UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-Q





x
            QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended July 31, 2010o
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the transition period from             
                         
                         
               
to





Commission
File Number: 001-34808





RENHUANG
PHARMACEUTICALS, INC.


(Exact
name of registrant as specified in its charter)





Nevada
            84-1273503(State
      or other jurisdiction of
            (I.R.S.
      Employerincorporation
      or organization)
            Identification
      No.)The
      11th Floor, Changjiang International Building, No. 28, Changjiang Road,
      Nangang District, Harbin, Heilongjiang Province, P.R. China
      150090
              (Address
      of principal executive offices)





86-451-8260-2162


(Registrant’s
Telephone Number, Including Area Code)





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


x Yes   o No





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


o Yes 
 o No




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




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




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


o Yes   x No





As
of September 2, 2010, there were 37,239,536 shares of the registrant’s $0.001
par value common stock issued and outstanding.





TABLE
OF CONTENTS





PART
      IItem
      1.
                  Financial
      Statements
                  1Condensed
      Consolidated Balance Sheets as of July 31, 2010 (unaudited) and October
      31, 2009 (audited)
                  1Condensed Consolidated Statements
      of Operations and Comprehensive Income for the Three and Nine Months Ended July 31, 2010 and
      2009 (unaudited)
                  2Condensed
      Consolidated Statements of Cash Flows for the Nine Months Ended July 31,
      2010 and 2009 (unaudited)
                  3Notes
      to the Condensed Consolidated Financial Statements
    (unaudited)
                  4Item
      2.
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  27Item
      3.
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  35Item
      4.
                  Controls
      and Procedures
                  35PART
      IIItem
      1.
                  Legal
      Proceedings
                  36Item
      1A.
                  Risk
      Factors
                  36Item
      2.
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  36Item
      3.
                  Defaults
      Upon Senior Securities
                  36Item
      4.
                  [REMOVED
      AND RESERVED]
                  36Item
      5.
                  Other
      Information
                  36Item
      6.
                  Exhibits
                  37Signature
      Page
                  38




ii




In
this Quarterly Report on Form 10-Q, references to “dollars” and “$” are to
United States dollars and, unless the context otherwise requires, references to
“we,” “us” and “our” refer to Renhuang Pharmaceuticals, Inc. and its
consolidated subsidiaries.





This
Quarterly Report contains certain forward-looking statements. When used in this
Quarterly Report, statements which are not historical in nature, including the
words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend,” “may,”
“project,” “plan” or “continue,” and similar expressions are intended to
identify forward-looking statements. They also include statements containing
anticipated business developments, a projection of revenues, earnings or losses,
capital expenditures, dividends, capital structure or other financial
terms.




The
forward-looking statements in this Quarterly Report are based upon management’s
beliefs, assumptions and expectations of our future operations and economic
performance, taking into account the information currently available to them.
These statements are not statements of historical fact. Forward-looking
statements involve risks and uncertainties, some of which are not currently
known to us that may cause our actual results, performance or financial
condition to be materially different from the expectations of future results,
performance or financial condition we express or imply in any forward-looking
statements. These forward-looking statements are based on our current plans
and expectations and are subject to a number of uncertainties and risks that
could significantly affect current plans and expectations and our future
financial condition and results.




We
undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this filing might not occur. We qualify any and all
of our forward-looking statements entirely by these cautionary factors. As
a consequence, current plans, anticipated actions and future financial
conditions and results may differ from those expressed in any forward-looking
statements made by or on our behalf. You are cautioned not to unduly rely on
such forward-looking statements when evaluating the information presented
herein.




iii


PART I





Item 1.  Financial
Statements.




RENHUANG
PHARMACEUTICALS, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS




Note
                                                
                                                July 31,
                                                  2010
                                                
                                                
                                                October 31,
                                                  2009US$
                                                
                                                
                                                US$(Unaudited)
                                                
                                                
                                                (Audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                
                                                
                                                
                                                28,749,480
                                                
                                                
                                                
                                                8,111,514Trade
      receivables, net
                                                7
                                                
                                                
                                                10,817,824
                                                
                                                
                                                
                                                23,203,410Due
      from related parties
                                                11
                                                
                                                
                                                -
                                                
                                                
                                                
                                                130,199Inventory,
      net
                                                9
                                                
                                                
                                                3,573,349
                                                
                                                
                                                
                                                3,024,016Deposits
                                                11
                                                
                                                
                                                1,473,796
                                                
                                                
                                                
                                                -Prepayments
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                89,281Other
      receivables, net
                                                8
                                                
                                                
                                                144,011
                                                
                                                
                                                
                                                102,613Total
      current assets
                                                
                                                
                                                
                                                44,758,460
                                                
                                                
                                                
                                                34,661,033Property
      and equipment, net
                                                10
                                                
                                                
                                                2,090,592
                                                
                                                
                                                
                                                2,352,163Deposits
                                                11
                                                
                                                
                                                18,695,870
                                                
                                                
                                                
                                                16,137,000Total
      assets
                                                
                                                
                                                
                                                65,544,922
                                                
                                                
                                                
                                                53,150,196LIABILITIES
      AND SHAREHOLDERS’ EQUITYLiabilitiesCurrent
      liabilities:Accounts
      payable
                                                
                                                
                                                
                                                256,993
                                                
                                                
                                                
                                                369,329Value
      added tax payable
                                                
                                                
                                                
                                                471,282
                                                
                                                
                                                
                                                1,186,642Accrued
      employee benefits
                                                
                                                
                                                
                                                1,422,006
                                                
                                                
                                                
                                                1,136,267Warrant
      liability
                                                
                                                
                                                
                                                342,770
                                                
                                                
                                                
                                                -Total
      current liabilities
                                                
                                                
                                                
                                                2,493,051
                                                
                                                
                                                
                                                2,692,238Commitments
      and Contingencies
                                                17Shareholders’
      equityPreferred
      stock (no par value, 1,000,000 shares authorized; none issued and
      outstanding as of July 31, 2010 and October 31, 2009)
                                                14
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Common
      stock ($0.001 par value, 100,000,000 sharesauthorized;
      37,239,536 issued andoutstanding
      as of July 31, 2010 and October 31, 2009)
                                                14
                                                
                                                
                                                37,240
                                                
                                                
                                                
                                                37,240Additional
      paid-in capital
                                                
                                                
                                                
                                                7,651,460
                                                
                                                
                                                
                                                7,596,525Common
      stock warrants
                                                15
                                                
                                                
                                                496,732
                                                
                                                
                                                
                                                496,732Reserves
                                                16
                                                
                                                
                                                3,372,697
                                                
                                                
                                                
                                                3,372,697Accumulated
      other comprehensive income
                                                
                                                
                                                
                                                3,669,590
                                                
                                                
                                                
                                                3,367,659Retained
      earnings
                                                
                                                
                                                
                                                47,824,152
                                                
                                                
                                                
                                                35,587,105Total
      shareholders’ equity
                                                
                                                
                                                
                                                63,051,871
                                                
                                                
                                                
                                                50,457,958Total
      liabilities and shareholders’ equity
                                                
                                                
                                                
                                                65,544,922
                                                
                                                
                                                
                                                53,150,196





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




1




RENHUANG
PHARMACEUTICALS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME




Three months ended
                                                                July 31,
                                                              
                                                              
                                                              Nine months ended
                                                                July 31,Note
                                                              
                                                              2010
                                                              
                                                              
                                                              2009
                                                              
                                                              
                                                              2010
                                                              
                                                              
                                                              2009US$
                                                              
                                                              
                                                              US$
                                                              
                                                              
                                                              US$
                                                              
                                                              
                                                              US$(Unaudited)
                                                              
                                                              
                                                              (Unaudited)
                                                              
                                                              
                                                              (Unaudited)
                                                              
                                                              
                                                              (Unaudited)Sales,
      net
                                                              
                                                              
                                                              
                                                              9,263,892
                                                              
                                                              
                                                              
                                                              6,442,197
                                                              
                                                              
                                                              
                                                              38,489,012
                                                              
                                                              
                                                              
                                                              28,915,072Cost
      of goods sold
                                                              
                                                              
                                                              
                                                              (4,620,568
                                                              )
                                                              
                                                              
                                                              (2,942,649
                                                              )
                                                              
                                                              
                                                              (18,151,062
                                                              )
                                                              
                                                              
                                                              (13,825,692
                                                              )Gross
      profit
                                                              
                                                              
                                                              
                                                              4,643,324
                                                              
                                                              
                                                              
                                                              3,499,548
                                                              
                                                              
                                                              
                                                              20,337,950
                                                              
                                                              
                                                              
                                                              15,089,380Operating
      and administrative expenses:Sales
      and marketing
                                                              
                                                              
                                                              
                                                              1,284,990
                                                              
                                                              
                                                              
                                                              1,109,540
                                                              
                                                              
                                                              
                                                              3,689,290
                                                              
                                                              
                                                              
                                                              2,534,865General
      and administrative
                                                              
                                                              
                                                              
                                                              395,131
                                                              
                                                              
                                                              
                                                              499,949
                                                              
                                                              
                                                              
                                                              2,208,965
                                                              
                                                              
                                                              
                                                              1,712,342Research
      and development
                                                              
                                                              
                                                              
                                                              1,528,933
                                                              
                                                              
                                                              
                                                              1,227,411
                                                              
                                                              
                                                              
                                                              2,251,854
                                                              
                                                              
                                                              
                                                              1,833,391Total
      operating expenses
                                                              
                                                              
                                                              
                                                              3,209,054
                                                              
                                                              
                                                              
                                                              2,836,900
                                                              
                                                              
                                                              
                                                              8,150,109
                                                              
                                                              
                                                              
                                                              6,080,598Income
      from operations
                                                              
                                                              
                                                              
                                                              1,434,270
                                                              
                                                              
                                                              
                                                              662,648
                                                              
                                                              
                                                              
                                                              12,187,841
                                                              
                                                              
                                                              
                                                              9,008,782Other
      income:Interest
      income
                                                              
                                                              
                                                              
                                                              22,039
                                                              
                                                              
                                                              
                                                              12,054
                                                              
                                                              
                                                              
                                                              49,206
                                                              
                                                              
                                                              
                                                              31,204Income
      from operations before income tax expenses
                                                              
                                                              
                                                              
                                                              1,456,309
                                                              
                                                              
                                                              
                                                              674,702
                                                              
                                                              
                                                              
                                                              12,237,047
                                                              
                                                              
                                                              
                                                              9,039,986Income
      tax expenses
                                                              5
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -Net
      income
                                                              
                                                              
                                                              
                                                              1,456,309
                                                              
                                                              
                                                              
                                                              674,702
                                                              
                                                              
                                                              
                                                              12,237,047
                                                              
                                                              
                                                              
                                                              9,039,986Other
      comprehensive income:Cumulative
      currency translation adjustments
                                                              
                                                              
                                                              
                                                              461,820
                                                              
                                                              
                                                              
                                                              (93,739
                                                              )
                                                              
                                                              
                                                              301,931
                                                              
                                                              
                                                              
                                                              (79,568
                                                              )Total
      comprehensive income
                                                              
                                                              
                                                              
                                                              1,918,129
                                                              
                                                              
                                                              
                                                              580,963
                                                              
                                                              
                                                              
                                                              12,538,978
                                                              
                                                              
                                                              
                                                              8,960,418Earnings
      per common stock- Basic
                                                              
                                                              
                                                              
                                                              0.04
                                                              
                                                              
                                                              
                                                              0.02
                                                              
                                                              
                                                              
                                                              0.33
                                                              
                                                              
                                                              
                                                              0.26Earnings
      per common stock - Diluted
                                                              
                                                              
                                                              
                                                              0.04
                                                              
                                                              
                                                              
                                                              0.02
                                                              
                                                              
                                                              
                                                              0.32
                                                              
                                                              
                                                              
                                                              0.26Weighted
      average common stock outstandingBasic
                                                              
                                                              
                                                              
                                                              37,239,536
                                                              
                                                              
                                                              
                                                              36,796,990
                                                              
                                                              
                                                              
                                                              37,239,536
                                                              
                                                              
                                                              
                                                              35,096,680Diluted
                                                              
                                                              
                                                              
                                                              37,901,089
                                                              
                                                              
                                                              
                                                              36,796,990
                                                              
                                                              
                                                              
                                                              37,793,370
                                                              
                                                              
                                                              
                                                              35,096,680




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


2




RENHUANG
PHARMACEUTICALS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS





For
      the nine months ended
                                            July
      31,2010
                                          
                                          
                                          2009US$
                                          
                                          
                                          US$(Unaudited)
                                          
                                          
                                          (Unaudited)Cash
      flows from operating activities:Net
      income
                                          
                                          
                                          12,237,047
                                          
                                          
                                          
                                          9,039,986Adjustments
      to reconcile net income to operating activities:Depreciation
      of property and equipment
                                          
                                          
                                          261,572
                                          
                                          
                                          
                                          265,559Warrants
      issued for services
                                          
                                          
                                          342,770
                                          
                                          
                                          
                                          -Share
      compensation
                                          
                                          
                                          42,759
                                          
                                          
                                          
                                          -Changes
      in assets and liabilities:Decrease
      (increase) in trade receivables
                                          
                                          
                                          12,385,586
                                          
                                          
                                          
                                          (5,868,520
                                          )Decrease
      (increase) in due from related parties
                                          
                                          
                                          130,199
                                          
                                          
                                          
                                          (321,010
                                          )Decrease
      (increase) in inventory, net
                                          
                                          
                                          (549,333
                                          )
                                          
                                          
                                          43,425Decrease
      (increase) in prepayments and in other receivables
                                          
                                          
                                          (1,425,913
                                          )
                                          
                                          
                                          77,805Decrease
      in accounts payable
                                          
                                          
                                          (112,336
                                          )
                                          
                                          
                                          (93,249
                                          )Decrease
      in value added tax payable
                                          
                                          
                                          (715,360
                                          )
                                          
                                          
                                          (270,065
                                          )Increase in
      accrued employee benefits
                                          
                                          
                                          285,739
                                          
                                          
                                          
                                          281,611Decrease
      in other payables
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (96,754
                                          )Net
      cash provided by operating activities
                                          
                                          
                                          22,882,730
                                          
                                          
                                          
                                          3,058,788Cash
      flows from investing activities:Purchase
      of property and equipment
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (16,183
                                          )Deposits
      for office properties
                                          
                                          
                                          (2,558,870
                                          )
                                          
                                          
                                          -Net
      cash used in investing activities
                                          
                                          
                                          (2,558,870
                                          )
                                          
                                          
                                          (16,183
                                          )Effect
      of exchange rate changes on cash
                                          
                                          
                                          314,106
                                          
                                          
                                          
                                          (22,551
                                          )Net
      increase in cash and cash equivalents
                                          
                                          
                                          20,637,966
                                          
                                          
                                          
                                          3,042,605Cash
      and cash equivalents, beginning of year
                                          
                                          
                                          8,111,514
                                          
                                          
                                          
                                          9,747,693Cash
      and cash equivalents, end of year
                                          
                                          
                                          28,749,480
                                          
                                          
                                          
                                          12,767,747Supplemental
      disclosure of cash flow information:Cash
      paid during the year for income taxes
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Interest
      paid during the year
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -





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


3




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





1. 
ORGANIZATION AND NATURE OF OPERATION





The
accompanying consolidated financial statements include the financial statements
of Renhuang Pharmaceuticals, Inc. (“Renhuang”) and its subsidiaries. 
Renhuang and its subsidiaries are collectively referred to as the
“Company.”





Renhuang
was incorporated in the State of Nevada on August 18, 1988, originally under the
corporate name of Solutions, Incorporated.  It was inactive until August
16, 1996, when it changed its corporate name to Suarro Communications, Inc, and
engaged in the business of providing internet based business services. 
This line of business was discontinued in 2006, and Renhuang became a
non-operating public company.  Renhuang underwent a number of corporate
name changes as follows:





June
      1997
            
            ComTech
      Consolidation Group, IncFebruary
      1999
            
            E-Net
      CorporationMay
      1999
            
            E-Net
      Financial CorporationJanuary
      2000
            
            E-Net.Com
      CorporationFebruary
      2000
            
            E-Net
      Financial.Com CorporationJanuary
      2002
            
            Anza
      Capital, Inc (“Anza”)June
      2006
            
            Renhuang
      Pharmaceuticals, Inc.





Effective
August 28, 2006, Renhuang completed the acquisition of 100% ownership of Harbin
Renhuang Pharmaceutical Company Limited, a company incorporated in the British
Virgin Islands.  As a result, Harbin Renhuang Pharmaceutical Company
Limited became a wholly owned subsidiary of Renhuang.





Harbin
Renhuang Pharmaceutical Company Limited owns 100% of the registered capital of
Harbin Renhuang Pharmaceutical Co. Ltd (“Renhuang China”).





The core
activities of subsidiaries included in the consolidated financial statements are
as follow:


·
            Harbin Renhuang Pharmaceutical
      Company Limited – Investment
holding.


·
            Renhuang China –
      Development, manufacturing and distribution of pharmaceutical
      products.





Renhuang
China’s principal country of operations is the People’s Republic of China (the
“PRC”) and maintains their accounting records in Renminbi (“RMB”). 
Substantially all of the Company’s assets and operation are located in the
PRC.





2. 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis
of presentation of financial statements





The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q.  Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements and related
notes.  The accompanying unaudited condensed consolidated financial
statements and related notes should be read in conjunction with the audited
consolidated financial statements of the Company and notes thereto for the year
ended October 31, 2009, which are included in the Company’s Form 10-K for the
year ended October 31, 2009, filed with the SEC on January 29,
2010.





In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (which include only normal
recurring adjustments) necessary to present fairly the balance sheets of
Renhuang Pharmaceuticals, Inc. and its subsidiaries as of July 31, 2010, the
results of their operations for the three and nine months ended July 31, 2010
and 2009, and their cash flows for the nine months ended July 31, 2010 and
2009.  The results of operations for the three and nine months ended July
31, 2010 and 2009 are not necessarily indicative of the results to be expected
for the entire year.




4


RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




The
accompanying condensed consolidated financial statements are expressed in terms
of US dollars.




In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standard (“SFAS”) No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162.  This statement modifies the
Generally Accepted Accounting Principles (“GAAP”) hierarchy by establishing only
two levels of GAAP, authoritative and nonauthoritative accounting literature.
Effective July 2009, the FASB Accounting Standards Codification (“ASC”), also
known collectively as the “Codification,” is considered the single source of
authoritative U.S. accounting and reporting standards, except for additional
authoritative rules and interpretive releases issued by the SEC. 
Nonauthoritative guidance and literature would include, among other things, FASB
Concepts Statements, American Institute of Certified Public Accountants Issue
Papers and Technical Practice Aids and accounting textbooks. The Codification
was developed to organize GAAP pronouncements by topic so that users can more
easily access authoritative accounting guidance.  It is organized by topic,
subtopic, section, and paragraph, each of which is identified by a numerical
designation.  This statement applies beginning in third quarter 2009. 
All accounting references have been updated, and therefore SFAS references have
been replaced with ASC references.





The
Company operates in one operating segment in accordance with accounting guidance
FASB ASC Topic 280, “Segment
Reporting.” Our CEO has been identified as the chief operating decision
maker as defined by FASB ASC Topic 280.





Principles
of consolidation





The
condensed consolidated financial statements include the financial statements of
Renhuang and its subsidiaries.





All
inter-company transactions and balances have been eliminated in
consolidation.





Effective
beginning third quarter 2009, the FASB Topic 810, “Consolidation Topic,” revised
the accounting treatment for noncontrolling minority interests of
partially-owned subsidiaries.  Noncontrolling minority interests represent
the portion of earnings that is not within the parent company’s control. These
amounts are now required to be reported as equity instead of as a liability on
the balance sheet.  In addition this statement requires net income from
noncontrolling minority interest to be shown separately on the consolidated
statements of operations and comprehensive income.  As the Company has no
noncontrolling interest at July 31, 2010, this change did not have an impact on
the Company’s condensed consolidated financial statements.




Use
of estimates





The
preparation of these consolidated financial statements in conformity with US
GAAP requires management to make estimates and assumptions that affected the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the consolidated financial statements and the
reported amounts of net sales and expenses during the reported
periods.





Significant
estimates and assumptions by management include, among others, uncollectible
accounts receivable, slow moving, obsolete and/or damaged inventory, property
and equipment, reserve for employee benefit obligations, stock warrant
valuation, and other uncertainties. Actual results may differ from these
estimates.  The current economic environment has increased the degree of
uncertainty inherent in these estimates and assumptions.




5




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




Foreign
currency translation





The
Company’s principal country of operations is the PRC. The financial position and
results of operations of the subsidiaries are determined using the local
currency (“Renminbi” or “RMB”) as the functional currency.





Translation
of amounts from RMB into US dollars for reporting purposes is performed by
translating the results of operations denominated in foreign currency at the
weighted average rate of exchange during the reporting period. Assets and
liabilities denominated in foreign currencies at the balance sheet date are
translated at the market rate of exchange ruling at that date. The registered
equity capital denominated in the functional currency is translated at the
historical rate of exchange at the time of capital contribution. All translation
adjustments resulting from the translation of the financial statements into the
reporting currency (US dollars) are reported as a component of accumulated other
comprehensive income in shareholders’ equity.





As of
July 31, 2010 and October 31, 2009 the exchange rate was RMB6.79 and RMB6.82,
respectively. Translation adjustment totaled $461,820 and ($93,739) for the
three months ended July 31, 2010 and 2009, respectively, and $301,931 and
($79,568) for the nine months ended July 31, 2010 and 2009.





Cash
and cash equivalents





Cash and
cash equivalents represent cash on hand and demand deposits placed with banks or
other financial institutions, which have original maturities less than three
months.  There are no restriction to cash at July 31, 2010 and October 31,
2009.  Substantially all of the Company’s cash is held in bank accounts in
the PRC and is not protected by the Federal Deposit Insurance Corporation
(“FDIC”) insurance or any other similar insurance.  Given the current
economic environment and risks in the banking industry, there is a risk that
deposits may not be readily available.





Trade
receivables, net





Trade
receivables are recorded at the invoiced amount and do not bear interest. Trade
receivable payment terms vary and amounts due from customers are stated in the
financial statements net of an allowance for doubtful accounts and sales
rebates. The Company maintains an allowance for doubtful accounts for estimated
losses inherent in its trade receivables.  Trade receivables outstanding
longer than the payment terms are considered past due. The Company determines
its allowance by considering a number of factors, including the length of time
the trade receivable is past due, the Company’s previous loss history, the
counter party’s current ability to pay its obligation to the Company, and the
condition of the general economy and the industry as a whole. The Company writes
off receivables when they are deemed uncollectible, and payments subsequently
received on such trade receivables are credited to the allowance for doubtful
accounts.  There were no write offs for the three and nine months ended
July 31, 2010 and 2009.  The Company does not have any off-balance sheet
credit exposure related to its customers.




Inventory,
net





Inventory
consists of raw materials, work-in-progress and finished goods and is valued at
the lower of cost or market value. The value of inventory is determined using
the weighted average cost method and includes any related production overhead
costs incurred in bringing the inventory to their present location and
condition. Overhead costs included in finished goods include, direct labor cost
and other costs directly applicable to the manufacturing process.





The
Company estimates an inventory allowance for excessive, slow moving and obsolete
inventories as well as inventory whose carrying value is in excess of net
realizable value.  Inventory amounts are reported net of such
allowances.  There were no inventory write offs for the three and nine
months ended July 31, 2010 and 2009.




6




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




Property
and equipment, net





Property
and equipment are recorded at cost. Expenditures for major additions and
improvements are capitalized and minor replacements, maintenance, and repairs
are charged to expense as incurred. When property and equipment are retired or
otherwise disposed of, the cost and accumulated depreciation are removed from
the accounts and any resulting gain or loss is included in the results of
operations for the respective period.





Depreciation
is provided over the estimated useful lives of the related assets using the
straight-line method.  The estimated useful lives for significant property,
plant and equipment categories are as follows:





Machinery
      and equipment
              10
      yearsOffice
      equipment and furnishings
              5-10
      yearsMotor
      vehicles
              5-10
      years




Long-lived assets





The
Company’s long-lived assets and other assets (consisting of property and
equipment) are reviewed for impairment in accordance with the guidance of the
FASB Topic ASC 360, “Property,
Plant, and Equipment,” and FASB ASC Topic 205 “Presentation of Financial
Statements.”  The Company tests for impairment losses on long-lived
assets used in operations whenever events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. Recoverability of
an asset to be held and used is measured by a comparison of the carrying amount
of an asset to the future undiscounted cash flows expected to be generated by
the asset. If such asset is considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds its fair value. Impairment evaluations involve management’s estimates on
asset useful lives and future cash flows.  Actual useful lives and cash
flows could be different from those estimated by management which could have a
material effect on our reporting results and financial positions.  Fair
value is determined through various valuation techniques including discounted
cash flow models, quoted market values and third-party independent appraisals,
as considered necessary. Through the three and nine months ended July 31, 2010
and 2009, the Company had not experienced impairment losses on its long-lived
assets. However, there can be no assurances that demand for the Company’s
products or services will continue, which could result in an impairment of
long-lived assets in the future.





Warrant
liability





On March
25, 2010, the Company issued warrants (the “Warrants”) for 160,000 common shares
to a service provider that have an exercise price of $2.00 per share and a
contractual life of 3 years.  The terms of the Warrant agreement include
the following factors that in accordance with FASB Topic ASC 815, requires that
the Warrants be classified at their fair value to liabilities each reporting
period.





·
            The holder of the Warrants (the
      “Holder”) is entitled to the benefits of Rule 144 promulgated under the
      Securities Act of 1933, as amended and any other rule or regulation of the
      SEC that may at any time permit the Holder to sell securities of the
      Company to the public without registration.  Non compliance with such
      rules and regulations could result in the Company having to settle the
      Warrant obligation in cash.





·
            The exercise price and number of
      shares issuable upon exercise of the Warrants (the “Warrant Shares”) are
      subject to adjustment for standard dilutive events, including the issuance
      of common stock, or securities convertible into or exercisable for shares
      of common stock, that will adversely affect the Holder’s rights under the
      Warrants.  There were no dilutive events in the three and nine months
      ended July 31, 2010, which would have resulted in an adjustment to the
      exercise price or number of Warrant
  Shares.




7


RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




At July
31, 2010, the fair value of the Company’s warrants liability was $342,770. 
The Company used the Black-Scholes valuation model to estimate the fair value of
the Warrants.  The valuation was based on the assumptions noted in the
following table.




Expected volatility
                        
                        
                        205.3
                        %Expected dividends
                        
                        
                        0
                        %Expected term (in years)
                        
                        
                        3 yearsRisk-free rate
                        
                        
                        1.69
                        %





Fair
value of financial instruments





The
Company applies the provisions of accounting guidance, FASB Topic ASC 825 that
requires all entities to disclose the fair value of financial instruments, both
assets and liabilities recognized and not recognized on the balance sheet, for
which it is practicable to estimate fair value, and defines fair value of a
financial instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties.  As of July 31, 2010 and
October 31, 2009 the carrying value of cash, trade receivables, other
receivables, accounts payable, and warrant liability approximated their fair
value.





Fair
value measurements





Effective
April 1, 2009, the FASB ASC Topic 825, “Financial Instruments,”
requires disclosures about fair value of financial instruments in quarterly
reports as well as in annual reports.




The FASB
ASC Topic 820, “Fair Value
Measurements and Disclosures,” clarifies the definition of fair value for
financial reporting, establishes a framework for measuring fair value and
requires additional disclosures about the use of fair value
measurements.





Various
inputs are considered when determining the fair value of the Company’s financial
instruments. The inputs or methodologies used for valuing securities are
not necessarily an indication of the risk associated with investing in these
securities.  These inputs are summarized in the three broad levels listed
below.





·
            Level 1 – observable market
      inputs that are unadjusted quoted prices for identical assets or
      liabilities in active
markets.





·
            Level 2 – other significant
      observable inputs (including quoted prices for similar securities,
      interest rates, credit risk,
etc...).





·
            Level 3 – significant
      unobservable inputs (including the Company’s own assumptions in
      determining the fair value of financial
    instruments).





The
Company’s adoption of FASB ASC Topic 825 did not have a material impact on the
Company’s condensed consolidated financial statements.





The
carrying value of financial assets and liabilities recorded at fair value is
measured on a recurring or nonrecurring basis. Financial assets and liabilities
measured on a non-recurring basis are those that are adjusted to fair value when
a significant event occurs. The Company had no financial assets or liabilities
carried and measured on a nonrecurring basis during the reporting periods.
Financial assets and liabilities measured on a recurring basis are those that
are adjusted to fair value each time a financial statement is
prepared.




8




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




The
availability of inputs observable in the market varies from instrument to
instrument and depends on a variety of factors including the type of instrument,
whether the instrument is actively traded, and other characteristics particular
to the transaction. For many financial instruments, pricing inputs are readily
observable in the market, the valuation methodology used is widely accepted by
market participants, and the valuation does not require significant management
discretion. For other financial instruments, pricing inputs are less observable
in the market and may require management judgment.





Revenue
recognition





Revenue
is recognized in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition,” which
states that revenue should be recognized when the following criteria are met:
(1) persuasive evidence of an arrangement exists; (2) the service has been
rendered; (3) the selling price is fixed or determinable; and (4) collection of
the resulting receivable is reasonably assured.





Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.





As of
July 31, 2010, the Company has no sales or contracts that included multiple
deliverables that would fall under the scope of FASB Topic ASC 605, “Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task
Force.”





The
Company provided annual sales rebates to its distributors based upon sales
volumes.  Sales rebates are recorded as a current liability at the
time of the sale based upon the Company’s estimates of whether each customer
would be entitled to rebates for the period.  At quarter end, the accrued
rebate amount is adjusted to the actual amount earned and reclassified to
trade receivables in accordance with legal right of offset.  Sales rebates
were deducted from sales in the accompanying consolidated statements of
operations and comprehensive income.





As of
July 31, 2010 and October 31, 2009, the Company has accrued $550,217 and
$3,020,898, respectively, for sales rebates.   For the three months
ended July 31, 2010 and 2009, the Company has deducted sales rebates in the
amount of $1,018,359 and $1,361,965, respectively, from sales.  For the
nine months ended July 31, 2010 and 2009, the Company has deducted sales rebates
in the amount of $4,923,196 and $6,545,697, respectively, from sales. 
Sales rebates are calculated based on terms specified in contracts with
individual distributors.





Sales
returns and allowances





The
Company does not allow return of products except for products that were damaged
during shipment. The total amount of returned product is less than 0.05% of
total sales. The cost of damaged products is netted against sales and cost of
goods sold, respectively.





Cost
of goods sold





Cost of
goods sold primarily consists of direct and indirect manufacturing costs,
including production overhead costs, shipping and handling costs for the
products sold.





Sales
and marketing





Sales and
marketing costs consist primarily of advertising and market promotion expenses,
and other overhead expenses incurred by the Company’s sales and marketing
personnel. Advertising expenses amounted to $1,232,000 and $1,085,756 during the
three months ended July 31, 2010 and 2009, respectively and $3,558,109 and
$2,476,007 during the nine months ended July 31, 2010 and 2009,
respectively.




9





RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




Advertising
costs are expensed as incurred.





Research
and development





Research
and development (“R&D”) costs are expensed as incurred.





Employee
benefit costs





According
to the PRC regulations on pension, a company contributes to a defined
contribution retirement plan organized by municipal government in the province
in which the Renhuang China was registered and all qualified employees are
eligible to participate in the plan. Contributions to the plan are calculated at
20% of the employees’ salaries above a fixed threshold amount, employees
contribute 4% and the Renhuang China contributes the balance of
16%.





Share-based
compensation




For
purposes of determining the variables used in the calculation of stock
compensation expense under the provisions of FASB ASC Topic 505, “Equity” and FASB ASC Topic
718, “Compensation — Stock
Compensation,” we perform an analysis of current market data and
historical Company data to calculate an estimate of implied volatility, the
expected term of the option and the expected forfeiture rate. With the exception
of the expected forfeiture rate, which is not an input, we use these estimates
as variables in the Black-Scholes option pricing model. Depending upon the
number of stock options granted, any fluctuations in these calculations could
have a material effect on the results presented in our condensed consolidated
statement of income and other comprehensive income. In addition, any differences
between estimated forfeitures and actual forfeitures could also have a material
impact on our financial statements.




Share-based
compensation amounted to $26,165 and $0 in the three months ended July 31, 2010
and 2009, respectively and $42,759 and $0 in the nine months ended July 31, 2010
and 2009, respectively.





Taxation





Taxation
on profits earned in the PRC has been calculated on the estimated assessable
profits for the year at the rates of taxation prevailing in the PRC in which the
Company operates after taking into effect the benefits from any special tax
credits or “tax holidays” allowed in the country of operations.





The
Company accounts for income tax under the provisions of FASB ASC Topic 740,
“Income Taxes,” which
requires recognition of deferred tax assets and liabilities for the expected
future tax consequences of the events that have been included in the financial
statements or tax returns. Deferred income taxes are recognized for all
significant temporary differences between tax and financial statements bases of
assets and liabilities. Valuation allowances are established against net
deferred tax assets when it is more likely than not that some portion or all of
the deferred tax asset will not be realized.





The
Company does not have any long-term deferred tax assets or liabilities in China
that will exist once the tax holiday expires. The Company does not have any
significant deferred tax asset or liabilities that relate to tax jurisdictions
not covered by the tax holiday.





The
Company does not accrue United States income tax on unremitted earnings from
foreign operations, as it is the Company’s intention to invest these earnings in
the foreign operations indefinitely.




10




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




Generally,
years beginning after fiscal 2006, the Company is open to examination by PRC
taxing authorities.  In the United States, we are open to examination from
2006 onward.





Enterprise
income tax





On March
16, 2007, the PRC National People’s Congress passed the PRC Enterprise Income
Tax Law (“New EIT Law”) which became effective on January 1, 2008. 
Pursuant to the New EIT Law, a unified enterprise income tax rate of 25 percent
and unified tax deduction standards will be applied consistently to both
domestic-invested enterprises and foreign-invested enterprises.  However,
the New EIT Law repealed most of the existing preferential tax rates and tax
holidays.  A five-year transition period is allowed for enterprises that
obtained preferential tax treatment under the prior tax regime.  Under the
prior tax regime, foreign-invested enterprises were generally subject to a 30
percent federal tax rate plus a 3 percent local tax rate for a total tax rate of
33 percent.





Renhuang
China secured preferential tax treatment in the jurisdiction where it conducts
its manufacturing activity, where it was granted tax holiday from the local
government, for being a new and high-technology enterprise.





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 basis. Deferred tax
assets, including tax loss and credit carryforwards, 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 of deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in the
deferred tax assets and deferred tax liabilities. The components of the deferred
tax assets and liabilities are individually classified as current and noncurrent
based on their characteristics. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be
realized.





A
provision has not been made at July 31, 2010 for U.S. or additional foreign
withholding taxes on approximately $48,527,354 of undistributed earnings of
foreign subsidiaries because it is the present intention of management to
reinvest the undistributed earnings indefinitely in foreign operations.
Generally, such earnings become subject to U.S. tax upon the remittance of
dividends and under certain other circumstances. It is not practicable to
estimate the amount of deferred tax liability on such undistributed
earnings.





The
Company recognizes that virtually all tax positions in the PRC are not free of
some degree of uncertainty due to tax law and policy changes by the State.
However, the Company cannot reasonably quantify political risk factors and thus
must depend on guidance issued by current State officials.





Based on
all known facts and circumstances and current tax law, the Company believes that
the total amount of unrecognized tax benefits as of July 31, 2010, is not
material to its results of operations, financial condition or cash flows. The
Company also believes that the total amount of unrecognized tax benefits as of
October 31, 2009, if recognized, would not have a material effect on its
effective tax rate. The Company further believes that there are no tax positions
for which it is reasonably possible, based on current Chinese tax law and
policy, that the unrecognized tax benefits will significantly increase or
decrease over the next 12 months producing, individually or in the aggregate, a
material effect on the Company’s results of operations, financial condition or
cash flows.





Value
added tax





The
Provisional Regulations of The People’s Republic of China Concerning Value Added
Tax promulgated by the State Council came into effect on January 1, 1994. Under
these regulations and the Implementing Rules of the Provisional Regulations of
the PRC Concerning Value Added Tax, value added tax is imposed on goods sold in
or imported into the PRC and on processing, repair and replacement services
provided within the PRC.




11


RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




Value
added tax payable in The People’s Republic of China is charged on an aggregated
basis at a rate of 13% or 17% (depending on the type of goods involved) on the
full price collected for the goods sold or, in the case of taxable services
provided, at a rate of 17% on the charges for the taxable services provided, but
excluding, in respect of both goods and services, any amount paid in respect of
value added tax included in the price or charges, and less any deductible value
added tax already paid by the taxpayer on purchases of goods and services in the
same financial year.





Comprehensive
Income





Total
comprehensive income is defined as all changes in shareholders’ equity during a
period, other than those resulting from investments by and distributions to
shareholders (i.e., issuance of equity securities and dividends). 
Generally, for the Company, total comprehensive income equals net income plus or
minus adjustments for currency translation.  Total comprehensive income
represents the activity for a period net of related tax and was $1,918,129 and
$580,963 for the three months ended July 31, 2010 and 2009, respectively and
$12,538,978 and $8,960,418 for the nine months ended July 31, 2010 and 2009,
respectively.





While
total comprehensive income is the activity in a period and is largely driven by
net earnings in that period, accumulated other comprehensive income or loss
(“AOCI”) represents the cumulative balance of other comprehensive income as of
the balance sheet date.  For the Company, AOCI is primarily the cumulative
balance related to the currency adjustments and increased overall equity by
$301,931 as of July 31, 2010 and decreased overall equity by $79,568 as of July
31, 2009.





Earnings
per share





Basic net
earnings per common stock is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common stock outstanding
during the period. Diluted net earnings per common stock is determined using the
weighted-average number of common stock outstanding during the period, adjusted
for the dilutive effect of common stock equivalents, using the treasury stock
method, consisting of shares that might be issued upon exercise of common stock
warrants. In periods where losses are reported, the weighted-average number of
common stock outstanding excludes common stock equivalents, because their
inclusion would be anti-dilutive.





Basic
earnings per share is based on the weighted-average number of shares of common
stock outstanding.  Earnings per share, assuming dilution, is based on the
weighted-average number of shares of common stock outstanding adjusted for the
effects of common stock that may be issued as a result of the following types of
potentially dilutive instruments:




–
            warrants,


–
              employee stock options,
      and


–
              other equity awards, which
      include long-term incentive
awards.





The FASB
Topic ASC 260, “Earnings per
Share,” requires the Company to include additional shares in the
computation of earnings per share, assuming dilution.  The additional
shares included in diluted earnings per share represent the number of shares
that would be issued if all of the Company’s outstanding dilutive instruments
were converted into common stock.




12




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





Diluted
earnings per share are based on the assumption that all dilutive options were
converted or exercised. Dilution is computed by applying the treasury stock
method. Under this method, options are assumed to be exercised at the time of
issuance, and as if funds obtained thereby were used to purchase common stock at
the average market price during the period.




Warrants





The
Company evaluates its warrants on an ongoing basis considering the accounting
guidance of FASB Topic ASC 825, which establishes standards for issuers of
financial instruments with characteristics of both liabilities and equity
related to the classification and measurement of those instruments. The warrants
are evaluated considering the accounting guidance of FASB Topic ASC 815, which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities.





Freestanding
financial instruments with characteristics of both liabilities and
equity





In
accordance with accounting guidance FASB Topic ASC 825, the Company accounts for
financial instruments as a liability if it embodies an obligation to repurchase
the issuer’s equity shares, or is indexed to such an obligation, and that
requires or may require the issuer to settle the obligation by transferring
assets. Freestanding financial instruments are financial instruments that are
entered into separately and apart from any of the entity’s other financial
instruments or equity transactions, or that is entered into in conjunction with
some other transaction and is legally detachable and separately exercisable. The
liability recorded is the per share price to be paid and is offset to
equity.  As of July 31, 2010 and October 31, 2009, there were no financial
instruments recorded as liability.





3. 
ACCOUNTING PRONOUNCEMENTS





Accounting
Standards Update (“ASU”) ASU No. 2010-09 (ASC Topic 855), which amends
Subsequent Events Recognition and Disclosures, ASU No. 2009-16 (ASC Topic 860),
which amends Accounting for Transfer of Financial Assets, ASU No. 2009-05 (ASC
Topic 820), which amends Fair Value Measurements and Disclosures - Overall, ASU
No. 2009-08, Earnings per Share, ASU No. 2009-12 (ASC Topic 820), Investments in
Certain Entities That Calculate Net Asset Value per Share, and various other
ASU’s No. 2009-2 through ASU No. 2010-19 which contain technical corrections to
existing guidance or affect guidance to specialized industries or entities were
recently issued. These updates have no current applicability to the Company, or
their effect on the financial statements would not have been
significant.




In April
2010, the FASB issued Accounting Standards Update, 2010-17, Revenue
Recognition—Milestone Method (Topic 605): “Milestone Method of Revenue
Recognition—a consensus of the FASB Emerging Issues Task Force.” 
This is an update regarding the milestone method of revenue recognition. The
scope of this update is limited to arrangements that include milestones relating
to research or development deliverables. The update specifies criteria that must
be met for a vendor to recognize consideration that is contingent upon
achievement of a substantive milestone in its entirety in the period in which
the milestone is achieved. The criteria apply to milestones in arrangements
within the scope of this update regardless of whether the arrangement is
determined to have single or multiple deliverables or units of accounting. The
update will be effective for fiscal years, and interim periods within those
years, beginning on or after June 15, 2010. Early application is permitted.
Companies can apply this guidance prospectively to milestones achieved after
adoption. However, retrospective application to all prior periods is also
permitted. This update is not expected to have a material impact on the
Company’s financial statements.




13


RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




In March
2010, the FASB issued Accounting Standards Update, 2010-13, Compensation—Stock
Compensation (Topic 718): “Effect of Denominating the Exercise
Price of a Share-Based Payment Award in the Currency of the Market in Which the
Underlying Equity Security Trades—a consensus of the FASB Emerging Issues Task
Force.”  This is an update regarding the effect of denominating
the exercise price of a share-based payment awards in the currency of the market
in which the underlying equity securities trades and that currency is different
from (1) entity’s functional currency, (2) functional currency of the foreign
operation for which the employee provides services,
and (3) payroll currency of the employee. The update clarifies that an employee
share-based payment award with an exercise price denominated in the currency of
a market in which a substantial portion of the entity’s equity securities trades
should be considered an equity award assuming all other criteria for equity
classification are met. The update will be effective for interim and annual
periods beginning on or after December 15, 2010, and will be applied
prospectively. Affected entities will be required to record a cumulative
catch-up adjustment for all awards outstanding as of the beginning of the annual
period in which the guidance is adopted. This update is not expected to have a
material impact on the Company’s financial statements.





In March,
2010, the FASB issued Accounting Standards Update, 2010-11, Derivatives and
Hedging (Topic 815): “Scope
Exception Related to Embedded Credit Derivatives.”  This update
clarifies the type of embedded credit derivative that is exempt from embedded
derivative bifurcation requirements. Specifically, only one form of embedded
credit derivative qualifies for the exemption – one that is related only to the
subordination of one financial instrument to another. As a result, entities that
have contracts containing an embedded credit derivative feature in a form other
than such subordination may need to separately account for the embedded credit
derivative feature. This update also has transition provisions, which permit
entities to make a special one-time election to apply the fair value option to
any investment in a beneficial interest in securitized financial assets,
regardless of whether such investments contain embedded derivative features.
This update is effective on the first day of the first fiscal quarter beginning
after June 15, 2010. Early adoption is permitted at the beginning of any fiscal
quarter beginning after March 5, 2010. This update is not expected to have a
material impact on the Company’s financial statements





In
January 2010, the FASB issued Accounting Standards Update, 2010-06, Fair
Value Measurements and Disclosures (Topic 820): “Improving Disclosures about Fair
Value Measurements.”  This update provides guidance to improve
disclosures about fair value measurements. This guidance amends previous
guidance on fair value measurements to add new requirements for disclosures
about transfers into and out of Levels 1 and 2 and separate disclosures about
purchases, sales, issuances, and settlements relating to Level 3 measurement on
a gross basis rather than on a net basis as currently required. This update also
clarifies existing fair value disclosures about the level of disaggregation and
about inputs and valuation techniques used to measure fair value. This guidance
is effective for annual and interim periods beginning after December 15,
2009, except for the requirement to provide the Level 3 activities of purchases,
sales, issuances, and settlements on a gross basis, which will be effective for
annual and interim periods beginning after December 15, 2010. Early
application is permitted and, in the period of initial adoption, entities are
not required to provide the amended disclosures for any previous periods
presented for comparative purposes. The adoption of this update did not have a
significant impact on the Company’s financial statements.





In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (Topic 605): “ Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task Force.” This
update provides application guidance on whether multiple deliverables exist, how
the deliverables should be separated and how the consideration should be
allocated to one or more units of accounting. This update establishes a selling
price hierarchy for determining the selling price of a deliverable. The selling
price used for each deliverable will be based on vendor-specific objective
evidence, if available, third-party evidence if vendor-specific objective
evidence is not available, or estimated selling price if neither vendor-specific
or third-party evidence is available. The Company will be required to apply this
guidance prospectively for revenue arrangements entered into or materially
modified after January 1, 2011; however, earlier application is permitted. The
Company has not determined the impact that this update may have on its financial
statements.





In June
2009, the FASB issued guidance related to accounting for transfers of financial
assets. This guidance improves the information that a reporting entity provides
in its financial reports about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance and cash flows; and a
continuing interest in transferred financial assets. In addition, this guidance
amends various ASC concepts with respect to accounting for transfers and
servicing of financial assets and extinguishments of liabilities, including
removing the concept of qualified special purpose entities.  This guidance must be
applied to transfers occurring on or after the effective date. On February 1,
2010, the Company adopted this guidance.  The adoption of this guidance did
not have a material impact on the Company’s financial
statements.


14


RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




In June
2009, the FASB issued guidance which amends certain ASC concepts related to
consolidation of variable interest entities. Among other accounting and
disclosure requirements, this guidance replaces the quantitative-based risks and
rewards calculation for determining which enterprise has a controlling financial
interest in a variable interest entity with an approach focused on identifying
which enterprise has the power to direct the activities of a variable interest
entity and the obligation to absorb losses of the entity or the right to receive
benefits from the entity. On February 1, 2010, the Company adopted this
guidance.  The adoption of this guidance did not have a material impact on
the Company’s financial statements.




4. CONCENTRATIONS OF BUSINESS AND CREDIT
RISK





The
Company conducts all of its primary trade in the PRC.  There can be no
assurance that the Company will be able to successfully conduct its trade, and
failure to do so would have a material adverse effect on the Company’s financial
position, results of operations and cash flows. Also, the success of the
Company’s operations is subject to numerous contingencies, some of which are
beyond management’s control. These contingencies include general economic
conditions, price of raw material, competition, governmental and political
conditions, and changes in regulations. Because the Company is dependent on
foreign trade in the PRC, the Company is subject to various additional
political, economic and other uncertainties. Among other risks, the Company’s
operations will be subject to risk of restrictions on transfer of funds,
domestic and international customs, changing taxation policies, foreign exchange
restrictions, and political and governmental regulations.





(1)
Cash and cash equivalents





The
Company maintains certain bank accounts in the PRC which are not protected by
FDIC insurance or other insurance.  Cash balance held in PRC bank accounts
to $28,749,480 and $8,111,514, as of July 31, 2010 and October 31, 2009,
respectively.  No cash balances were restricted as at July 31, 2010 and
October 31, 2009.





As of
July 31, 2010 and October 31, 2009, substantially all of the Company’s cash and
cash equivalents were held by major financial institutions located in the PRC
which management believes are of high credit quality.





(2)
Sales and trade receivables





The
Company provides credit in the normal course of business and substantially all
customers are located in the PRC.  The Company performs ongoing credit
evaluations of its customers and maintains allowances for doubtful accounts
based on factors surrounding the credit risk of specific customers, historical
trends, and other information.  Three individual customers accounted for
10%-12% of net revenues during the three and nine months ended July 31, 2010 and
2009.




The
Company’s products are sold throughout the PRC. For three months ended July 31,
2010 and 2009, Siberian Ginseng (Acanthopanax) Series accounted for 43% and
55.3%, respectively, of total sales.  For nine months ended July 31, 2010
and 2009, Siberian Ginseng (Acanthopanax) Series accounted for 44% and 54.3%,
respectively, of total sales.





(3)
Foreign currency





The
Company operates in China, which may give rise to significant foreign currency
risks from fluctuations and the degree of volatility of foreign exchange rates
between U.S. dollars and the Chinese currency RMB.


15




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009




(4)
Dividends





Payments
of dividends may be subject to some restrictions due to the fact that the
operating activities are conducted in a subsidiary residing in the
PRC.





(5)
Price control





The
retail prices of certain pharmaceuticals sold in China, primarily those included
in the national and provincial Medical Insurance Catalogs are subject to price
controls in the form of fixed prices or price ceilings. As such, the retail
prices for certain of the Company’s pharmaceutical products can be adjusted
downward or upward from time to time. Price controls did not have a material
impact on the Company’s operation in the three and nine months ended July 31,
2010 and 2009.





(6)
Cost of goods sold





Cost of
goods sold is subject to price fluctuations due to various factors beyond the
Company’s control, including, among other pertinent factors, inflation and
changes in governmental regulations and programs.  The Company expects cost
of goods sold will continue to fluctuate and be affected by inflation in the
future.  The Company’s raw materials are purchased from various independent
suppliers, and do not rely on any one supplier.




5. 
INCOME TAXES





Taxation
on profits earned in the PRC has been calculated on the estimated assessable
profits for the year at the rates of taxation prevailing in the PRC in which the
Company operates after taking into effect the benefits from any special tax
credits or “tax holidays” allowed in the country of operations.  If the
Company did not have tax holiday, the effects of the tax per share were as
follows:





Three months ended
                              July 31,
                            
                            
                            Nine months ended
                              July 31,2010
                            
                            
                            2009
                            
                            
                            2010
                            
                            
                            2009US$
                            
                            
                            US$
                            
                            
                            US$
                            
                            
                            US$Tax
      savings
                            
                            
                            364,077
                            
                            
                            
                            168,676
                            
                            
                            
                            3,059,262
                            
                            
                            
                            2,259,997Benefit
      per share:Basic
                            
                            
                            0.01
                            
                            
                            
                            0.01
                            
                            
                            
                            0.08
                            
                            
                            
                            0.06Diluted
                            
                            
                            0.01
                            
                            
                            
                            0.01
                            
                            
                            
                            0.08
                            
                            
                            
                            0.06




16




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





Had the
tax exemption not been in place for the three and nine months ended July 31,
2010 and 2009, the Company estimates the following proforma financial statement
impact:





Three months ended
                                  July 31,
                                
                                
                                Nine months ended
                                  July 31,2010
                                
                                
                                2009
                                
                                
                                2010
                                
                                
                                2009US$
                                
                                
                                US$
                                
                                
                                US$
                                
                                
                                US$Net
      income before tax provision, as reported
                                
                                
                                1,456,309
                                
                                
                                
                                674,702
                                
                                
                                
                                12,237,047
                                
                                
                                
                                9,039,986Less
      Tax savings
                                
                                
                                (364,077
                                )
                                
                                
                                (168,676
                                )
                                
                                
                                (3,059,262
                                )
                                
                                
                                (2,259,997
                                )Proforma
      Net income
                                
                                
                                1,092,232
                                
                                
                                
                                506,026
                                
                                
                                
                                9,177,785
                                
                                
                                
                                6,779,989Proforma
      Net income per share:Basic
                                
                                
                                0.03
                                
                                
                                
                                0.01
                                
                                
                                
                                0.25
                                
                                
                                
                                0.19Diluted
                                
                                
                                0.03
                                
                                
                                
                                0.01
                                
                                
                                
                                0.24
                                
                                
                                
                                0.19





6. 
         EARNINGS PER SHARE





When
calculating diluted earnings per share for common stock equivalents, the
Earnings Per Share Topic, ASC 260, requires the Company to include the potential
shares that would be outstanding if all outstanding stock options or warrants
were exercised.   This is offset by shares the Company could
repurchase using the proceeds from these hypothetical exercises to obtain the
common stock equivalent.





The
following reconciles the components of the EPS computation:





Income
                                                
                                                
                                                Shares
                                                
                                                
                                                Per Share(Numerator)
                                                
                                                
                                                (Denominator)
                                                
                                                
                                                AmountUS$
                                                
                                                
                                                
                                                
                                                
                                                US$For
      the three months ended July 31, 2010:Net
      income
                                                
                                                
                                                1,456,309Basic
      EPS income available to common shareholders
                                                
                                                
                                                1,456,309
                                                
                                                
                                                
                                                37,239,536
                                                
                                                
                                                
                                                0.04Effect
      of dilutive securities:Share
      options
                                                
                                                
                                                
                                                
                                                
                                                
                                                26,392Warrants
                                                
                                                
                                                -
                                                
                                                
                                                
                                                635,161Diluted
      EPS income available to common shareholders
                                                
                                                
                                                1,456,309
                                                
                                                
                                                
                                                37,901,089
                                                
                                                
                                                
                                                0.04For
      the three months ended July 31, 2009:Net
      income
                                                
                                                
                                                674,702Basic
      EPS income available to common shareholders
                                                
                                                
                                                674,702
                                                
                                                
                                                
                                                36,796,990
                                                
                                                
                                                
                                                0.02Effect
      of dilutive securities:Share
      options
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Warrants
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Diluted
      EPS income available to common shareholders
                                                
                                                
                                                674,702
                                                
                                                
                                                
                                                36,796,990
                                                
                                                
                                                
                                                0.02





For the
three months ended July 31, 2010, 70,000 share options were excluded from the
calculation of diluted earnings per share because the exercise price exceeded
the average price of the Company’s common stock.


17




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





For the
three months ended July 31, 2009, there were no securities or other contracts to
issue common stock that need to be considered in the diluted earnings per share
calculation.





Income
                                                
                                                
                                                Shares
                                                
                                                
                                                Per Share(Numerator)
                                                
                                                
                                                (Denominator)
                                                
                                                
                                                AmountUS$
                                                
                                                
                                                
                                                
                                                
                                                US$For
      the nine months ended July 31, 2010:Net
      income
                                                
                                                
                                                12,237,047Basic
      EPS income available to common shareholders
                                                
                                                
                                                12,237,047
                                                
                                                
                                                
                                                37,239,536
                                                
                                                
                                                
                                                0.33Effect
      of dilutive securities:Share
      options
                                                
                                                
                                                
                                                
                                                
                                                
                                                21,416Warrants
                                                
                                                
                                                -
                                                
                                                
                                                
                                                532,418Diluted
      EPS income available to common shareholders
                                                
                                                
                                                12,237,047
                                                
                                                
                                                
                                                37,793,370
                                                
                                                
                                                
                                                0.32For
      the nine months ended July 31, 2009:Net
      income
                                                
                                                
                                                9,039,986Basic
      EPS income available to common shareholders
                                                
                                                
                                                9,039,986
                                                
                                                
                                                
                                                35,096,680
                                                
                                                
                                                
                                                0.26Effect
      of dilutive securities:Share
      options
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Warrants
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Diluted
      EPS income available to common shareholders
                                                
                                                
                                                9,039,986
                                                
                                                
                                                
                                                35,096,680
                                                
                                                
                                                
                                                0.26




For the
nine months ended July 31, 2010, 70,000 share options and 160,000 warrants were
excluded from the calculation of diluted earnings per share because the exercise
price exceeded the average price of the Company’s common stock.





For the
nine months ended July 31, 2009, there were no securities or other contracts to
issue common stock that need to be considered in the diluted earnings per share
calculation.





7. 
         TRADE RECEIVABLES,
NET





The trade
receivables amount included in the condensed consolidated balance sheets as at
July 31, 2010 and October 31, 2009 were as follows:





2010
                                          
                                          
                                          2009US$
                                          
                                          
                                          US$Trade
      receivables
                                          
                                          
                                          11,813,603
                                          
                                          
                                          
                                          26,667,816Less:
      Sales rebates
                                          
                                          
                                          (550,217
                                          )
                                          
                                          
                                          (3,020,898
                                          )Less:
      Allowance for doubtful accounts
                                          
                                          
                                          (445,562
                                          )
                                          
                                          
                                          (443,508
                                          )Trade
      receivables, net
                                          
                                          
                                          10,817,824
                                          
                                          
                                          
                                          23,203,410




18




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





8.           OTHER
RECEIVABLES, NET





The other
receivables amount included in the condensed consolidated balance sheets as at
July 31, 2010 and October 31, 2009 were as follows:





2010
                                  
                                  
                                  2009US$
                                  
                                  
                                  US$Other
      receivables
                                  
                                  
                                  506,047
                                  
                                  
                                  
                                  462,980Less:
      Allowance for doubtful accounts
                                  
                                  
                                  (362,036
                                  )
                                  
                                  
                                  (360,367
                                  )Other
      receivables, net
                                  
                                  
                                  144,011
                                  
                                  
                                  
                                  102,613





9.           INVENTORY,
NET





The
inventory amounts included in the condensed consolidated balance sheets for as
at July 31, 2010 and October 31, 2009 comprised of:





2010
                                
                                
                                2009US$
                                
                                
                                US$Raw
      materials
                                
                                
                                1,657,063
                                
                                
                                
                                1,530,283Work-in-progress
                                
                                
                                1,162,093
                                
                                
                                
                                1,006,984Finished
      goods
                                
                                
                                818,724
                                
                                
                                
                                550,982Less:  Inventory
      reserves
                                
                                
                                (64,531
                                )
                                
                                
                                (64,233
                                )Inventory,
      net
                                
                                
                                3,573,349
                                
                                
                                
                                3,024,016





10.         PROPERTY
AND EQUIPMENT, NET





Property
and equipment and related accumulated depreciation as of July 31, 2010 and
October 31, 2009 were as follows:





2010
                                      
                                      
                                      2009US$
                                      
                                      
                                      US$Machinery
      and equipment
                                      
                                      
                                      3,435,421
                                      
                                      
                                      
                                      3,435,421Office
      equipment and furnishings
                                      
                                      
                                      54,505
                                      
                                      
                                      
                                      53,086Motor
      vehicles
                                      
                                      
                                      53,332
                                      
                                      
                                      
                                      54,7493,543,257
                                      
                                      
                                      
                                      3,543,256Less:
      Accumulated depreciation
                                      
                                      
                                      (1,452,665
                                      )
                                      
                                      
                                      (1,191,093
                                      )Net
      book value
                                      
                                      
                                      2,090,592
                                      
                                      
                                      
                                      2,352,163





Depreciation
expense for the three months ended July 31, 2010 and 2009 was $80,496 and
$88,335, respectively, of which $76,622 and $84,552 were included as a
component of cost of goods sold in the respective
periods.





Depreciation
expense for the nine months ended July 31, 2010 and 2009 was $261,572 and
$265,559, respectively, of which $249,996 and $254,396 were included as a
component of cost of goods sold in the respective
periods.





No assets
were pledged for borrowings as at July 31, 2010 and October 31,
2009.


19


RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





11.
            RELATED PARTY
      TRANSACTIONS





Due from
related parties included in the condensed consolidated balance sheets as at July
31, 2010 and October 31, 2009 comprised of:





2010
                    
                    
                    2009US$
                    
                    
                    US$Due
      from related parties:Advances
      (1)
                    
                    
                    -
                    
                    
                    
                    130,199Deposits
      (2)
                    
                    
                    20,169,666
                    
                    
                    
                    16,137,000Total
                    
                    
                    20,169,666
                    
                    
                    
                    16,267,199





(1)
Advances





Mr. Li
Shaoming, our chairman, chief executive officer and president, is also chairman
and a 50% shareholder of Harbin Renhuang Pharmaceutical Stock Co. Ltd (“Stock
Co”).





As of
October 31, 2009, the Company has a net amount due from Stock Co, of
$130,199.  This amount consists of $539,130 of repair and maintenance
work performed on property and plant leased from Stock Co and paid for on Stock
Co’s behalf.  This is offset by $408,931 of professional fees in
connection with the acquisition of Harbin Renhuang Pharmaceutical Company
Limited in 2006, paid for by Stock Co on the Company’s behalf.  During
the quarter ended January 31, 2010, the Company received from Stock Co, a cash
payment of $539,130 resulting in a balance of $408,931 due to Stock Co, which
was settled in the quarter ended April 30, 2010.




(2)
Deposits





On
September 1, 2009, the Company through its wholly own subsidiary, Renhuang
China, entered into a Purchase Agreement with Stock Co, to acquire two
production patents, for a total consideration of $2,340,619.  Pursuant
to the Purchase Agreement, a payment of $1,467,000 was made to Stock Co, in
October 2009 and $1,473,796 and $1,467,000 was recorded as deposits on the
condensed consolidated balance sheet as at July 31, 2010 and October 31, 2009,
respectively.  Pursuant to the Purchase Agreement, final payment of
$877,732 is due by December 31, 2010, at which time title for the assets
will be transferred.  Accordingly the transaction is considered
incomplete as at July 31, 2010.




On
October 12, 2009, the Company through its wholly own subsidiary, Renhuang China,
entered into a Purchase Agreement with Stock Co, to acquire the land use right,
property and plant, for a total consideration of
$23,406,185.  Pursuant to the Purchase Agreement, a payment of
$14,670,000 was made to Stock Co, in October 2009 and $14,737,959 and
$14,670,000 was recorded as deposits on the condensed consolidated balance sheet
as at July 31, 2010 and October 31, 2009, respectively.  Pursuant to
the Purchase Agreement, final payment of $8,777,319 is due by December 31, 2011,
at which time title for the assets will be transferred.  Accordingly
the transaction is considered incomplete as at July 31, 2010.




On April
10, 2010, the Company through its wholly own subsidiary, Renhuang China, entered
into a Purchase Agreement with Hongxiangmingyuan of Heilongjiang Yongtai
Company, to acquire two office floors for a total consideration of
$5,612,306.  Pursuant to the Purchase Agreement, a payment of
$3,957,911 was made in April 2010 and recorded as deposits on the condensed
consolidated balance sheet.  Pursuant to the Purchase Agreement, final
payment of $1,683,692 is due by December 20, 2012, at which time title for the
assets will be transferred.  Accordingly the transaction is considered
incomplete as at July 31, 2010.


20





RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





(3)
Related party transactions





The
Company leases property and plant from Stock Co.  Rental expenses
related to this lease, incurred and expensed to condensed consolidated
statements of operations and comprehensive income during the three months ended
July 31, 2010 and 2009 amounted to $153,738 and $153,600, respectively, during
the nine months ended July 31, 2010 and 2009 amounted to $461,214 and $460,800,
respectively.





During
the three and nine months ended July 31, 2010 and 2009, the Company sold goods
in the amount of $0 and $374,301, respectively, to Heilongjiang Renhuang
Pharmaceutical Limited, a company where Mr. Li Shaoming is a major
shareholder.





12.           EMPLOYEE
BENEFITS





The
full-time employees of the Company’s subsidiary that is incorporated in the PRC
are entitled to staff welfare benefits, including medical care, welfare
subsidies, unemployment insurance and pension benefits. The PRC companies are
required to accrue for these benefits based on certain percentages of the
employees’ salaries in accordance with the relevant regulations, and to make
contributions to the state-sponsored pension and medical plans out of the
amounts accrued for medical and pension benefits. The total amounts expensed to
the condensed consolidated statements of operations and comprehensive income for
such employee benefits amounted to approximately $84,783 and $92,946 for the
three months ended July 31, 2010 and 2009, respectively and $289,118 and
$293,437 for the nine months ended July 30, 2010 and 2009, respectively. The PRC
government is responsible for the medical benefits and ultimate pension
liability to these employees.




13.          ASSETS
AND LIABILITIES MEASURED AT FAIR VALUE





At July
31, 2010, the Company had no assets measured at fair value and the following
liabilities measured at fair value:





Fair value measurementQuoted prices
                                      in active
                                      markets of
                                      identical
                                      assets
                                      (Level 1)
                                    
                                    
                                    Significant
                                      other
                                      observable
                                      inputs
                                      (Level 2)
                                    
                                    Significant
                                      unobservable
                                      inputs
                                      (Level 3)US$
                                    
                                    
                                    US$
                                    
                                    US$Warrants
      liability
                                    
                                    
                                    -
                                    
                                    
                                    
                                    342,770





At
October 31, 2009, the Company had no assets and liabilities measured at fair
value.





14.           PREFERRED
STOCK, COMMON STOCK AND EQUITY TRANSACTIONS





(1)  Preferred
Stock





The
Company’s articles of incorporation provide that our board of directors will be
authorized to issue from time to time, without further stockholder approval, up
to 1,000,000 additional shares of preferred stock in one or more series and to
fix or alter the designations, preferences, rights and any qualifications,
limitations or restrictions of the shares of each series, including the dividend
rights, dividend rates, conversion rights, voting rights, rights of redemption,
including sinking fund provisions, redemption price or prices, liquidation
preferences and the number of shares constituting
any series or designations of any series. Such shares of preferred stock could
have preferences over our common stock with respect to dividends and liquidation
rights.  As at July 31, 2010 and October 31, 2009, there is no preferred
stock outstanding.





21




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





(2)  Common
Stock and Equity Transactions





During
the three and nine months ended July 31, 2010, the Company recorded $11,882 and
$25,815, respectively, of share-based compensation expense in connection with an
option to purchase 50,000 shares valued at $47,527 granted to an employee on
January 13, 2010.





During
the three and nine months ended July 31, 2010, the Company recorded $14,283 and
$16,944 of share-based compensation expense in connection with an option to
purchase 70,000 shares valued at $171,397 granted to an independent director on
April 13, 2010.





15.           OPTION
PLAN AND WARRANTS





(1)  2003
Omnibus Plan




On
February 28, 2003, our board of directors approved the Renhuang Pharmaceuticals,
Inc. 2003 Omnibus Securities Plan (the “2003 Plan”), which was approved by our
shareholders on April 11, 2003. The 2003 Plan offers selected employees,
directors, and consultants an opportunity to acquire our common stock, and
serves to encourage such persons to remain employed by us and to attract new
employees. The 2003 Plan allows for the award of stock and options, up to 25,000
(after giving effect to the 1-for-30 reverse stock split in 2006) shares of our
common stock. On May 1, of each year, the number of shares in the 2003
Securities Plan is automatically adjusted to an amount equal to ten percent of
our outstanding stock on July 31, of the immediately preceding year. As of July
31, 2010, the number of shares of common stock outstanding was 37,239,536 making
3,723,954 shares of common stock subject to the 2003 Plan.




On April
13, 2010, an option to purchase 70,000 shares was granted under the 2003 Plan to
an independent director that vests on a quarterly basis beginning three
months from the date of grant, conditioned upon continued service on such
quarterly dates, and has a contractual life of 3 years.  The fair
value of the option award is estimated on the date of grant using the
Black-Scholes option valuation model to be $171,397, of which $14,283 and
$16,944 was recorded as compensation expense in the three and nine months ended
July 31, 2010.  The valuation was based on the assumptions noted in
the following table.





Expected
      volatility
                    
                    
                    227.9
                    %Expected
      dividends
                    
                    
                    0
                    %Expected
      term (in years)
                    
                    3
      yearsRisk-free
      rate
                    
                    
                    1.65
                    %





The
risk-free interest rate is based on the U.S. Treasury yield curve in effect for
the expected term of the option at the time of grant.  The dividend
yield on our common stock is assumed to be zero since we do not pay dividends
and have no current plans to pay them in the future.  The market price
volatility of our common stock was based on historical volatility since April
13, 2009.  Our methodology is consistent with prior period volatility
assumptions.  The expected life of the options is based upon our
anticipated expectations of exercise behavior since no options have been
exercised in the past to provide relevant historical data.




22




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





(2)  2007
Non-Qualified Company Stock Grant and Option Plan





On March
19, 2007, our board of directors approved the 2007 Non-Qualified Company Stock
Grant and Option Plan (the “2007 Plan”).   The 2007 Plan is
intended to serve as an incentive to and to encourage stock ownership by
our  directors, officers, and employees, and certain persons rendering
service to us, so that such persons may acquire or increase their proprietary
interest in our success, and to encourage them to remain in our
service.  Under the 2007, up to 200,000 shares of our common stock may
be subject to options.





On
January 13, 2010, an option to purchase 50,000 shares was granted under the 2007
Plan to an employee that vests on the 12-month anniversary of the date of grant,
conditioned upon continued employment on such date, and has a contractual life
of 3 years.  The fair value of the option award is estimated on the
date of grant using the Black-Scholes option valuation model to be $47,527, of
which $11,882 and $25,815 was recorded as compensation expense in the three and
nine months ended July 31, 2010, respectively.  The valuation was
based on the assumptions noted in the following table.





Expected
      volatility
                      
                      
                      236.5
                      %Expected
      dividends
                      
                      
                      0
                      %Expected
      term (in years)
                      
                      3
      yearsRisk-free
      rate
                      
                      
                      1.5
                      %





The
risk-free interest rate is based on the U.S. Treasury yield curve in effect for
the expected term of the option at the time of grant.  The dividend
yield on our common stock is assumed to be zero since we do not pay dividends
and have no current plans to pay them in the future.  The market price
volatility of our common stock was based on historical volatility since January
13, 2009.  Our methodology is consistent with prior period volatility
assumptions.  The expected life of the options is based upon our
anticipated expectations of exercise behavior since no options have been
exercised in the past to provide relevant historical data.





A summary
of option activity under the Company’s option  plan as of July 31,
2010 and movement during the nine months then ended are as follow:




Options
                    
                    
                    Weighted
                      average
                      exercise price
                    
                    
                    Aggregate
                      intrinsic
                      value
                    
                    
                    Weighted
                      average
                      remaining
                      contractual
                      termUS$
                    
                    
                    US$Outstanding
      at November 1, 2009
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Granted
                    
                    
                    120,000
                    
                    
                    
                    1.92
                    
                    
                    
                    16,100
                    
                    
                    
                    2.60Exercised
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Forfeited
      or expired
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Outstanding
      at July 31, 2010
                    
                    
                    120,000
                    
                    
                    
                    1.92
                    
                    
                    
                    16,100
                    
                    
                    
                    2.60  23




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





A summary
of the status of the Company’s non-vested options as of July 31, 2010 and
movements during the nine months then ended are as follow:





Options
                  
                  
                  Weighted average
                    granted date fair
                    valueUS$Non-vested
      at November 1, 2009
                  
                  
                  -
                  
                  
                  
                  -Granted
                  
                  
                  120,000
                  
                  
                  
                  1.91Vested
                  
                  
                  -
                  
                  
                  
                  -Forfeited
      or expired
                  
                  
                  -
                  
                  
                  
                  -Non-vested
      at July 31, 2010
                  
                  
                  120,000
                  
                  
                  
                  1.91





As of
July 31, 2010, there was $202,330 of unrecognized compensation cost related to
non-vested share-based compensation granted under the Company’s option
plan.  The cost is expected to be recognized over a period of 2.96
years.





(3)  Warrants





As of
July 31, 2010, the Company has 1,231,428 warrants outstanding at an average
exercise price of $1.25 per warrant for one share each of the Company’s common
stock. The warrants expire in 2012 and 2013.





Warrants
                      
                      
                      Average exercise
                        priceUS$Outstanding
      warrants at November 1, 2009
                      
                      
                      1,071,428
                      
                      
                      
                      0.88Warrants
      granted
                      
                      
                      160,000
                      
                      
                      
                      2.00Exercised
                      
                      
                      -
                      
                      
                      
                      -Expired/cancelled
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      warrants at July 31, 2010
                      
                      
                      1,231,428
                      
                      
                      
                      1.25





Information
regarding the warrants outstanding at July 31, 2010 is summarized as
below:




Warrants outstanding atJuly 31, 2010Weighted
                        
                        
                        WeightedAverage
                        
                        
                        AverageRemaining
                        
                        
                        ExerciseExercise
      Prices
                        
                        Warrants
                        
                        
                        Contractual
                        
                        
                        PriceUS$
                        
                        Outstanding
                        
                        
                        Life
      (years)
                        
                        
                        US$0.88
                        
                        
                        1,071,4282.00
                        
                        
                        160,0001,231,428
                        
                        
                        
                        1.91
                        
                        
                        
                        1.02





24




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





16.           STATUTORY
RESERVES





The
reserve funds as of July 31, 2010 and October 31, 2009 were comprised of the
following:




2010
                  
                  
                  2009US$
                  
                  
                  US$Statutory
      surplus reserve
                  
                  
                  3,090,320
                  
                  
                  
                  3,090,320Public
      welfare fund
                  
                  
                  282,377
                  
                  
                  
                  282,377Total
                  
                  
                  3,372,697
                  
                  
                  
                  3,372,697




(1) Statutory
reserves





Pursuant
to the relevant laws and regulations of the PRC, the Company is required to
annually transfer 10% of its after tax profit as reported on financial
statements prepared under the accounting principles of the PRC to a statutory
surplus reserve fund until the balance reaches 50% of the registered share
capital.  This reserve can be used to make up any losses incurred or
to increase share capital.  Except for reducing losses incurred, any
other application may not result in this reserve balance falling below 25% of
the registered capital.





(2)
Public welfare funds





Prior to
January 1, 2007, the Company was required each year to transfer 5% of its after
tax profit as reported on consolidated financial statements prepared under the
accounting principles of the PRC to the public welfare funds.  This
reserve was restricted to capital expenditure for employees’ collective welfare
facilities that are owned by the Company.  The public welfare funds
are not available for distribution to the stockholders (except in
liquidation).  Once capital expenditures for staff welfare facilities
have been made, an equivalent amount must be transferred from the public welfare
funds to the discretionary common reserve funds.  Due to a change in
PRC law, appropriation of profit to the public welfare funds is no longer
required.





17.           COMMITMENTS
AND CONTINGENCIES





The
Company has various purchase commitments for materials, supplies and services
incident to the ordinary conduct of business, generally for quantities required
for the Company’s business and at prevailing market prices. No material annual
loss is expected from these commitments and there are no minimum purchase
commitments.





The
Company and its subsidiaries are self-insured, and they do not carry any
property insurance, general liability insurance, or any other insurance that
covers the risks of their business operations. As a result any material loss or
damage to its properties or other assets, or personal injuries arising from its
business operations would have a material adverse effect on the Company’s
financial condition and operations.




The
Company is not involved in any legal matters arising in the normal course of
business. While incapable of estimation, in the opinion of the management, the
individual regulatory and legal matters in which it might involve in the future
are not expected to have a material adverse effect on the Company’s financial
position, results of operations, or cash flows.




25




RENHUANG
PHARMACEUTICALS, INC.


NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


July
31, 2010 and 2009





(1)  Operating
lease arrangements





The
Company leases office premise from a third party, Heilongjiang Jiusanyouzhi Co.,
Ltd.  The lease is from May 1, 2007 to April 30, 2010, with monthly
rental payment of $10,484.





The
Company also leases property and plant from a related party, Harbin Renhuang
Pharmaceutical Stock Co. Ltd.  The lease is from April 30, 2009 to May
1, 2010, with monthly rental payment of $51,246.





As of
July 31, 2010, there is no minimum lease payment in future years.





During
the three months ended July 31, 2010 and 2009, the Company incurred rental
expenses in the amount of $186,301 and $153,659, respectively.





During
the nine months ended July 31, 2010 and 2009, the Company incurred rental
expenses in the amount of $366,977 and $374,416, respectively.





(2)  Capital
commitments





As of
July 31, 2010, the Company has capital commitments for purchase of land use
right, property and equipment, office floors and production patents of
approximately $11,338,743.





18.           SUBSEQUENT
EVENT





In May
2009, the FASB issued accounting guidance now codified as FASB ASC Topic 855,
“Subsequent Events,”
which establishes general standards of accounting for, and disclosures of,
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued.  FASB ASC Topic 855 is
effective for interim or fiscal periods ending after June 15, 2009.





Management
has evaluated subsequent events from July 31, 2010 to September 17, 2010, the
date which the Company’s condensed consolidated financial statements have been
issued and were available to be issued.  As of August 3, 2010, Ms. Yan
Yi Chen, the Company's Chief Financial Officer, resigned for personal
reasons.  Subsequent events that may occur after September 17, 2010
have not been evaluated in the condensed consolidated financial statements as of
July 31, 2010.


26


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





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited consolidated
financial statements and related notes appearing elsewhere in this Quarterly
Report.  In addition to historical financial information, the
following discussion contains forward-looking statements that reflect our plans,
estimates and beliefs.  Our actual results could differ materially
from those discussed in the forward-looking statements.  Factors that
could cause or contribute to these differences include those discussed below and
elsewhere in this Quarterly Report. See also Risk Factors contained in our Form
10-K for the year ended October 31, 2009.





Overview





We are a
high-tech enterprise engaged in the development, manufacturing, and distribution
of botanical products, bio-pharmaceutical products, and traditional Chinese
medicines, or TCM, in the People’s Republic of China. We have three GMP
certified production facilities - Ah City natural and biopharmaceutical plant,
Dongfanghong pharmaceutical plant and Qingyang natural extraction plant -capable
of producing 18 dosage forms and over 200 different products. Our products
include but are not limited to (i) botanical anti-depression and
nerve-regulation products, (ii) biopharmaceutical products, and (iii) botanical
antibiotic and traditional OTC Chinese medicines.  Botanical
anti-depression and nerve-regulation products account for over 50% of our
revenues and we intend to strengthen our developments in this
area.  We have entered into sales agency agreements with sales agents
in 19 provinces and four municipalities, through which our products are sold to
over 3,000 distributors and over 70 sales centers across 24 provinces in
China.





Factors
Affecting our Results of Operations





Our
operating results are primarily affected by the following factors




·
            Pharmaceutical
      Industry Growth.We believe the market for
      pharmaceutical products in China is growing rapidly driven by China’s
      economic growth, increased pharmaceutical expenditure, an aging
      population, increased lifestyle-related diseases, government support of
      the pharmaceutical industry, as well as the increased availability of
      funding for medical insurance in China.   In particular, in
      January 2009, the PRC’s State Council passed a far-reaching medical
      reform plan (“Health Reform”) to help provide universal primary medical
      insurance coverage and increased access to medical facilities to a greater
      majority of its citizens.  We expect these factors to continue
      to drive industry growth.





·
            Production
      Capacity.We
      believe much of the pharmaceutical market in China is still underserved,
      particularly with respect to treatment of depression, melancholy and nerve
      regulation. In 2009 the demand for our products that treat depression,
      melancholy and regulate nerves, increased and we were able to increase our
      production of such products to capture much of this growth. We believe our
      facilities with the ability to manufacture 18 dosage forms and over
      200 products will allow us to capture future market growth and increase
      our revenue and market share
accordingly.





·
            Perceptions
      of Product Quality. We believe that rising health concerns in China
      have contributed to a greater demand for health-care products with
      perceived health benefits.  We believe many consumers in China
      tend to prefer natural health care products with, we believe, limited side
      effects.  Accordingly, we believe our reputation for quality and
      leadership position in a number of our products allow our products to
      command a higher average selling price and generate higher gross margins
      than our competitors.





·
            Raw
      Material Supply and Prices.  The per unit costs of
      producing our products are subject to the supply and price volatility of
      raw materials, which are affected by various market factors such as market
      demands, fluctuations in production and
  competition.





·
            Expenses
      Associated with
      Research and Development. In order to enhance
      our existing products and develop new products for the market, we have
      devoted significant resources to
R&D.


27


·
            Expenses
      Associated with Sales and Marketing.In order to promote
      our product brand and gain greater market awareness, we have devoted
      significant resources to sales and marketing, in particular advertising
      activities.





·
            Pricing of
      Our Products.  Seven of our products, which accounted for
      36% of our total revenues in fiscal year 2009, are subject to government
      pricing control.  We do not believe pricing control will
      influence our sales significantly and expect that the health care reform
      will help increase our sales.





·
            Demand for
      Our Products.  We expect the market demand for our
      botanic anti-depression and nerve-regulation products will increase along
      with the growth of the general market for such
  products.





Results of
Operations





Three-Month
Period Ended July 31, 2010 Compared to Three-Month Period Ended July 31,
2009





The
following table sets forth certain information regarding our results of
operation.





Three Months Ended July 312010
                
                
                2009($ in thousands)Statements
      of Operations DataSales,
      net
                
                
                9,264
                
                
                
                6,442Cost
      of goods sold
                
                
                4,621
                
                
                
                2,942Gross
      profit
                
                
                4,643
                
                
                
                3,500Operating
      and administrative expensesSales
      and marketing
                
                
                1,285
                
                
                
                1,110General
      and administrative
                
                
                395
                
                
                
                500Research
      and development
                
                
                1,529
                
                
                
                1,227Other
      income
                
                
                22
                
                
                
                12Income
      from operation before income tax expenses
                
                
                1,456
                
                
                
                675Income
      tax expenses
                
                
                -
                
                
                
                -Net
      income
                
                
                1,456
                
                
                
                675Other
      comprehensive income:Cumulative
      currency translation adjustments
                
                
                462
                
                
                
                (94
                )Total
      comprehensive income
                
                
                1,918
                
                
                
                581





Total
Comprehensive Income


Total
comprehensive income increased by approximately $1,337 thousand, or 230.1%, from
approximately $581 thousand in 2009 to approximately $1,918 thousand in
2010.  This increase was mainly attributable to the increased
sale of our Botanical antibiotic products, Banlangen Granules and Compound
Honeysuckle Granules that were introduced to the market in the last quarter of
2009 and an increase in average selling prices across our products.  Our
gross profit margin decreased from 54.3% in 2009 to 50.1% in 2010, as a result
of reduced sales rebates and price increases of a number of our
products.





Sales


Our sales
consist primarily of revenues generated from sales of Botanical anti-depression
and nerve-regulation products, Biopharmaceutical products and Botanical
antibiotics and traditional OTC Chinese medicines.  Sales increased by
approximately $2,822 thousand, or 43.8%, from approximately $6,442 thousand in
2009 to approximately $9,264 thousand in 2010.  This increase in sales
was primarily attributable to strong demands for our Botanical antibiotic
products, Banlangen Granules and Compound Honeysuckle Granules that were
introduced to the market in the last quarter of 2009, in addition to an increase
in average selling prices across our products.





We
provide incentive sales rebates to our sales agents.  The rebate rate,
which is determined on a product basis, averaged 11% and 21% of sales for the
three months ended July 31, 2010 and 2009, respectively.  Sales
rebates are netted against total sales. For the three months ended July 31, 2010
and 2009, the Company has deducted sales rebatesin the amountof $1,018,359 and $1,361,965,
respectively, from sales.  Sales rebates arecalculated based on terms specified in
contracts with individual distributors.  In addition,the Company is using different sales
channels and relying less on the use of sales
agents.


28




The
following table sets forth information regarding the sales of our principal
products before sales rebate during the three months ended July 31, 2010 and
2009:





2010
                
                
                2009
                
                
                2010 over 2009Product name
                
                Quantity
                  (Pack’000)
                
                
                Amount
                  ($’000)
                
                
                % of Sales
                
                
                Quantity
                  (Pack’000)
                
                
                Amount
                  ($’000)
                
                
                % of Sales
                
                
                Quantity
                  (Pack’000)
                
                
                Amount
                  ($’000)
                
                
                % of SalesSiberian
      Ginseng (Acanthopanax) Series
                
                
                53
                
                
                
                4,439
                
                
                
                43.9
                
                
                
                67
                
                
                
                4,333
                
                
                
                55.3
                
                
                
                (14
                )
                
                
                106
                
                
                
                2.4Tianma
      Series
                
                
                9
                
                
                
                763
                
                
                
                7.5
                
                
                
                10
                
                
                
                754
                
                
                
                9.6
                
                
                
                (1
                )
                
                
                9
                
                
                
                1.2Compound
      Yangjiao Tablets
                
                
                13
                
                
                
                1,352
                
                
                
                13.4
                
                
                
                17
                
                
                
                1,322
                
                
                
                16.9
                
                
                
                (4
                )
                
                
                30
                
                
                
                2.3Shark
      Vital Capsules
                
                
                1
                
                
                
                235
                
                
                
                2.3
                
                
                
                2
                
                
                
                759
                
                
                
                9.7
                
                
                
                (1
                )
                
                
                (524
                )
                
                
                (69
                )Shengmai
      Granules
                
                
                16
                
                
                
                677
                
                
                
                6.7
                
                
                
                18
                
                
                
                663
                
                
                
                8.5
                
                
                
                (2
                )
                
                
                14
                
                
                
                2.1Banlangen
      Granules
                
                
                9
                
                
                
                290
                
                
                
                2.9
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                9
                
                
                
                290
                
                
                
                100Compound
      Honeysuckle Granules
                
                
                39
                
                
                
                2,350
                
                
                
                23.3
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                39
                
                
                
                2,350
                
                
                
                100Total
                
                
                140
                
                
                
                10,106
                
                
                
                100.0
                
                
                
                114
                
                
                
                7,831
                
                
                
                100.0





We
experienced a slight decrease in the demand of a number of our products mainly
from reduced order volumes as the effect of the Health Reform filters through
the chain drug stores.  The chain drug stores reacting to the
potential competition that the Heath Reform may bring are being cautious and
maintaining lower than usual stock levels.  As the PRC government
moves forward with the Health Reform, hospitals, health clinics and institutions
will be established in villages, remote regions and under-developed cities,
creating additional channels for the rural population to purchase drugs aside
from the chain drug stores.  We expect the Health Reform, when fully
in place, will greatly improve the rural population’s access to healthcare, and
therefore increase the demand for our products.  We have established
Medical Reform Sales Department as a dedicated resource focused on capturing
this tremendous growth opportunity.




This quarter ended July 31, 2010, we
introduced two new products to the market,Qing Re Jie Du Oral Liquid, which
detoxified and removing heat from intestines,and Compound Schisandra Tablets, also
known as magnolia vine, has been clinicallyproven to have significant benefits to
the functioning and regulation of the centralnervous system and for upper body
respiration.




In the
last quarter of 2009, we introduced two new products to the market, Banlangen
Granules and Compound Honeysuckle Granules, both of which have well accepted
anti-viral qualities, and were in great demand during and post the H1N1 pandemic
and the winter season.





In 2010,
we experienced an increase in the average sales price per pack of our products,
as demonstrated in the table below:




2010
                
                
                2009Sales
      revenues (in thousands)
                
                $
                10,106
                
                
                $
                7,831Total
      sales quantity (pack in thousands)
                
                
                140
                
                
                
                114Average
      selling prices/pack (in thousands)
                
                $
                72.19
                
                
                $
                68.69





The
increase in average sales price per pack, as reflected in the table, is
primarily attributable to a change in sale mix, with more products with lower
average price per pack sold, namely Banlangen Granules and Compound Honeysuckle
Granules.  Overall, the average price of individual products sold in
both 2010 and 2009 increased as demonstrated in the following table, which
reflects the average sales price per pack by product for 2010 and 2009 and the
percentage change in the sales price per pack.


29




Average Price Per PackProduct
                      
                      2010
                      
                      
                      2009
                      
                      
                      Percentage ChangeSiberian
      Ginseng (Acanthopanax) Series
                      
                      $
                      83.75
                      
                      
                      $
                      64.67
                      
                      
                      
                      29.5Tianma
      Series
                      
                      
                      84.78
                      
                      
                      
                      75.40
                      
                      
                      
                      12.4Compound
      Yangjiao Tablets
                      
                      
                      104.00
                      
                      
                      
                      77.76
                      
                      
                      
                      33.74Shark
      Vital Capsules
                      
                      
                      235.00
                      
                      
                      
                      379.50
                      
                      
                      
                      (38.08
                      )Shengmai
      Granules
                      
                      
                      42.31
                      
                      
                      
                      36.83
                      
                      
                      
                      14.9Banlangen
      Granules
                      
                      
                      32.22
                      
                      
                      
                      -
                      
                      
                      
                      100.0Compound Honeysuckle
    Granules
                      
                      
                      60.26
                      
                      
                      
                      -
                      
                      
                      
                      100.0





In
addition to increasing the price of Shengmai Granules, we recently introduced
new dosage forms to our existing Botanical anti-depression and nerve-regulation
product category, which contain less sugar content and are suitable for diabetic
patient consumption.  We were able to demand a higher price for these
new dosage forms, namely in our Siberian Ginseng (Acanthopanax) Series and
Compound Yangjiao Tablets.  We plan to launch our latest product,
Badger Oil, a natural medicine for the treatment of burns with no known toxic
side effects or allergic reactions in the last quarter of the
year.  Based on market research, we anticipate positive market
acceptance to the new product.





Cost
of Goods Sold


Our costs
of goods sold consist primarily of direct and indirect manufacturing costs,
including production overhead costs, and shipping and handling costs for the
products sold.  Cost of goods sold increased approximately $1,679
thousand, or 57.1%, from approximately $2,942 thousand in 2009 to approximately
$4,621 thousand in 2010.





Although
we anticipate that the cost of goods will increase due to inflationary price
increases, we do not believe that such increases will be material for fiscal
year 2010.  We anticipate that beyond 2010, our price for raw
materials and other production costs will continue to increase due to inflation.
If our costs of goods increase, this may have a negative effect on our net
income because, due to market conditions and competitive conditions, we may not
be able to increase the price for our products in proportion to the increase of
our costs of goods sold.





Operating
and Administrative Expenses


Our total
operating expenses increased by approximately $372 thousand, or 13.1%, from
approximately $2,837 thousand in 2009 to approximately $3,209 thousand in 2010.
This increase was primarily attributable to an increase of approximately $175
thousand, or 15.8%, in sales and marketing expenses from approximately $1,110
thousand for 2009 to approximately $1,285 thousand for 2010, as we continued to
invest in our distribution network and increase TV advertising to increase
product market share and create greater consumer awareness of our premium
quality products.  This increase was also attributable to a decrease
of approximately $105 thousand, or 21% in general and administrative expenses
from approximately $500 thousand for 2009 to approximately $395 thousand for
2010,  and an increase of research and development expenses of
approximately $302 thousand, or 24.6% from approximately $1,227 thousand for
2009 to approximately $1,529 thousand for 2010.  We expect research
and development expenses to continue to increase in the coming quarters as our
pipeline projects advance and our pipeline size grows.





Income
from Operations


As a
result of the foregoing, our income from operations increased by approximately
$781 thousand, or 115.7%, from approximately $675 thousand in 2009 to
approximately $1,456 thousand in 2010.





Income
Tax Expenses


We are
subject to U.S. federal and state income taxes.  Our subsidiary
registered in the PRC is subject to enterprise income taxes.  For the
fiscal year of 2010 and 2009, our PRC subsidiary was granted a tax holiday and
is entitled to full exemption from enterprise income taxes of 25%.




30




Cumulative
Currency Translation Adjustments


Our
principal country of operations is the PRC and our functional currency is the
Renminbi, but our reporting currency is the U.S. dollar.  All
translation adjustments resulting from the translation of our financial
statements into U.S. dollars are reported as cumulative currency translation
adjustments.  Our cumulative currency translation adjustments
increased by approximately $556 thousand, or 591.5%, from approximately negative
$94 thousand in 2009 to approximately $462 thousand in 2010.





Nine-Month
Period Ended July 31, 2010 Compared to Nine-Month Period Ended July 31,
2009





The
following table sets forth certain information regarding our results of
operation.





Nine Months Ended July 312010
                
                
                2009($ in thousands)Statements
      of Operations DataSales,
      net
                
                
                38,489
                
                
                
                28,915Cost
      of goods sold
                
                
                18,151
                
                
                
                13,826Gross
      profit
                
                
                20,338
                
                
                
                15,089Operating
      and administrative expensesSales
      and marketing
                
                
                3,689
                
                
                
                2,535General
      and administrative
                
                
                2,209
                
                
                
                1,712Research
      and development
                
                
                2,252
                
                
                
                1,833Other
      income
                
                
                49
                
                
                
                31Income
      from operation before income tax expenses
                
                
                12,237
                
                
                
                9,040Income
      tax expenses
                
                
                -
                
                
                
                -Net
      income
                
                
                12,237
                
                
                
                9,040Other
      comprehensive income:Cumulative
      currency translation adjustments
                
                
                302
                
                
                
                (80
                )Total
      comprehensive income
                
                
                12,539
                
                
                
                8,960





Total
Comprehensive Income


Total
comprehensive income increased by approximately $3,579 thousand, or 39.9%, from
approximately $8,960 thousand in 2009 to approximately $12,539 thousand in
2010.  This increase was mainly attributable to the increased
sales of our Botanical antibiotic products, Banlangen Granules and Compound
Honeysuckle Granules that were introduced to the market in the last quarter of
2009 and an increase in average selling prices across our
products.  Our gross profit margin increased from 52.2% in 2009 to
52.8% in 2010, as a result of reduced sales rebates and prices increases of a
number of our products.





Sales


Our sales
consist primarily of revenues generated from sales of Botanical anti-depression
and nerve-regulation products, Biopharmaceutical products and Botanical
antibiotics and traditional OTC Chinese medicines.  Sales increased by
approximately $9,574 thousand, or 33.1%, from approximately $28,915 thousand in
2009 to approximately $38,489 thousand in 2010.  This increase in
sales was primarily attributable to strong demands for our Botanical antibiotic
products, Banlangen Granules and Compound Honeysuckle Granules that were
introduced to the market in the last quarter of 2009, in addition to an increase
in average selling prices across our products.





We
provide incentive sales rebates to our sales agents.  The rebate rate,
which is determined on a product basis, averaged 13% and 23% of sales for the
nine months ended July 31, 2010 and 2009, respectively.  Sales rebates
are netted against total sales. For the nine months ended July 31, 2010
and 2009, the Company has deducted sales rebates inthe amount of $4,923,196 and $6,545,697,
respectively, from sales.  Sales rebates are calculatedbased on terms specified in contracts
with individual distributors.In addition, the
Companyis using different sales channels and
relying less on the use of sales agents.




31




The
following table sets forth information regarding the sales of our principal
products before sales rebate during the nine months ended July 31, 2010 and
2009:




2010
                
                
                2009
                
                
                2010 over 2009Product name
                
                Quantity
                  (Pack’000)
                
                
                Amount
                  ($’000)
                
                
                % of Sales
                
                
                Quantity
                  (Pack’000)
                
                
                Amount
                  ($’000)
                
                
                % of Sales
                
                
                Quantity
                  (Pack’000)
                
                
                Amount
                  ($’000)
                
                
                % of SalesSiberian
      Ginseng (Acanthopanax) Series
                
                
                236
                
                
                
                19,121
                
                
                
                44.3
                
                
                
                296
                
                
                
                19,272
                
                
                
                54.3
                
                
                
                (60
                )
                
                
                (151
                )
                
                
                (0.8
                )Tianma
      Series
                
                
                46
                
                
                
                3,553
                
                
                
                8.2
                
                
                
                47
                
                
                
                3,509
                
                
                
                9.9
                
                
                
                (1
                )
                
                
                44
                
                
                
                1.3Compound
      Yangjiao Tablets
                
                
                59
                
                
                
                5,528
                
                
                
                12.8
                
                
                
                65
                
                
                
                5,175
                
                
                
                14.6
                
                
                
                (6
                )
                
                
                353
                
                
                
                6.8Shark
      Vital Capsules
                
                
                4
                
                
                
                1,973
                
                
                
                4.6
                
                
                
                10
                
                
                
                4,814
                
                
                
                13.6
                
                
                
                (6
                )
                
                
                (2,841
                )
                
                
                (59.0
                )Shengmai
      Granules
                
                
                68
                
                
                
                2,772
                
                
                
                6.4
                
                
                
                79
                
                
                
                2,692
                
                
                
                7.6
                
                
                
                (11
                )
                
                
                80
                
                
                
                3.0Banlangen
      Granules
                
                
                45
                
                
                
                1,230
                
                
                
                2.8
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                45
                
                
                
                1,230
                
                
                
                100.0Compound
      Honeysuckle Granules
                
                
                152
                
                
                
                9,028
                
                
                
                20.9
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                152
                
                
                
                9,028
                
                
                
                100.0Total
                
                
                610
                
                
                
                43,205
                
                
                
                100.0
                
                
                
                497
                
                
                
                35,462
                
                
                
                100.0





In the
first quarter of 2010, we increased the price of a number of our products
namely, Siberian Ginseng (Acanthoopanax) Series and Shengmai Granules, which has
led to a temporary softening in demand for these products as a result of the
price increases.  Although sales declined slightly in these product
categories in the first quarter, we show volume rebounded in the second and
third quarter, however, this was offset by a slight decrease in the demand
of a number of our products mainly from reduced order volumes as the effect of
the Health Reform filters through the chain drug stores.  The chain
drug stores reacting to the potential competition that the Heath Reform may
bring are being cautious and maintaining lower than usual stock
levels.  As the PRC government moves forward with the Health Reform,
hospitals, health clinics and institutions will be established in villages,
remote regions and under-developed cities, creating additional channels for the
rural population to purchase drugs aside from the chain drug
stores.  We expect the Health Reform, when fully in place, will
greatly improve the rural population’s access to healthcare, and therefore
increase the demand for our products.  We have established Medical
Reform Sales Department as a dedicated resource focused on capturing this
tremendous growth opportunity.




This quarter ended July 31, 2010, we
introduced two new products to the market,Qing Re Jie Du Oral Liquid, which
detoxified and removing heat from intestines,and Compound Schisandra Tablets, also
known as magnolia vine, has been clinicallyproven to have significant benefits to
the functioning and
regulation of the centralnervous system and for upper body
respiration.


In the
last quarter of 2009, we introduced two new products to the market, Banlangen
Granules and Compound Honeysuckle Granules, both of which have well accepted
anti-viral qualities, and were in great demand during and post the H1N1 pandemic
and the winter season.





In 2010,
we experienced a decrease in the average sales price per pack of our products,
as demonstrated in the table below:




2010
                
                
                2009Sales revenues (in thousands)
                
                $
                43,205
                
                
                $
                35,462Total
      sales quantity (pack in thousands)
                
                
                610
                
                
                
                497Average
      selling prices/pack (in thousands)
                
                $
                70.83
                
                
                $
                71.35


32




The
decrease in average sales price per pack, as reflected in the table, is
primarily attributable to a change in sale mix, with more products with lower
average price per pack sold, namely Banlangen Granules and Compound Honeysuckle
Granules.  Overall, the average price of individual products sold in
both 2010 and 2009 increased as demonstrated in the following table, which
reflects the average sales price per pack by product for 2010 and 2009 and the
percentage change in the sales price per pack.




Average Price Per PackProduct
                  
                  2010
                  
                  
                  2009
                  
                  
                  Percentage ChangeSiberian
      Ginseng (Acanthopanax) Series
                  
                  $
                  81.02
                  
                  
                  $
                  65.11
                  
                  
                  
                  24.4Tianma
      Series
                  
                  
                  77.24
                  
                  
                  
                  74.66
                  
                  
                  
                  3.5Compound
      Yangjiao Tablets
                  
                  
                  93.69
                  
                  
                  
                  79.62
                  
                  
                  
                  17.7Shark
      Vital Capsules
                  
                  
                  493.25
                  
                  
                  
                  481.40
                  
                  
                  
                  2.5Shengmai
      Granules
                  
                  
                  40.76
                  
                  
                  
                  34.08
                  
                  
                  
                  19.6Banlangen
      Granules
                  
                  
                  27.33
                  
                  
                  
                  -
                  
                  
                  
                  100.0Compound
      Honeysuckle Granules
                  
                  
                  59.40
                  
                  
                  
                  -
                  
                  
                  
                  100.0





In
addition to increasing the price of a number of our products in the first
quarter of 2010, namely Siberian Ginseng (Acanthoopanax) Series and Shengmai
Granules, we recently introduced new dosage forms to our existing Botanical
anti-depression and nerve-regulation product category, which contain less sugar
content and are suitable for diabetic patient consumption.  We were
able to demand a higher price for these new dosage forms, namely in our Siberian
Ginseng (Acanthopanax) Series and Compound Yangjiao Tablets.  We plan
to launch our latest product, Badger Oil, a natural medicine for the treatment
of burns with no known toxic side effects or allergic reactions in the last
quarter of the year.  Based on market research, we anticipate positive
market acceptance to the new product.





Cost
of Goods Sold


Our costs
of goods sold consist primarily of direct and indirect manufacturing costs,
including production overhead costs, and shipping and handling costs for the
products sold.  Cost of goods sold increased approximately $4,325
thousand, or 31.3%, from approximately $13,826 thousand in 2009 to approximately
$18,151 thousand in 2010.  This increase was primarily attributable to
increased products sold and increase in raw material prices, namely sugar, which
had a price increase in March 2010 of approximately 32%.





Although
we anticipate that the cost of goods will increase due to inflationary price
increases, we do not believe that such increases will be material for fiscal
year 2010.  We anticipate that beyond 2010, our price for raw
materials and other production costs will continue to increase due to inflation.
If our costs of goods increase, this may have a negative effect on our net
income because, due to market conditions and competitive conditions, we may not
be able to increase the price for our products in proportion to the increase of
our costs of goods sold.





Operating
and Administrative Expenses


Our total
operating expenses increased by approximately $2,070 thousand, or 34.0%, from
approximately $6,080 thousand in 2009 to approximately $8,150 thousand in 2010.
This increase was primarily attributable to an increase of approximately $1,154
thousand, or 45.5%, in sales and marketing expenses from approximately $2,535
thousand for 2009 to approximately $3,689 thousand for 2010, as we continued to
invest in our distribution network and increase TV advertising to increase
product market share and create greater consumer awareness of our premium
quality products.  This increase was also attributable to an increase
of approximately $497 thousand, or 29.0% in general and administrative expenses
from approximately $1,712 thousand for 2009 to approximately $2,209 thousand for
2010, and an increase of approximately $419 thousand, or 22.9% in research and
development expenses from approximately $1,833 thousand for 2009 to
approximately $2,252 thousand for 2010.  We expect research and
development expenses to continue to increase in the coming quarters as our
pipeline projects advance and our pipeline size grows.





Income
from Operations


As a
result of the foregoing, our income from operations increased by approximately
$3,197 thousand, or 35.4%, from approximately $9,040 thousand in 2009 to
approximately $12,237 thousand in 2010.


33




Income
Tax Expenses


We are
subject to U.S. federal and state income taxes.  Our subsidiary
registered in the PRC is subject to enterprise income taxes.  For the
fiscal year of 2010 and 2009, our PRC subsidiary was granted a tax holiday and
is entitled to full exemption from enterprise income taxes of 25%.





Cumulative
Currency Translation Adjustments


Our
principal country of operations is the PRC and our functional currency is the
Renminbi, but our reporting currency is the U.S. dollar.  All
translation adjustments resulting from the translation of our financial
statements into U.S. dollars are reported as cumulative currency translation
adjustments.  Our cumulative currency translation adjustments
increased by approximately $382 thousand, or 477.5%, from approximately negative
$80 thousand in 2009 to approximately $302 thousand in 2010.




Liquidity
and Capital Resources




We had
retained earnings of approximately $47,824 thousand and $35,587 thousand as of
July 31, 2010 and October 31, 2009, respectively.  As of July 31,
2010, we had cash and cash equivalents of approximately $28,749 thousand and
total current assets of approximately $44,758 thousand.  As of July
31, 2010, we had a working capital surplus of approximately $42,265
thousand.   We believe our cash and cash equivalents are adequate
to satisfy our working capital needs and sustain our ongoing operations for the
next twelve months.





Our
summary cash flow information is as follows:




Nine months ended July 31Net cash provided by (used in):
                
                2010
                
                
                2009($ in thousands)Operating
      activities
                
                
                22,883
                
                
                
                3,059Investing
      activities
                
                
                (2,559
                )
                
                
                (16
                )Financing
      activities
                
                
                -
                
                
                
                -





Net
Cash Provided by Operating Activities


Net cash
provided by operating activities increased approximately $19,824 thousand, from
net cash provided by operating activities of approximately $3,059 thousand in
2009 to net cash provided by operating activities of approximately $22,883
thousand in 2010.  This increase was primarily attributable to an
increase in net income from operations of approximately $12,237 thousand, and a
reduction in trade receivables of approximately $12,386 thousand, as average
days sales outstanding fell to 118 days in 2010 from 186 days in 2009, which
included a period of sales term incentives.  We have recently
tightened our credit terms with our customers to be within 100 days and will
continue to increase our collection efforts to reduce our days sales
outstanding.  This increase in net cash provided by operating
activities was also attributable to a reduction in amounts due from related
parties by approximately $130 thousand, and a decrease in inventory level by
approximately $549 thousand.  Furthermore, this increase in net cash
provided by operating activities was offset in part by a decrease in value added
tax payable of approximately $715 thousand.





Net
Cash Used in Investing Activities


Net cash
used in investing activities increased approximately $2,543 thousand, from
approximately $16 in 2009 to approximately $2,559 thousand in
2010.  This increase was primarily attributable to approximately
$2,559 thousand of payments made to purchase office floors from a third party
during the period ending April 30, 2010.





Outstanding
Long-Term Indebtedness





None.





Off-balance
Sheet Arrangements





We do not
have any off-balance sheet arrangements.


34




Capital
commitments





We have
capital commitments for purchase of land use right, property and equipment and
production patents from a related party, Stock Co, of approximately
$9,655,051.  In addition, on April 10, 2010, the Company, through its
wholly own subsidiary, Harbin Renhuang Pharmaceutical Co. Ltd, entered into a
Property Sale and Purchase Contract (“Purchase Agreement”) with
Hongxiangmingyuan of Heilongjiang Yongtai Company, to acquire two office floors
in a building located in the Nangang District, Harbin, PRC, for total
consideration of $5,612,306.  Pursuant to the Purchase Agreement, a
payment of $3,928,614 was made in April 2010, and the final payment of
approximately $1,683,692 is due by December 20, 2012, at which time title to the
property will be transferred to the Company.  We expect to fund these
commitments with cash provided from operations.





Item 3. Quantitative and Qualitative
Disclosures about Market Risk.





Because
we are a smaller reporting company, this Item 3 is not applicable.





Item 4. Controls and
Procedures.





Evaluation
of Disclosure Controls and Procedures





As of
July 31, 2010, we carried out an evaluation, under the supervision and with the
participation of our management, including our chief executive officer and chief
financial officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures, as such term is defined under Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended.  We did not timely file our quarterly reports on Form 10-Q
for the quarters ended January 31, April 30, and July 31, 2008 which were filed
in January 2010.  In addition, we did not timely file a Form 8-K, Item
4. Non-Reliance on Previously Issued Financial Statement or a Related Audit
Report or Completed Interim Review.  Accordingly, based upon that
evaluation, the chief executive officer and chief financial officer have
concluded that our disclosure controls and procedures were not effective to
ensure that information required to be disclosed in our periodic reports filed
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified by the Securities and Exchange Commission’s rules and
regulations.





Changes
in Internal Controls Over Financial Reporting





As
previously disclosed in our Form 10-K for the year ended October 31, 2009, as of
July 31, 2010, we have not yet completed documentation of controls placed in
operation to adequately address our financial reporting
risks.  Accordingly, we have not yet had the opportunity to assess the
effectiveness of our procedures to determine whether our internal control over
financial reporting is effective.   Further, as discussed above,
in light of our failure to timely file our periodic reports, we did not believe
that our disclosure controls and procedures were effective at July 31,
2010.  Accordingly, management has concluded that we did not maintain
effective internal control over financial reporting as of July 31,
2010.





As a
result of the above, since the third quarter of our 2009 fiscal year, we have
begun the implementation of remedial measures including hiring of a new chief
financial officer in January 2010 (which resigned on August 3, 2010 for personal
reason and replaced by an interim chief financial officer), adding additional
staff, appointing three independent Directors to our Board of Directors,
engaging consultants to advise management on the preparation of Sarbanes-Oxley
Section 404 compliance with internal controls over financial reporting for
fiscal year 2010, providing relevant training to our staff, implementing more
rigorous policies and procedures relating to period-end financial reporting and
other key processes, strengthening key controls such as journal-entry approval,
reconciliation procedures and maintaining relevant supporting documentation. We
expect to continue to implement additional financial and management controls and
procedures going forward.  As a result of these measures and until we
have completed the remediation process, there has been and will be changes and
further improvement to our internal controls over financial
reporting.




35




PART II





Item 1. Legal
Proceedings.





As of
August 30, 2010, we are not a party to, or threatened by, any legal
proceedings.




Item 1A. Risk
Factors.





Because
we are a smaller reporting company, this Item 1A is not applicable.





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





None.





Item 3.  Defaults upon Senior
Securities.





In the
nine-month period ended July 31, 2010, and subsequent period through the date
hereof, we did not default upon any senior securities.





Item 4. [REMOVED
AND RESERVED].





Item 5.  Other
Information.





None.


36




Item
6.  Exhibits.





Exhibit
                  No.
                
                Description3.1
                
                Restated
      Articles of Incorporation(1)3.2
                
                Second
      Restated Bylaws(1)3.3
                
                Certificate
      of Amendment to Articles of Incorporation(2)10.1
                
                Renhuang
      Pharmaceuticals, Inc. 2007 Non-Qualified Company Stock Grant and Option
      Plan(3)10.2
                
                2003
      Omnibus Securities Plan(4)10.4
                
                English
      translation of Purchase Agreement for Patents, dated September 1,
      2009(5)10.5
                
                English
      translation of Purchase Agreement for Ah City Natural and
      Biopharmaceutical Plant, dated October 12, 2009(5)10.6
                
                English
      translation of Purchase Agreement with Hongxiangmingyuan of Heilongjiang
      Yongtai Company, dated April 10, 2010(6)10.7
                
                Independent
      Director Agreement with Mr. Xiaoheng (Sean) Shao, dated April 13,
      2010(6)10.8
                
                Independent
      Director Agreement with Mr. Bingchun Wu, dated April 19, 2010(6)10.9
                
                Independent
      Director Agreement with Mr. Changxiong Sun, dated April 19, 2010(6)10.10
                
                Acquisition
      Agreement with Yichun Red Star Forest Bureau of Acanthopanax Resources,
      dated July 8, 2010(7)21.1
                
                Subsidiaries
      of the registrant(2)31.1
                
                Certification
      of Principal Executive Officer pursuant to Rules 13a-14 and 15d-14(a), as
      adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002*31.2
                
                Certification
      of Principal Financial Officer pursuant to Rules 13a-14 and 15d-14(a), as
      adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002*32.1
                
                Certification
      of Principal Executive and Financial Officers pursuant to 18 U.S.C.
      § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
      of 2002*





*
              Filed
      herewith.
 (1)
              Incorporated by reference from
      Form 8-K filed with the SEC on April 22,
  2003.
 (2)
              Incorporated by reference from
      Form 10-K filed with the SEC on February 13,
  2007.
 (3)
              Incorporated by reference from
      Form 8-K filed with the SEC on May 2,
  2007.
 (4)
              Incorporated by reference from
      Form 8-K filed with the SEC on April 22,
  2003.
 (5)
              Incorporated by reference from
      Form 10-K filed with the SEC on January 29,
  2010.
 (6)
              Incorporated
      by reference from Form 10-Q filed with the SEC on June 7,
      2010.
 (7)
              Incorporated
      by reference from Form 8-K filed with the SEC on July 14,
      2010.


37




SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this Report to be signed on our behalf by the undersigned, thereunto
duly authorized.




Date:
      September 17, 2010
                    RENHUANG
      PHARMACEUTICALS, INC.By:
                    /s/
      Li ShaomingLi
      Shaoming, Chief Executive Officer and President(Principal
      Executive Officer)Date:
      September 17, 2010
                    By:
                    /s/
      Lu XiaoyingLu
      Xiaoying, Interim Chief Financial Officer(Principal
      Accounting and Financial Officer)


38