Century is a Chinese limited liability company and a wholly owned subsidiary of Lotus Pharmaceutical International, Inc. Lotus Century is primarily engaged in development of innovative medicines, medical technology consulting and outsourcing services, and related training services.



Current Business Operations



As discussed above, our operations are conducted through Liang Fang and its affiliated company, En Zhe Jia, both of which are limited liability companies headquartered in PRC and organized under the laws of PRC. Our business is composed of four parts: (1) Manufacturing and distribution of pharmaceutical products, including the manufacture of pharmaceutical products for other distributors (OEM manufacturing), (2) retailing of Western and traditional Chinese medications and accessories, (3) leasing retail space to licensed physicians and other parties and (4) research and development.



Results of Operations



Nine months Ended September 30, 2007 versus nine months Ended September 30, 2006



Total Revenues



Total revenues for the nine months ended September 30, 2007 were $37,649,336 as compared to total revenues of $25,079,689 for the nine months ended September 30, 2006, an increase of $12,569,649 or approximately 50.12%. For the nine months ended September 30, 2007 and 2006, net revenues consisted of the following:




2007
        
        2006Wholesale
        
        $
        25,715,018
        
        $
        18,863,467Retail
        
        
        3,244,739
        
        
        3,011,110Other revenues
        
        
        8,689,579
        
        
        3,205,112Total Revenues
        
        $
        37,649,336
        
        $
        25,079,689





        For the nine months ended September 30, 2007, wholesale revenues increased by $6,851,551 or 36.32%. The significant increase in tangible product revenues is mainly attributed to the reversal of a sales return allowance of approximately $2,200,000 recorded in 2006 as discussed below and increased sales of third party manufactured products and continued strong sales of our best selling product, VALSARTAN Capsules, a medicine for primary hypertension or high blood pressure.





        For the nine months ended September 30, 2007, retail revenues increased by $233,629 or 7.76%. The increase is primarily attributable to the Beijing government approving medicine expense reimbursements based on receipts from our retail pharmacy stores beginning in March 2006. Accordingly, customers who purchase medicines from our pharmacies can be reimbursed by the government. Additionally, several of our retail stores were newly renovated in 2007 and attracted more customers.



- 22 -


        For the nine months ended September 30, 2007, other revenues increased by $5,484,467. The significant increase in other revenues is attributed to the following:




2007
        
        2006Leasing revenues
        
        $
        619,541
        
        $
        507,339Third-party manufacturing
        
        
        7,054,613
        
        
        1,891,866Advertising revenues
        
        
        452,610
        
        
        448,973Research and lab testing services
        
        
        562,815
        
        
        356,934Total other revenues
        
        $
        8,689,579
        
        $
        3,205,112





        During 2006, we began performing third party contract manufacturing projects. In connection with third-party manufacturing, the customers supply the raw materials and we are paid a fee for manufacturing their product. During 2006 and in fiscal 2007, we have entered into manufacturing contracts with various parties to manufacture drugs. We expect third-party manufacturing revenues to increase during 2007 as we continue to manufacture for existing customers and obtain new customers.





        In 2006, we entered into an advertisement contract whereby we receive approximately $50,000 per month for the lease of counter and other space at our retail locations.





        In the 2007 and 2006 period, we performed research and development and lab testing projects for various third parties and performed drug testing and analysis.



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 nine months ended September 30, 2007, cost of sales amounted to $22,738,456 or approximately 60.40% of total revenues as compared to cost of sales of $17,482,064 or approximately 69.71% of total revenues for the nine months ended September 30, 2006. The decrease in cost of sales as a percentage of revenue is attributable to lower raw material costs as well as more efficient manufacturing production.



Gross Profit



Gross profit for the nine months ended September 30, 2007 was $14,910,880 or 39.60% of total revenues, as compared to $7,597,625 or 30.29% of revenues for the nine months ended September 30, 2006.



Operating Expenses



Total operating expenses for the nine months ended September 30, 2007 were $7,045,234, an increase of $4,057.049 or 135.8%, from total operating expenses in the nine months ended September 30, 2006 of $2,988,185. This increase included the following:



For the nine months ended September 30, 2007, selling expenses amounted to $2,864,746 as compared to $1,191,170 for the nine months ended September 30, 2006, an increase of $1,673,576 or 140.50%. This increase is primarily attributable to an increase in advertising costs, and an increase in other selling expenses. In July 2007, we signed an advertising campaign agreement with a Beijing based advertising firm. Commercials and ads are placed in various local TV stations, magazines and newspapers to promote our drugs and corporate image. We expect our selling expenses to increase as our revenues increase and expect to spend increased funds on advertising and promotion of our products as well as sales training. We also intend to continue expanding our marketing efforts related to our products.



- 23 -

For the nine months ended September 30, 2007, research and development costs amounted to $1,549,132 as compared to $290,503 for the nine months ended September 30, 2006, an increase of $1,258,629 or 433.26%. In fiscal 2006, we decreased our research and development activities to concentrate on the sale and marketing of developed products. We currently have 4 drugs in the pipeline that are in the process of waiting for government approval. In fiscal 2007, we resumed our research and development activities to begin the development of new pharmaceutical products. We recently contracted a third party to perform research and development work for three more new drugs. We expect the three new drugs research and development projects to be finalized in 2009.



For the nine months ended September 30, 2007, general and administrative expenses were $2,631,356 as compared to $1,506,512 for the nine months ended September 30, 2006, an increase of $1,124,844, or 74.67% as summarized below:




Nine months ended
September 30,2007
        
        2006Salaries and related benefits
        
        $
        1,311,215
        
        $
        565,432Amortization
        
        
        106,684
        
        
        137,734Professional fees
        
        
        167,766
        
        
        -Depreciation
        
        
        20,849
        
        
        15,947Rent
        
        
        227,997
        
        
        185,355Travel and entertainment
        
        
        273,074
        
        
        228,075Other
        
        
        523,771
        
        
        389,916Total
        
        $
        2,631,356
        
        $
        1,506,512



The changes in these expenses from the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 included the following:





        Salaries and related benefits increased $745,783, or 131.90% primarily due the increase in directors fee, executives compensations and increased pay rates and benefits for corporate employees. For the nine months ended September 30, 2007, we incurred directors fees of $182,500 and recorded compensation expense for our chief executive officer and chief financial officer of $183,150. We did not incur these fees in the prior year. The remaining increase is primarily attributable to increased pay rates and benefits for corporate employees.





        Amortization of our intangible assets decreased by $31,050 or approximately 22.5%. The decrease is attributable by the reduction of amortization expense from fully amortized manufacturing rights of $75,639 offset by an increase in the amortization of revenue rights of $44,589.





        Professional fees increased $167,766 or 100% due to an increase in accounting and legal fees activities related to being a public entity.





        Depreciation increased by $4,902 or approximately 30.74%.





        Rent increased by $42,642 or approximately 23.01%.





        Travel and entertainment expenses increased by $44,999 or 19.73% due to increased executive and corporate related travel and entertainment activities.





        Other selling, general and administrative expenses, which includes utilities, office supplies and expenses increased by $133,855 or 34.3 % due to increase in corporate office spending.



- 24 -

Income from Operations



We reported income from operations of $7,865,646 for the nine months ended September 30, 2007 as compared to income from operations of $4,609,440 for the nine months ended September 30, 2006, an increase of $3,256,206 or approximately 70.6%.



Other Income (Expense)



For the nine months ended September 30, 2007, total other expense amounted to $1,765,480 as compared to other expenses of $308,711 for the nine months ended September 30, 2006, an increase of $1,456,769. This change is primarily attributable to:





        For the nine months ended September 30, 2007, we recorded debt issuance costs of $146,699 compared to $0 for the nine months ended September 30, 2006 due to our recent funding.





        For the nine months ended September 30, 2007, we recorded registration rights penalties of $110,000 related to the late filing of our registration statement on Form SB-2.





        For the nine months ended September 30, 2007, net interest expense was $1,508,781 as compared to $308,711 for the nine months ended September 30, 2006, an increase of $1,200,070. This increase is attributable to the amortization of debt discount of approximately $1,042,000 and the interest payment of approximately $267,000 in connection with our debt funding. This increase was offset by a reduction of interest expense from our related party notes payable due to the repayment of this debt and interest income.



Net Income



As a result of these factors, we reported net income of $6.100,166 for the nine months ended September 30, 2007 as compared to net income of $4,300,729 for the nine months ended September 30, 2006. This translates to basic and diluted net income per common share of $0.15 and $0.14 for the nine months ended September 30, 2007 and $0.11 and 0.11 for the nine months ended September 30, 2006, respectively.



Other Comprehensive Income



As described elsewhere herein, the functional currency of Lotus East is the RMB. The financial statements are translated to 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 shown on the consolidated statements of operations. As a result of this non-cash gain, we reported comprehensive income of $552,815 for the nine months ended September 30, 2007 as compared to $197,345 for comparable period in fiscal 2006.



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 September 30, 2007, we had a cash balance of $6,194,302. These funds are located in financial institutions located as follows:




China
        
        $ 6,163,098USA
        
        31,204Total
        
        $ 6,194,302



- 25 -

Our working capital position increased $7,098,675 to $15,514,498 at September 30, 2007 from $8,415,823 at December 31, 2006. This increase in working capital is primarily attributable to an increase in cash of approximately $4.1 million and an increase in accounts receivable of approximately $6.3 million, a decrease of approximately $171,000 in advance from customers, and a decrease of approximately $102,000 in accounts payable and accrued expenses and offset by a decrease in prepaid expenses and other current assets of approximately $251,000, an decrease in inventories of approximately $2.4 million, an increase in taxes payable of approximately $1.3 million, and an increase in unearned revenue of approximately $123,000 and an increase in net convertible debt of approximately $2.4 million. The increase in accounts receivable and corresponding decrease inventories reflects the effects of increased sales during
fiscal 2007 and the corresponding receivables generated by those sales.



At September 30, 2007, our inventories of raw materials and finished goods totaled $1,136,351 and the reserve for obsolete inventory amounted to $284,088. We had a net decrease in inventories of approximately $2,390,000 from December 31, 2006. We expect to continue to improve our inventory production forecast and gradually reduce the inventory levels to improve our inventory turnover rate.



At September 30, 2007, we maintain an allowance for doubtful accounts on accounts receivable balances of $1,182,208 as compared to $539,627 at December 31, 2006, an increase of $642,571 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 amongst our competitors for a company 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 September 30, 2007 our balance sheet reflected advances from customers of $68,426, a decrease of $162,914, or approximately 70.42%, from December 31, 2006.



Our balance sheet at September 30, 2007 also reflects a balance due to related parties of $33,150 which were derived from prior year working capital advances made to us by our President and Vice President of the Company as well as an amount payable of approximately $957,700 related to an assignment agreement as discussed elsewhere in this quarterly 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 September 30, 2007 also reflects notes payable to related parties of approximately $2.9 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 nine months ended September 30, 2007, we repaid approximately $2 million of these loan balances.



Net cash provided by operating activities for the nine months ended September 30, 2007 was $3,688,656 as compared to $828,541 for the nine months ended September 30, 2006. For the nine months ended September 30, 2007, net cash provided by operating activities was attributable primarily to our net income of $6,100,166, the add back of depreciation and amortization of $422,055, amortization of debt issuance costs of $146,699, the amortization of debt discount of $1,041,774, stock compensation of $239,200, and subtract decrease in allowance for doubtful accounts and sales return of $1,723,258. Net cash provided by operating activities was also attributable to a decrease in inventory balance of $2,390,052, decrease in prepaid and other current assets of 251,225, and increase in VAT, an increase in accounts receivable of $6,327,758 and a decrease in advances from customers of $170,971. For the nine months ended
September 30, 2006, net cash provided by operating activities was attributable primarily to increases in our accounts receivable and inventory balances of $2,218,221 and 2,687,949, respectively, offset by net income of $4,300,729, depreciation and amortization of $433,158, an increase in allowance for doubtful accounts of $114,368 and changes in other asset and liability accounts of $886,456.



- 26 -

Net cash used in investing activities for the nine months ended September 30, 2007 was $417,040 attributable to payment received on due from related parties of $801,238 and offset by the purchase of property and equipment of $384,198. Net cash provided by investing activities for the nine months ended September 30, 2006 amounted to $754,746 and consisted of payments received from related party advances due.



Net cash used in financing activities was $116,778 for the nine months ended September 30, 2007 and was 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 $1,971,772, payments on related party advances of $863,480 and the payment of debt issuance costs of $231,526 as compared to net cash used in financing activities of $508,366 for the nine months ended September 30, 2006 and reflects repayments of related party advances.



We reported a net increase in cash for the nine months ended September 30, 2007 of $4,105,146 as compared to a net increase in cash of $1,091,816 for the nine months ended September 30, 2006.



We currently have no material commitments for capital expenditures. Other than working capital and loans from related parties, and from our recent capital raising transaction as discussed below, we presently have no other alternative source of working capital. We may not have sufficient working capital to fund the expansion of our production line, an upgrade of our manufacturing facilities and technologies, expand our retail operations, and fund research and development projects as well as providing working capital necessary for our ongoing operations and obligations. As of the date of this report, we have no plans to upgrade our manufacturing facilities. We plan on expanding our retail operations by adding 5 retail locations during the fourth quarter of 2007 which we anticipate will cost approximately $1,000,000. Additionally, in February 2008, we are required to repay convertible debt of $2,870,000 if the
investor decides not to convert this debt to common stock under the terms of the agreement. In connection with an assignment agreement, we agreed to pay Mr. Liu an aggregate of approximately $1,150,000 to be paid in 5 equal annual installments of approximately $230,000 of which approximately $179,000 has been paid. Also, at September 30, 2007, we reflect a liability of approximately $3,437,000 for unpaid VAT and service taxes.



We intend to pay for our current retail expansion and debt obligation from working capital. However, we may need to raise additional working capital to fund these projects, repay our debt obligations and to seek acquisitions. We are seeking to raise additional capital through the sale of equity securities. 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.



Certain Effects of Potential Product Returns  on our Financial Statements



As described elsewhere herein, our return policy typically allows product returns for products within a 12 month window from six months prior to the expiration date and up to six months after the expiration date of a product. Under generally accepted accounting principles we are required to estimate the level of sales which will ultimately be returned pursuant to our return policy, and record a related reserve at the time of sale which is reflected on our balance sheet as a deduction from accounts receivable. The amount of these reserves are deducted from our gross sales to determine our net revenues for the period. The amount of actual product returns could be either higher or lower than the amounts we accrued and any changes in our estimates are recorded in the income statement, as either an increase or decrease in our gross sales to determine our net revenues for the period, in the period of the change. If
we over or under estimate the quantity of product which will ultimately be returned, there may be a material impact to our financial statements.



Historically, approximately 65% of our total revenues consist of sales of four principal products and product returns from these principal products, as well as our other products, have been immaterial. Accordingly, based upon our experience we historically do not record a reserve at the time of sale and there have been no accounting entries related to our product return policy which have reduced our gross revenues or had any material impact on our financial statements



- 27 -

During the fourth quarter of fiscal 2006, however, we sold approximately $2,300,000 of products which were either less popular products or products that were nearing their expiration dates to existing customers at reduced prices in a one-time transaction. The customers had the right to return these products pursuant to our product return policy. Because of the one-time nature of the transaction and the age of the products sold, we did not believe that the customary assumptions which we utilize when determining the amount of reserve to establish for product returns were appropriate as it was more than remotely possible that all or substantially all of the products would be returned by the customer and we would not collect any revenues from this transaction. Accordingly, we believed that it was prudent to fully reserve the amount of the sales and at December 31, 2006 we increased our allowance for sales returns
by $2,300,000 which equaled 100% of the amount of revenues recorded in the transaction. This accounting treatment had the effect of reducing our net revenues by $2,300,000 during the fourth quarter of fiscal 2006. However, we recorded cost of sales related to this product of approximately $2,200,000 during the year fiscal 2006, which had the effect of increasing our cost of sales during the year by that amount, and correspondingly reducing our gross profit and income from operations. Based on managements estimate, during 2006 we wrote off inventory that we deemed obsolete.



During the nine months ended September 30, 2007 we collected substantially all of the amounts billed to these customers for the product. Accordingly, we reduced our allowance for sales returns at September 30, 2007 by approximately $2,200,000 recorded as a reserve at December 31, 2006. The collection of this receivable had the effect of increasing our net revenues for the nine month period by $2,200,000, even through the sales of these products were actually made during the fourth quarter of fiscal 2006. Because we recorded the costs associated with these products in our cost of sales during fiscal 2006, both our gross profit margin and income from operations for the nine months ended September 30, 2007 increased by $2,200,000.



Recent Capital Raising Transactions



On February 12, 2007, we entered into Subscription Agreements with two accredited investors (the Purchasers). Pursuant to the Agreements, we issued to the Purchasers Secured Convertible Notes, (Notes), with an aggregate principle value of $3,000,000, plus interest on the unpaid principal balance at a rate equal to 14.0% per annum. The maturity date of the Notes is February 12, 2008. Interest on the Notes commences accruing on February 12, 2007 and is payable on April 30, 2007 and on the last business day of each calendar quarter thereafter. Interest is payable in cash, except that upon notice to the Purchasers in writing not less than 15 trading days prior to the relevant interest payment date, we may deliver common stock that were registered exclusively for the purpose of satisfying the payment of interest and not principal (Interest Shares) valued at 75% of the average of
the three lowest closing bid prices of the common stock as report by Bloomberg L.P. for the 20 trading days ending on the trading day preceding the relevant interest payment date. In the event of default under the terms of the Notes, at the option of the Purchaser, all sums of principal and interest remaining unpaid will become immediately due and payable. The notes are convertible into shares of common stock of the Company a rate equal to $1.00 per share, subject to adjustment. The transaction closed on February 12, 2007.



The Purchasers also received Common Stock Purchase Warrants (the Warrants). Pursuant to the terms of the Warrants, the Purchasers are entitled to purchase up to 1,500,000 shares of our common stock at an exercise price of $1.50 per share. The Warrants have a term of 5 years after the issue date of February 12, 2007.



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. 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.



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 its return estimates.



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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 sheet. 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.



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. At September 30, 2007,
accounts receivable, net of allowance for doubtful accounts and sales returns, amounted to $15,673,542.



Inventories



Inventory is 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, 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.



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
        3 to 8 years



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Income Taxes



Taxes are calculated in accordance with taxation principles currently effective in the United States and PRC. The Company accounts 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 July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (FIN 48),Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109 (SFAS 109). The interpretation clarifies the accounting for uncertainty in income taxes recognized in an entitys financial statements in accordance with SFAS 109,Accounting for Income Taxes.It prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact, if any, of FIN 48 on our financial statements.



In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(SFAS 157), which provides guidance for how companies should measure fair value when required to use a fair value measurement for recognition or disclosure purposes under generally accepted accounting principle (GAAP). SFAS 157 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the impact, if any, the adoption of SFAS 157 will have on our financial statements.



In December 2006, FASB Staff Position No. EITF 00-19-2,Accounting for Registration Payment Arrangements,was issued. The FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with SFAS No. 5,Accounting for Contingencies.We believe that our current accounting is consistent with the FSP. Accordingly, adoption of the FSP had no effect on our financial statements.



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. We are currently assessing the impact, if any, the adoption of SFAS 159 will have on our financial statements.



Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.



Off Balance Sheet Arrangements



As of the date of this Registration Statement, 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. 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.



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ITEM 3. CONTROLS AND PROCEDURES



As required by Rule 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as of September 30, 2007, the end of the period covered by this quarterly report, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, concluded its evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this quarterly report, is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and to reasonably assure that such information is accumulated and communicated to our management, including our Chief Executive Officer, to allow timely decisions regarding required
disclosure. Based on that evaluation, the Companys Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this Quarterly Report on Form 10-QSB.



Our management, including our Chief Executive Officer, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls 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.



In connection with the preparation of our quarterly report on Form 10-QSB for the period ended September 30, 2007, our management identified material weaknesses in the Companys internal controls over financial reporting. As defined by the Public Accounting Oversight Board (the PCAOB) in Auditing Standard No. 2., a material weakness is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the interim financial statements will not be prevented or detected.



The identified material weaknesses in the Companys internal controls over financial reporting have resulted in insufficient controls related to inventory accounting, accounts receivable and payable cut-offs, accrued expenses and segregation of duties.



On September 28, 2006, in connection with the completion of the Lotus International acquisition, we hired our Chief Financial Officer. Our CFO is becoming more familiar with the Company, its finances and accounting needs. Additionally, the Companys CEO is becoming more familiar with SEC disclosure requirements and procedures. The Companys management believes that substantial remediation measures are required in order to improve the



Companys internal controls. We are currently researching accounting software packages and plan on implementing accounting software in September 2007. We believe that the material weaknesses identified above resulted in part from inadequate staffing and training within the Companys finance and accounting group. We are continuing to train existing staff. We believe that we will face challenges in integrating procedures and operations and integration activities may affect our internal control over financial reporting. We intend on continuing to work to improve our internal controls.



There have been no changes in our internal control over financial reporting identified in connection with the evaluation that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II  OTHER INFORMATION




Item 1.
        Legal Proceedings



None.




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



In September 2007, the Company issued 210,000 shares of common stock to seven directors of the Company for services rendered. The shares were issued at the fair values at the date of the issuance of $210,000 or $1.00 per share.



The above recipients were sophisticated investors who had such knowledge and experience in financial, investment and business matters that they were capable of evaluating the merits and risks of the prospective investment in our securities. The recipients had access to business and financial information concerning our company. The issuance was exempt from registration under the Securities Act in reliance on an exemption provided by Section 4(2) of that act.




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.




31.1
        Rule 13a-14(a)/15d-14(a) certification of Chief Executive Officer




31.2
        Rule 13a-14(a)/15d-14(a) certification of Principal Financial Officer




32.1
        Section 1350 certification of Chief Executive Officer




32.2
        Section 1350 certification of Principal Accounting Officer



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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: February 21, 2008
        By:/s/ Liu Zhong YiLiu Zhong YiChief Executive Officer, Principal Executive Officer




Date: February 21, 2008
        By:/s/ Adam WassermanAdam WassermanChief Financial Officer, Principal Financial andAccounting officer



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