UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM 10-K





(Mark
      One)x
                              ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the fiscal year ended:
                              December
      31, 2008o
                              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the transition period from ____________ to ____________Commission
      file number:
                              000-26059




CHINA
      SKY ONE MEDICAL, INC.(Exact
      name of registrant as specified in its
charter)





Nevada
              
              87-0430322(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (I.R.S.
      Employer
                Identification
      No.)Room
      1706, Di Wang Building, No. 30 Gan Shui Road,
                Nangang
      District, Harbin, People’s Republic of China
              
              150001(Address
      of principal executive offices)
              
              (Zip
      Code)




Registrant’s
      telephone number, including area code:
                86-451-53994069
      (China)




Securities
      registered pursuant to Section 12(b) of the Act:





Title
      of each class
                
                Name
      of each exchange on which registeredNone
                
                Not
      Applicable




Securities
      registered pursuant to Section 12(g) of the
  Act:Common
      Stock(Title
      of Class)





Indicate
by check mark if the registrant is a well-known seasonal issuer, as defined in
Rule 405 of the Securities Act.


Yes  ̈ 
   No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
section 13 or Section 15(d) of the Act.


Yes  ̈ 
   No x





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


Yes x 
   No  ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.


x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a small reporting
company:




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).


Yes  ̈ 
   No x





As of
June 30, 2008, the aggregate market value of the voting and non-voting common
equity held by non-affiliates was approximately $62,853,570, based on the last
closing price of $11.13 per share, as quoted on the American Stock
Exchange.





As of
March 31, 2009, the registrant had 16,446,467 shares of common stock issued and
outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE





A
description of “Documents Incorporated by Reference” is contained in Item 15 of
this report.








CHINA
SKY ONE MEDICAL, INC.





ANNUAL
REPORT ON FORM 10-K





TABLE
OF CONTENTS





PAGESpecial
      Note Regarding Forward-Looking Statements
                                      
                                      1PART IItem
      1.
                                      
                                      Business
                                      
                                      2Item
      1A.
                                      
                                      Risk
      Factors
                                      
                                      19Item
      1B.
                                      
                                      Unresolved
      Staff Comments
                                      
                                      30Item
      2.
                                      
                                      Properties
                                      
                                      30Item
      3.
                                      
                                      Legal
      Proceedings
                                      
                                      31Item
      4.
                                      
                                      Submission
      of Matters to a Vote of Security Holders
                                      
                                      31PART IIItem
      5.
                                      
                                      Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                                      
                                      32Item
      6.
                                      
                                      Selected
      Financial Data
                                      
                                      37Item
      7.
                                      
                                      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                      
                                      38Item
      7A.
                                      
                                      Quantitative
      and Qualitative Disclosures About Market Risk
                                      
                                      47Item
      8.
                                      
                                      Financial
      Statements and Supplementary Data
                                      
                                      F-1Item
      9.
                                      
                                      Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
                                      
                                      48Item
      9A.
                                      
                                      Controls
      and Procedures
                                      
                                      48Item
      9B.
                                      
                                      Other
      Information
                                      
                                      49PART IIIItem
      10.
                                      
                                      Directors,
      Executive Officers and Corporate Governance
                                      
                                      50Item
      11.
                                      
                                      Executive
      Compensation
                                      
                                      55Item
      12.
                                      
                                      Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                                      
                                      59Item
      13.
                                      
                                      Certain
      Relationships and Related Transactions, and Director
      Independence
                                      
                                      60Item
      14.
                                      
                                      Principal
      Accounting Fees and Services
                                      
                                      61Item
      15.
                                      
                                      Exhibits,
      Financial Statement Schedules
                                      
                                      63Signatures
                                      
                                      65




- i
-


SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS





This Annual Report on Form 10-K,
together with other statements and information we publicly disseminate, contains
certain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended.  We intend such forward-looking statements to be
covered by the safe harbor provisions for forward-looking statements contained
in the Private Securities Litigation Reform Act of 1995, and include this
statement for purposes of complying with these safe harbor
provisions.





Forward-looking statements, which are
based on certain assumptions and describe our future plans, strategies and
expectations, are generally identifiable by use of the words “believe,”
“expect,” “intend,” “anticipate,” “estimate,” “project” or similar
expressions.  You should not rely on forward-looking statements since they
involve known and unknown risks, uncertainties and other factors that are, in
some cases, beyond our control and which could materially affect actual results,
performances or achievements.





Factors that may cause actual results
to differ materially from current expectations include, but are not limited to
the “Risk Factors” discussed in Part 1, Item 1A of this Annual Report on Form
10-K.  Accordingly, there is no assurance that our expectations will be
realized.  Except as otherwise required by the federal securities laws, we
disclaim any obligations or undertaking to publicly release any updates or
revisions to any forward-looking statement contained herein (or elsewhere) to
reflect any change our expectations with regard thereto, or any change in
events, conditions or circumstances on which any such statement is
based.





The terms “the Company,” “we,” “us” and
“our” refer to China Sky One Medical, Inc., together with our consolidated
subsidiaries.


- 1
-


PART I





Item
1.  Business.





General





We are engaged, through our China based
indirect subsidiaries described below, in the development, manufacture,
marketing and sale of over-the-counter, branded nutritional supplements and
over-the-counter plant and herb based pharmaceutical and medicinal products.
  Our principal products are external use Traditional Chinese Herbal
Remedies/Medicines commonly referred to in the industry as “TCM.”  We have
evolved into an integrated manufacturer, marketer and distributor of external
use Chinese medicine products sold primarily in China and through Chinese
domestic pharmaceutical chains and have been expanding our worldwide sales
effort as well.  We sell both our own manufactured products, as well as
medicinal and pharmaceutical products manufactured by others in
China.





Corporate
History





China Sky One Medical, Inc. (“China Sky
One”), is a Nevada corporation formed on February 7, 1986, formerly known as
Comet Technologies, Inc.  On July 26, 2006, after our acquisition of a
China based nutritional supplements business, we changed our name to “China Sky
One Medical, Inc.”





ACPG, our non-operating United States
holding company subsidiary, was incorporated on December 16, 2003, in the State
of California, under the name “QQ Group, Inc.”  It changed its name to
“American California Pharmaceutical Group, Inc.” in anticipation of the Stock
Exchange Agreement with China Sky One (then known as “Comet Technologies, Inc.”)
and TDR, described herein.  On December 8, 2005, ACPG completed a stock
exchange transaction with TDR  an operating company based in the People’s
Republic of China (“PRC”) and TDR’s subsidiaries, each of which were fully
operating companies in the PRC.  Under the terms of the agreement, ACPG
exchanged 100% of its issued and outstanding common stock for 100% of the
capital stock of TDR and its subsidiaries, described below.





Thereafter, on May 11, 2006, ACPG
entered into a Stock Exchange Agreement (the “Exchange Agreement”) with the
shareholders of China Sky One.  The terms of the Exchange Agreement were
consummated and the acquisition was completed on May 30, 2006.  As a result
of the transaction, we issued a total of 10,193,377 shares of our common voting
stock to the stockholders of ACPG, in exchange for 100% of the capital stock of
ACPG, resulting in ACPG becoming our wholly-owned subsidiary.





TDR, formerly known as “Harbin City
Tian Di Ren Medical Co.,” was originally formed in 1994 and maintained its
principal executive office in Harbin City of Heilongjiang Province, in the
PRC.   TDR was reorganized and incorporated as a limited liability
company on December 29, 2000, under the “Corporation Laws and Regulations” of
the PRC.   At the time of the TDR Acquisition by ACPG in December of
2005,  TDR had two wholly-owned subsidiaries, Harbin First Bio-Engineering
Company Limited and Kangxi Medical Care Product Factory, until July, 2006, when
the two were merged, with Harbin First Bio-Engineering Company Limited as the
surviving subsidiary of TDR.





As of October 16, 2006, we organized
Harbin Tian Qing Biotech Application Company as a wholly-owned PRC subsidiary of
TDR, to conduct research and development in the areas of tissue and stem cell
banks, which is described in more detail below.





On April 3, 2008, TDR completed its
acquisition of Heilongjiang Tianlong Pharmaceutical, Inc., a corporation with a
variety of SFDA approved medicines and new medicine applications, organized
under the laws of the PRC (“Tianlong”), which is in the business of
manufacturing external-use pharmaceuticals. TDR previously acquired the Beijing
sales office of Tianlong in mid-2006.  TDR acquired 100% of the issued and
outstanding capital stock of Tianlong from its sole stockholder, in
consideration for an aggregate purchase price of approximately $8,300,000,
consisting of (i) $8,000,000 in cash, and (ii) 23,850 shares of our common
stock.


- 2
-


On April 18, 2008, TDR consummated its
acquisition of Heilongjiang Haina Pharmaceutical Inc., a recently formed
corporation organized under the laws of the PRC (“Haina”) licensed as a
wholesaler of TCD, bio-medicines, bio-products, medicinal devices, antibiotics
and chemical medicines. Haina did not have an established sales network and was
acquired for its primary asset, a Good Supply Practice (GSP) license (License
No. A-HLJ03-010), issued by the Heilongjiang province office of the SFDA. The
SFDA recently started issuing such licenses to resellers of medicines that
maintain certain quality controls. The GSP license was issued as of December 21,
2006 and will expire on January 29, 2012 and will enable us to expand its sales
of medicinal products without having to go through a lengthy license application
process.  TDR acquired 100% of the issued and outstanding capital stock of
Haina from its three stockholders in consideration for payment of approximately
$437,375. TDR had been overseeing the operations of Haina Pharmaceutical since
January of 2008, as part of our due diligence prior to closing of this
acquisition.





On September 5, 2008, TDR acquired Peng
Lai Jin Chuang Pharmaceutical Company (“Jin Chuang”), a corporation organized
under the laws of the PRC, from Peng Lai Jin Chuang Group Corporation (the
“Seller”). Jin Chuang, which has received Good Manufacturing Practice
certification from the SFDA, was organized to develop, manufacture and
distribute pharmaceutical, medicinal and diagnostic products in the PRC. In
connection with the acquisition of Jin Chuang, TDR acquired all of Jin Chuang’s
assets, including, without limitation, franchise, production and operating
rights to a portfolio of twenty (20) medicines approved by the SFDA, for an
aggregate purchase price of approximately $7.1 million, consisting of (i)
approximately $2.5 million in cash, and (ii) 381,606 shares of our common
stock.





Principal
Products and Markets





We are engaged, through TDR and its
respective subsidiaries in the PRC, in the development, manufacture, marketing
and sale of over-the-counter, branded nutritional supplements and
over-the-counter plant and herb based pharmaceutical and medicinal products.
 We have evolved into an integrated manufacturer, marketer and distributor
of external use Chinese medicine products sold primarily to and through China
domestic pharmaceutical chains.  The Company sells both its own
manufactured products, and medicinal and pharmaceutical products manufactured by
others in the PRC.





With the exception of Jin Chuang, which
is located in Shan Dong Province, PRC, all of our manufacturing facilities are
located in Heilongjiang Province, PRC.  In addition, we have sales offices
located in 22 provinces across China.





Our principal products are external use
Traditional Chinese Herbal Remedies/Medicines (“TCM”).  Using various
formulas, we produce a number of TCM products with several forms of delivery
including creams and ointments, powders, sprays, various medicated skin patch
products, and herbs believed to have complimentary effects.  We intend to
concentrate many of our efforts during the next several years on development,
production and sales of TCM products and biological test kits and in particular,
tissue and our stem cell research as described more fully below.





Our principal operations are in China,
where TDR and its subsidiaries have manufacturing facilities and sales
distribution covering most of China and the Hong Kong Special Administration
Region.  Our overall revenues were $91,816,183 in 2008, of which, export
sales for our main countries of export (in order of revenues during the year
ended 2008) were as follows:





Export Country
                      
                      2008RevenuesMalaysia
                      
                      $
                      8,821,616Germany
                      
                      $
                      23,445Russia
                      
                      $
                      2,897Taiwan
                      
                      $
                      6,087TOTAL:
                      
                      $
                      8,859,191





TDR has also established several
long-term relationships with well-known universities and enterprises in the PRC,
as described below under “- Current Research and Development.”  Through
these relationships, we hope to develop a number of additional products that we
will be able to manufacture and market both in the PRC and in other countries.





- 3
-


Below is a chart depicting our
corporate organization:











SFDA
Licenses





The State
Food and Drug Administration of the government of Heilongjiang Province, PRC
(“SFDA”) issues the licenses and petitions for permission to manufacture and
market pharmaceutical products in the PRC.  Our licenses relate primarily
to medical machine producing licenses which are needed mainly for topical
products, ointments and external test kits.  TCM products also require a
permit for sales, which permits are generally granted on a non-exclusive basis
for four to five years depending on the TCM.  TDR has been granted 29
product licenses and permits, inclusive of our recently approved Cardiac Arrest
Early Examination, Micro-Albuminuria Diagnostic Kit, and Early Pregnancy Test
Kit, which have allowed TDR to commercialize a total of 29 products.  TDR
is undertaking efforts to develop a series of 25 new products, and is planning
to register these products with the SFDA over the next 5 years.   TDR has
also registered 7 patents with the State Intellectual Property Rights Bureau of
the PRC, which includes packing design patents as well as product ingredients
patents.  TDR plans to continue registering patents resulting from its
ongoing product research and development.


- 4
-





In
addition to the above:





·
            as
      a result of TDR’s acquisition of Tianlong in April 2008, TDR acquired all
      of Tianlongs’s assets, which included, among other things, 69
      SFDA-approved medicines, and an additional 20 new medicines, which have
      been submitted for approval to the SFDA;
and




·
            as
      a result of TDR’s acquisition of Jin Chuang in September 2008, TDR
      acquired franchise, production and operating rights to a portfolio of 20
      medicines approved by the SFDA, and an additional 2 new medicines, which
      have been submitted for approval to the
SFDA.




Our
TDR Subsidiary Owns the Following Subsidiaries in China





Harbin First
Bio-Engineering





On
September 26, 2003, TDR formed Harbin First Bio-Engineering Company Limited
(referred to herein as “Harbin Bio-Engineering”) as its wholly owned subsidiary,
with an authorized capital of $241,546 (2 million RMB).  Harbin
Bio-Engineering focuses on research and development of the use of natural
medicinal plants and biological technology products, such as Endothelin-1. 
Harbin Bio-Engineering, which officially commenced production on July 21,
2006, is one of the first companies in Heilongjiang Province conducting research
and development of high technology biological products.  Harbin
Bio-Engineering  has two production lines:





·
            an
      enzyme immunity reagent kit production line;
and




·
            a
      colloid gold production line.




Harbin Tian Qing Biotech
Application





On October 16, 2006, TDR organized
Harbin Tian Qing Biotech Application Company (referred to herein as “Tian Qing
Biotech”) as its wholly-owned subsidiary, to conduct research and development in
the areas of tissue and stem cell banks, which is described in more detail
below. (See “Research and Development” below.)





Heilongjiang Tianlong
Pharmaceutical





On April 3, 2008, TDR completed the
acquisition of Heilongjiang Tianlong Pharmaceutical, Inc., a corporation
organized under the laws of the PRC (referred to herein as “Tianlong”), which is
in the business of manufacturing external-use pharmaceuticals.  Previously,
in 2006, TDR had acquired the Beijing office of Tianlong.  Tianlong’s
assets included, among other things, GMP-certified manufacturing facilities,
state-of-the-art manufacturing equipment, an research and development center,
sixty-nine (69) SFDA-approved medicines, and an additional thirty-eight (38) new
medicines, which have been submitted for approval to the SFDA.





Heilongjiang Haina
Pharmaceutical





On April 18, 2008, TDR consummated its
acquisition of Heilongjiang Haina Pharmaceutical Inc., a corporation organized
under the laws of the PRC (referred to herein as “Haina”), which is licensed as
a wholesaler of TCD, bio-medicines, bio-products, medicinal devices, antibiotics
and chemical medicines. At the time of the acquisition, Haina did not have an
established sales network and was acquired for its primary asset, a Good Supply
Practice (GSP) license (License No. A-HLJ03-010), issued by the Heilongjiang
province office of the SFDA. The SFDA recently started issuing such licenses to
resellers of medicines that maintain certain quality controls. The GSP license
was issued as of December 21, 2006 and will expire on January 29, 2012. 
This license will enable us to expand Haina’s sales of medicinal products
without having to go through a lengthy license application process.  TDR
had been overseeing the operations of Haina Pharmaceutical since January of
2008, as part of our due diligence prior to closing of this
acquisition.


- 5
-


Peng Lai Jin Chuang
Pharmaceutical





On September 5, 2008, TDR acquired Peng
Lai Jin Chuang Pharmaceutical Company, a corporation organized under the laws of
the PRC (referred to herein as “Jin Chuang”), from Peng Lai Jin Chuang Group
Corporation. Jin Chuang, which has received Good Manufacturing Practice
certification from the SFDA, was organized to develop, manufacture and
distribute pharmaceutical, medicinal and diagnostic products in the PRC. In
connection with the acquisition of Jin Chuang, TDR acquired all of Jin Chuang’s
assets, including, without limitation, franchise, production and operating
rights to a portfolio of twenty (20) medicines approved by the
SFDA.





Product
Line





We
manufacture over 90 branded products, which management believes enables us to
maintain better control over product quality and availability while also
reducing production costs.  We also sell a total of 7 products manufactured
by other firms (See “Other Products,” below).  Our manufacturing operations
are conducted in our indirect subsidiaries’ facilities located in Heilongjiang
Province and Shan Dong Province in the PRC.  Additionally, we maintain a
working relationship with a number of outside manufacturers, including softgel
manufacturers and packagers, and utilize these outside sources from time to
time.





We sell
our products under six main categories:





·
            Patches
      (4 items);




·
            Ointments
      (15 items);




·
            Sprays
       (9 items);




·
            Diagnostic
      Kits (3 items);




·
            Contract
      Sales (7 items); and




·
            Others
      (over 50 items)




A description of our main product lines
follows.




Sumei Slim Patch





The Sumei Slim Patch is marketed and
sold within and outside the PRC as a more natural way to lose weight.
 The Sumei Slim Patch uses Saponin, believed to regulate and restrain the
excessive secretion of certain hormones, while promoting others.  The Sumei
Slim Patch is also believed to foster weight loss and prevent weight
gain.





Pain Killer Patch





A pain killer patch applied to the
neck, shoulder and waist, this product is a treatment to fend off fever, promote
well-being and to relieve diarrhea.  The patch is used for a number of
ailments, including fever, headache, dysentery of a heat type, diarrhea and
stiffness and pain in the neck caused by hypertension.





Anti-Hypertension Patch





The anti-hypertension patch is based on
five thousand years of Chinese herbal vein therapy that has been adapted to a
modern trans-dermal therapeutic system (TTS).  The product utilizes a
Body-Yong-Guan point technique, which is believed to maximize the effectiveness
of the medicinal ingredients.  The product is believed to stimulate blood
capillaries and is believed to be effective in improving circulation and in
reducing blood pressure.


- 6
-


Dysmenorrheal Patch





This is a soft patch, applied
externally, for pain relief from dysmenorrheal (menstrual cramps) that combines
traditional Chinese point therapy and modern trans-dermal technology.  This
product contains a pure herb formula selected from rare Chinese herbs or plants
which is refined to extract the effective ingredients.  This product is
believed to be effective in regulating microcirculation, in balancing the
functions of the human body and in enhancing the immunity response of women.
 It is believed to be effective in treating the dysmenorrheal (cramping) in
a woman’s critical days, and in regulating pain and catamenia (menstruation
period).





Yin Ke Psoriasis Spray





Psoriasis is a skin disease that is
difficult to treat.  Our research scientists have focused their efforts in
finding treatments for this disease.  Yin Ke Psoriasis Spray is a spray
that contains Chinese herbal ingredients that are believed to be effective in
killing pathogenic ringworms inside or under the skin, causing scale-like skin
to fall off, and allowing healthy skin to grow.





Wart Removing Spray





This product has been developed to
eliminate the viruses in a tumors or warts.  The product is effective in
removing warts, through a strong permeation and sterilization process.  The
product is a highly concentrated washing liquid that is applied topically to the
affected area.





Chilblain Ointment





This product contains Rhizoma Paridis,
Rhizoina Bletilae and Camphor, and is refined from Chinese herbal materials.
 It is believed to be effective in improving blood circulation, and in
eliminating various symptoms of Chilblain (a cold injury that appears as an
inflamed swelling on the extremities), including itching and
swelling.





Hemorrhoids Ointment





This product contains Acetate, Radix
Notoginseng, and Rhizoma Coptidis.  The product is made in a soft ointment
that is effective in sterilizing and relieving hemorrhoid symptoms, including
itching, distending pain, burning, and bleeding.





Tinea Pedis Spray, Ointment and
Powder





This product contains Cortex
Pseudolaricis and Cortex Phellodendri, and is a treatment for killing various
pathogens on the skin surface and subcutaneously, such as mycete (a fungus),
trichopytic, staphylococcal bacteria aureus, bacillus coli, and candida albicans
(thrush).





Dermatitis Spray





This product is effective in
sterilization and in relieving itching in various kinds of skin pruritis
(intense itching condition) caused by eczema, urticaria (hives), seborrheic
dermatitis (flaking of skin, dandruff), herpes zoster (shingles), neurodermitis
and allergic dermatitis.


- 7
-


Dandruff Treatment Herbal
Shampoo





This product has been specifically
designed to treat dandruff, and is not intended for use as an ordinary shampoo.
  The product is believed to be effective in killing fungi and providing
nutrition to pallium cells.





Runze Eye Drop





This product is refined from active
ingredients extracted from natural herbs or plants, and functions as a
protection from infection, tiredness of optic nerves and myopia.





Testing Kits





Cardiac
Arrest Early Examination Kit





This
product is used for early stage diagnosis of myocardial infarction (heart
attacks).   We completed SFDA clinical testing of the Cardiac Arrest
Early Examination Kit and began sales of this product in 2007.  This kit is
patented in PRC.





Kidney
Disease Testing Kit





The
Urinate Micro Albumin Examination Testing Kit is used in connection with early
stage diagnosis for primary kidney disease, hypertension and diabetes.  We
completed SFDA clinical testing for the Urinate Micro Albumin Examination
Testing Kit and commenced sales of this product in 2007.  This kit is
patented in PRC.





Early
Pregnancy Test Kit





The early
pregnancy test kit is used to determine pregnancy through a urine sample. 
We completed SFDA clinical testing for this kit and commenced sales of this
product in 2007.  This kit is patented in PRC.





Other
Products





TDR
offers a number of additional products made from Chinese herbs and plants,
including a leukoderma ointment, rheumatism spray, Coryza powder, Hircus
removing spray, gonorrheal cleaning spray, a snoring retardant, deodorants, diet
tea, cough arresting patch, pharyngitis spray, Clindamycin Metronidazole
Liniment, Ganciclovir Injection, Loquat Syrup, Indigowoad Root Granule, and
others.





Historically
we have sold only products that we manufactured.  However, during the 2007
fiscal year, we began an initiative to sell medicinal products manufactured by
other companies under exclusive sales and marketing arrangements.   Set
forth in the table below is information concerning these products and the
intended treatment applications.





Product
      Name
                          
                          Treatment
      Applications
                          
                          Main
      ComponentOfloxacin
      Eye Drops
                          
                          Conjunctivitis,
      Keratitis
                          
                          OfloxacinRibavirin
      Nasal Drops
                          
                          Influenza
                          
                          RibavirinEconazole
      Nitrate Suppositories
                          
                          Colpitis
      (inflammation of the vagina)
                          
                          Econazole
      NitrateQianliming
      Nasal Drops
                          
                          Coryza
      (head cold)
                          
                          Ethyl
      Ester Hydroxybenzene, etc.Terbinafine
      Hydrochloride Liquor
                          
                          Tinea
      (scalp ringworm)
                          
                          Terbinafine
      HydrochlorideCompound
      Camphor Cream
                          
                          Eczema,
      dermatitis, etc.
                          
                          Camphor,
      Menthol, Methyl SalicylateTerbinafine
      Hydrochloride Cream
                          
                          Tinea
      (scalp ringworm)
                          
                          Terbinafine
      HydrochlorideSulfasalazine
      Suppositories
                          
                          Colonitis
                          
                          Sulfasalazine




- 8
-


Total
sales in 2008 from products manufactured by other companies under exclusive
sales arrangements totaled approximately $5,642,182 or approximately 6% of total
sales in the year ended December 31, 2008, as compared to $12,998,000 for the
year ended December 31, 2007.  We market and sell these products through
our existing distribution channels to our customers throughout the world and
primarily in China.   We intend  to expand our product line under
sales and manufacturing contracts with third-party manufacturers with a goal of
increasing sales revenue from current and new pharmaceutical and medicinal
products manufactured by other companies.





Revenues
by General Product Lines





Management believes that the most
accurate benchmark of revenue breakdown is based on the method of application as
different applications have different sales channels.  Below is a breakdown
of our revenues for 2008 based on application and application
usage.




Revenues based on Application
Category




Our total
revenues during fiscal 2008 and 2007 were approximately $91,801,000 and
$49,318,308, respectively.  The following table sets forth our principal
product categories based on application type and the approximate amount and
percentage of revenue from each of such product categories, during the fiscal
year ended December 31, 2008 and 2007:




For
      the Year Ended December 312008
                                                  
                                                  
                                                  2007Product
      Category
                                                    (97
      products)
                                                  Subsidiary
                                                  
                                                  Quantity
                                                    (Unit)
                                                  
                                                  
                                                  Sales
      USD
                                                  
                                                  
                                                  %
      of Sales
                                                  
                                                  
                                                  Quantity
                                                    (Unit)
                                                  
                                                  
                                                  Sales
      USD
                                                  
                                                  
                                                  %
      of SalesPatch
      (5 products)
                                                  TDR
                                                  
                                                  
                                                  9,494,535
                                                  
                                                  
                                                  $
                                                  35,484,230
                                                  
                                                  
                                                  
                                                  39
                                                  %
                                                  
                                                  
                                                  2,294,901
                                                  
                                                  
                                                  $
                                                  19,690,051
                                                  
                                                  
                                                  
                                                  39
                                                  %Ointment (20
      products)
                                                  TDR
      & TL
                                                  
                                                  
                                                  11,478,130
                                                  
                                                  
                                                  
                                                  23,068,210
                                                  
                                                  
                                                  
                                                  25
                                                  %
                                                  
                                                  
                                                  3,037,022
                                                  
                                                  
                                                  
                                                  6,190,003
                                                  
                                                  
                                                  
                                                  13
                                                  %Spray
      (19 products)
                                                  TDR
      & TL
                                                  
                                                  
                                                  3,941,295
                                                  
                                                  
                                                  
                                                  10,612,679
                                                  
                                                  
                                                  
                                                  12
                                                  %
                                                  
                                                  
                                                  3,580,266
                                                  
                                                  
                                                  
                                                  9,210,233
                                                  
                                                  
                                                  
                                                  19
                                                  %Diagnostic
      Kits (3 products)
                                                  First
                                                  
                                                  
                                                  2,184,013
                                                  
                                                  
                                                  
                                                  8,780,990
                                                  
                                                  
                                                  
                                                  10
                                                  %
                                                  
                                                  
                                                  739,151
                                                  
                                                  
                                                  
                                                  2,990,664
                                                  
                                                  
                                                  
                                                  6
                                                  %Contract
      Sales (7 products)
                                                  Haina
                                                  
                                                  
                                                  3,837,578
                                                  
                                                  
                                                  
                                                  5,655,085
                                                  
                                                  
                                                  
                                                  6
                                                  %
                                                  
                                                  
                                                  5,718,652
                                                  
                                                  
                                                  
                                                  8,197,758
                                                  
                                                  
                                                  
                                                  17
                                                  %others
      (43 products)
                                                  
                                                  
                                                  
                                                  4,306,972
                                                  
                                                  
                                                  
                                                  8,214,989
                                                  
                                                  
                                                  
                                                  8
                                                  %
                                                  
                                                  
                                                  1,896,193
                                                  
                                                  
                                                  
                                                  3,039,599
                                                  
                                                  
                                                  
                                                  6
                                                  %Total
                                                  
                                                  
                                                  
                                                  35,242,523
                                                  
                                                  
                                                  $
                                                  91,816,183
                                                  
                                                  
                                                  
                                                  100
                                                  %
                                                  
                                                  
                                                  17,266,185
                                                  
                                                  
                                                  $
                                                  49,318,308
                                                  
                                                  
                                                  
                                                  100
                                                  %


Research
and Development





We
currently conduct all of our research and development (“R&D”) activities,
either internally or through collaborative arrangements with universities and
research institutions in the PRC.  We have our own research, development
and laboratory facilities located at TRD’s principal headquarters in the city of
Harbin, Heilongjiang Province, PRC.  We have also recently organized Harbin
Tian Qing Biotech Application Company (“Tian Qing Biotech”) as a wholly-owned
PRC subsidiary of TDR, to conduct research and development in the areas of
tissue and stem cell banks, which is described in more detail below.  In
all, our internal R&D team currently consists of approximately 35 people, of
which 25 are full time researchers and 10are part time technical
experts.  Many of our team members are professors affiliated with
universities in the PRC.





Additionally,
we have established several long-term partnerships with well-known universities
and enterprises in the PRC.  We have:





·
            built
      a gene medicine laboratory through a collaborative effort with Harbin
      Medical University;




- 9
-


·
            established
      a cell laboratory with North East Agricultural University;
    and




·
            founded
      a monoclonal antibody laboratory with Jilin
  University.




Under our partnership arrangements with
other universities and research institutions, we will generally hold the
intellectual property rights to any developed technology.   As a result of
one of these collaborations with Harbin Medical University, a product known as
“Endothelin-1” is currently under developmentas a cancer suppressing
product.  Additional information relating to this product and other
products being developed is set forth under “Products Under Development” below
and under the general product descriptions throughout this
prospectus.





During the year ended December 31,
2008, we invested approximately $7,415,000 in R&D.  Our R&D
investments in 2007 were approximately $3,158,000.  Additional information
about our R&D investments is included in the financial statements to this
prospectus (and notes thereto) and our “Management Discussion and Analysis on
Financial Condition and Results of Operations” section below.





Products
Under Development





At present, our ongoing research is
divided into five general areas:





·
            the
      development of an enzyme linked immune technique to prepare extraneous
      diagnostic kits (see table below);




·
            the
      development of an enzyme linked gold colloid technique to prepare
      extraneous rapid diagnostic test
strip;




·
            the
      development of a gene recombination technique to prepare gene
      drug;




·
            the
      development of a biology protein chip for various tumor diagnostic
      applications; and




·
            the
      development of a cord blood stem cell bank described
  below.




- 10
-


Biological
Products - Examination and Diagnosis Kits





We currently have various biological
products under development at various stages of clinical testing and
development.  The development of some of these products are expected to be
completed as early as the end of fiscal 2009.  A summary of each of these
products is set forth in the table below.





Testing Kits Name
                  
                  Clinical Experiment and
    Status
                  
                  Application Area
                  
                  Patent or
                    Intellectual Property
  (IP)AIDS
      Early Examination Kit
                  
                  Completed
      clinical testing; application for manufacturing certificate
      submitted.
                  
                  Early
      stage diagnosis for AIDS
                  
                  Method
      of Anti-body preparation is our IP.Carcinoma
      Cervix Early Examination Kit
                  
                  Research
      completed and application for manufacturing certificate
      submitted.
                  
                  Early
      stage diagnosis for Carcinoma Cervix
                  
                  Anti-body
      preparation is our IP.Breast
      Cancer Early Examination Kit
                  
                  Research
      on product formula completed; application for production permit
      submitted.
                  
                  Early
      stage diagnosis for Breast Cancer.
                  
                  Anti-body
      preparation is our IP.Liver
      Cancer Early Examination Kit
                  
                  Research
      on product formula completed; clinical experiment in
    process.
                  
                  Early
      stage diagnosis for Liver Cancer.
                  
                  Anti-body
      preparation is our IP.Rectal
      Cancer Early Examination Kit
                  
                  Research
      on product formula completed; clinical experiment in
    process.
                  
                  Early
      stage diagnosis for Rectal Cancer.
                  
                  Anti-body
      preparation is our IP.Stomach
      Cancer Early Examination Kit
                  
                  Product
      research completed; clinical experiment in process.
                  
                  Early
      stage diagnosis for Stomach Cancer.
                  
                  Anti-body
      preparation is our IP.Multi-tumor
      Marker Protein Chip Assay Kit
                  
                  Product
      research in process.
                  
                  Early
      stage diagnosis for multiple cancers.
                  
                  Anti-body
      preparation is our IP.New
      Endostatin
                  
                  Toxicology
      test, teratogenicity test and quality standard completed; product research
      in process.
                  
                  Early
      stage diagnosis for cancer.
                  
                  Anti-body
      preparation is our
IP.





New
Products





We are currently conducting toxicology
experiments, quality standard measurement and other experimentation for our
products under development.  It is estimated that the experimental time
takes about another seven to eight months for each product. We also hope to
commence with clinical testing of 8 testing kit products in 2009 for uterine
cancer, cervical cancer, ovulatory cancer, liver cancer, breast cancer and
neisseria gonorrhea.  We cannot predict whether, and when, these efforts
will be successful, or the likelihood and/or timing of receiving SFDA approval
of each product.





Research
and Development





Research and Development for
Endothelin-1





One of our various products under
development is Endothelin-1.  We have already completed oxicology and
teratogenicity testing, and have established quality standards, and further
developments are underway to improve the product quality of Endothelin-1.
 In collaboration with Harbin Medical University, we have completed a
laboratory experimental study pertaining to Endothelin-1, which is required
prior to clinical trials, and are currently applying for approval to enter
clinical experiments. At such time as development and clinical testing is
successfully completed, we will commence efforts to market Endothelin-1 in the
PRC and, where legal, as a new anti-cancer medicine.  There can be no
assurance, of course, that these development efforts, or that any subsequent
efforts to obtain SFDA approval (or other foreign drug regulatory authority
approval where we may wish to market this drug) of the product, will be
successful.  We hope to develop Endothelin-1 as a cancer treatment drug
that works by “starving” cancer cells by restricting the generation of blood
vessels around cancer lesions, thereby inhibiting, to a degree, the source of
nutrients upon which the cancer cells survive.  Endothelin-1 has been
recognized by the PRC medical industry as a “Top Category in New
Medicine.”  In order to qualify as the “Top Category in New Medicine,” a
company must have intellectual property rights, high technology involvement,
strong innovation, and the medicine must be the first of its kind to be
introduced to the PRC.  TDR has ownership of the intellectual property
rights pertaining to this technology, and has obtained an invention patent in
China for Endothelin-1.   We expect that research and development and
testing will be completed for manufacturing in 2009.  To date we have
expensed over approximately $3,163,218 (unaudited) on research and development
for Endothelin-1.


- 11
-


Research and Development for Cord Blood
Stem Cell Bank





In 2006, we began implementing a plan
to establish a cord blood stem cell bank in the PRC, for the treatment of
various diseases such as leukemia, lymphoma and rebirth anemia.  We are now
in the process of perfecting our cultivation methods and freezing/storage of
stem cells.  It is expected that these efforts will continue over the next
two years or more in particular in the research and development of technology,
applications and methodology for the establishment of a cord blood stem cell
bank.  We have recently organized Harbin Tian Qing Biotech Application
Company (referred to herein as “Harbin Biotech”) as a wholly-owned subsidiary,
to conduct research and development in the areas of tissue and stem cell banks.
 This project will involve substantial expense and involve numerous risks.
 We entered into a development agreement with the Heilongjiang Provincial
Red Cross out-patient department for purposes of defraying the costs of
developing and marketing this product and are seeking additional R&D
partners with laboratories having substantial experience in this area for this
purpose as well.





Exclusive Regional License for Stem
Cell Research





Research in biotechnology areas such as
tissue and stem cell banks has historically been controlled tightly by the
government of the PRC.  Recently, however, the PRC government has altered
its policies to allow one company per each geographic area in China to become
actively engaged in research in these areas, with the result that many companies
have applied to become engaged in this area of research and
development.





In August 2006, we applied with the
Ministry of Health of the PRC to become engaged in the research and development
of stem cell and tissue banks and related biotechnology areas.  Following
an extensive review by the applicable local office of the Health Department of
Heilongjiang Province, our application was approved on October 16, 2006,
granting us, through our subsidiary, the exclusive right and license to become
engaged in tissue and stem cell bank activities in Heilongjiang Province,PRC,
through December 2010.  We intend to renew this license from time to time
as necessary. We
organized Harbin Biotech to conduct these business operations, as required by
Heilongjiang Province.  Cord blood stem cells have been shown to be
effective in treating a number of diseases, including but not limited to: (a)
various forms of blood diseases, including Mediterranean anemia, Dresbach’s
anemia, hypoplastic anemia, inborn cell deficiency, Evan’s syndrome, Fanconi’s
anemia, Kostmann’s syndrome, and Blackfan-Diamond’s anemia; (b) various
malignant diseases, including encephaloma, lymphoma, acute and chronic leukemia,
Ewing myoma, Neuoblastoma, germ cell tumor, and multiple myeloma; (c) metabolism
defects, including congenital dyskeratosis, Gunter’s disease, and Lesch-Nyhan’s
disease; (d) immunodeficiency disease, including chronic granuloma disease and
Wiskott-Aldrich syndrome; and (e) various auto-immune diseases.





Our Stem Cell Research





There are numerous advantages of cord
blood stem cell banks over traditional marrow transplants, including: a high
success rate; low rejection rate; rich source of cord blood; absence of
suffering of recipient; simple inspection and quick application; and low
matching requirements.  While we are not aware of a method to calculate the
size of the stem cell market, management believes that the market for this
business in PRC and elsewhere is potentially very large.  The entry into
this business will require strict examination and approval by PRC and local
governmental agencies and will require close collaboration with medical
institutions and academies.





Blood from umbilical cords—a byproduct
of normal childbirth—is a good source of potentially life-saving stem cells,
called Hematopoietic progenitor cells (HPCs), the type of stem cells also found
in bone marrow and mobilized peripheral blood that give rise to various kinds of
blood cells.  Transplants of these stem cells have been effective in
treating diseases of the blood and immune system, such as anemia and
leukemia.  Consequently, in many parts of the world, cord blood, once seen
as a waste to be discarded after a birth, is now viewed as a valuable
resource.


- 12
-





Over the past decade, several public
and private cord blood banks have been established in other parts of the world
to provide for the collection and preservation of these cells.  The PRC is
now making these activities available to a limited number of private enterprises
in different parts of the PRC, including the Heilongjiang Province where the
Company conducts its principal operations.  As indicated, our Harbin
Biotech subsidiary will have the exclusive right and license to establish a
research and development business in this area in northeast China through
2010.





Typically, public cord blood banks
collect and store umbilical cord blood donated by women at the birth of a child.
 This blood is preserved and stored and made available for a significant
fee to anyone who needs it in the future.  The children of the donor may,
in turn, be able to use the stored stem cells to fight various diseases, immune
deficiencies and genetic disorders.  Storing the stem cells will come at a
cost to the donor, consisting of a sizable initial fee and an annual maintenance
fee for each year of storage.





Through Harbin Biotech, we are in the
process of implementing a plan to establish a cord stem cell and tissue bank at
a new facility we are constructing outside Harbin, Heilongjiang Province,
PRC.  The first stage of construction is expected to be complete in late
2009.





This project represents a substantial
commitment and consequently involves a number of significant risks, including,
without limitation:





·
            our
      need to raise substantial additional capital to fund our stem cell R&D
      project over the next two or more years, through borrowings, the sale of
      equity or from income from operations, which, if not obtained on a timely
      basis, the could severely compromise this project and our
      rights,




·
            our
      continued compliance with laws and requirements of the PRC and reliance on
      a license from the PRC government to engage in these research and business
      operations in northeast China on an exclusive
  basis,




·
            the
      developing nature of stem cell banking and research, and numerous
      technical and development challenges, including issues pertaining to the
      long-term viability of cryogenically frozen cord blood,
  and




·
            our
      reliance on the efforts of management, in particular Liu Yan-Qing, our
      President to continue to manage our stem sell
  research.




There can be no assurance we will be
successful in obtaining capital when needed, or on favorable terms or that the
PRC government will not restrict or cancel our rights, or allow other
competitors to become engaged in this business in northeast China, which would
make it more difficult for us to compete.





While we do not expect that our
research and development in this area will have a negative impact on our current
core business – the manufacture, marketing and sale of nutritional and medicinal
products – the development of this business will require substantial managerial,
technical and financial resources.





During the 2008 fiscal year, we had
capital expenditures of over $4,358,265 on equipment and machinery; $8,590,651
on construction; as well as additional costs in previous periods on equipment,
construction and R&D described in this report.





Sales
Approach





We have established a domestic
marketing network for our products covering most of the PRC mainland, and have
employed sales agents in these areas.  Our target customers are chain drug
stores and hospitals in all cities.  We use distributors to sell products
in those countries and remote regions where we do not have sales agents.
 We have established a marketing network through independent agents to
develop an international market.  At present, while our primary initial
growth focus remains mainland PRC, we have also established over 20
international agents to sell our products, and are expanding our overseas sales
efforts. Outside of China, our products are currently sold in Malaysia, the
United Kingdom, Hong Kong, the United Arab Emirates, the United States, Russia,
Sweden and Ireland.


- 13
-





Materials
and Suppliers





We employ a purchasing staff with
extensive knowledge of our products who work with marketing, product
development, and formulations and quality control personnel to source raw
materials for products and other items.  Raw materials are sourced
principally in the PRC, and are generally available from a variety of suppliers.
 No one supplier accounts for more than 80% of our total raw material
purchases.  We seek to mitigate the risk of a shortage of raw materials,
through identification of alternative suppliers for the same or similar raw
materials, where available. We manufacture bulk branded products to allow more
extensive vertical integration and to improve the quality and consistency of raw
materials.





Customers
and Distribution





Currently, our products are sold
primarily in the PRC and, to a lesser extent, in [seven] other locations listed
above.  Approximately 90%of
our revenues in 2008 were from the sale of products in China and Hong Kong, with
Malaysia marking our largest country of export.





Over the past several years, we have
continuously expanded our distribution channels for our products.  As a
result, we have established representative sales offices in 22 provinces and 125
municipalities, and deployed sales managers and representatives in each of these
markets.





Our products are sold directly to
retail stores, including pharmacies and drug store chains, and through
independent distributors.  We currently have 233 customers, not including
branches of retail and drug supply chains. Four customers accounted for
approximately 40% of our total revenues in 2008.





As a means of accelerating our
distribution into other countries, we expect that we will enter into strategic
marketing arrangements with firms that have distribution channels, brand name
recognition, or other unique marketing strengths.  Under a typical
arrangement, we expect to will grant limited exclusivity to a sales agent or
distributor to certain products in a specified territory, subject to the agent
meeting specified minimum monthly or annual sales numbers. Consistent with this
approach, in March 2007, we entered into an exclusive strategic agreement with
Takasima Industries (“Takasima”), under the terms of which Takasima has been
engaged as the exclusive sales agent of our patch products in Malaysia.
 Takasima will offer our Slim Patch products in Malaysia, under Takasima’s
name brand.





We also export a number of our products
to various countries, including Malaysia, United Arab Emirates, United Kingdom,
Hong Kong, the United States, and others, and utilize agents and independent
distributors for these marketing and sales efforts.





We will continue efforts to expand our
markets into other provinces and larger cities in the PRC, and to other markets
worldwide.





Competition





Competition in the TCM, pharmaceutical,
and over-the-counter nutraceutical business is intense in China and throughout
the world.  We compete with various firms, many of which produce and market
products similar to our products, and many of which have greater resources than
us in terms of manufacturing and marketing capabilities, management expertise
and breadth, and financial wherewithal.  Some of these competitors are far
larger, have more resources then us and have stronger sales and distribution
networks.


- 14
-





Our direct competitors are other
domestic firms engaged in developing, manufacturing and marketing TCM and
nutraceutical products. There are many of these companies in the PRC, in
Heilongjiang Province, and even in the city of Harbin.





We expect that the competition for
medicinal products in the PRC and other world markets will become more intense
over the next few years both from existing competitors and new market entrants.
 We will also face competition from foreign companies who may have
established products, a strong proprietary pipeline and strong financial
resources.  Our management believes that we have certain competitive
advantages in introducing new products to market due to key focus areas for
development, our existing distribution channels, research and development
capabilities and our relationship with certain universities and other research
institutions.  However, there can be no assurance that we will be able to
compete and continue to grow in this highly competitive environment.
 Additional information relating to competition in the PRC can be found in
the “Risk Factors” section below.





Government
Regulation





Regulatory Environment





Our principal
sales market is in the PRC.  We are subject to the Pharmaceutical
Administrative Law of the PRC, which governs the licensing, manufacturing,
marketing and distribution of pharmaceutical products in the PRC, and sets
penalties for violations.   Our business is subject to various regulations
and permit systems of the government of the PRC.   Additionally, we
are subject to government licensing rights and regulations, which relating to
our stem cell R&D license.  Permits we attain for TCM products are
granted on a non-exclusive basis and one limited for four to five
years.





The
governmental approval process in the PRC for a newly developed health product
can be lengthy and difficult.  A product sample is first sent to a clinical
testing agent designated by the Ministry of Health, which conducts extensive
clinical testing and examinations of the product to verify if it has the
specified functions as stated by the company producing the product.  A
report will then be prepared and issued by the clinical testing agent confirming
or negating such functions.  It generally takes six months to one year for
a report to be issued by the testing agent, after submittal to the agent.
 The report must then be submitted to a provincial Health Management
Commission for approval.  Following this submittal, a letter of approval
issued by such commission will be submitted to the Ministry of Health for the
issuance of a certificate that authorizes sale and marketing of the product in
the PRC.





This
entire process will generally take between eighteen months and two years.  
The approval process will depend to a certain extent on whether a specified
product is a plant based pharmaceutical (“PBP”), or a plant based nutraceutical
(“PBN”).  PBPs are products composed of herbs, roots and plants that do not
use synthetic chemicals, with certain medicinal functions for treatment of one
or more illnesses.  PBPs are generally prescription-based but in some cases
may be sold over-the-counter.  PBNs, also frequently known as “dietary
supplements” or “nutritional supplements,” are also composed of herbs, roots and
plants, but are essentially prophylactic or preventive in nature.  All PBNs
are available over-the-counter without a prescription.  In the PRC, PBPs
require the approval of the SFDA, and PBNs only require the approval of state
and local governments prior to manufacturing and sale.  Obtaining the
approval from the SFDA is generally more complex and lengthy.





Because
we and our subsidiaries are wholly-owned enterprises, we are subject to the law
of foreign investment enterprises in the PRC, and the foreign company provisions
of the Company Law of China, which governs the conduct of our wholly-owned
subsidiaries and their officers and directors, and also limits our ability to
pay dividends.





Compliance
with Environmental Law





We comply
with the Environmental Protection Law of the PRC, as well as applicable local
regulations.   In addition to compliance with the PRC law and local
regulations, we consistently undertake active efforts to ensure the
environmental sustainability of our operations.  Because the manufacturing
of herb and plant-based products does not generally cause significant damage or
pollution to the environment, the cost of complying with applicable
environmental laws is not material.  In the event we fail to comply with
applicable laws, we may be subject to penalties.


- 15
-





Intellectual
Property





We regard
our service marks, trademarks, trade secrets, patents and similar intellectual
property (“IP”) as critical to our business.  We have relied, and will
continue to rely, on patent, trademark and trade secret law, as well as
confidentiality and license agreements with certain of our employees,
consultants, customers and others, to protect our proprietary
rights.





Under the
PRC State Protection law, certain herbal medicine products which have received
approval from the SFDA, have automatic protected IP rights for a seven-year
period from the date of grant of such approval.  An application can be
submitted to extend such protection for up to three consecutive seven-year
periods.  Once this protection period has expired, an applicant may apply
for patent protection in the PRC which lasts for up to 20 years for traditional
medicines depending on the type of patent, and is renewable for indefinite
number of times.  Patents for arts and crafts and packaging have 10 year
patent protection periods which are also renewable.  To a large extent, we
rely on such State Protection law to protect our IP rights with respect to our
products.  In addition, as of the date of this filing, we own a total of 7
patents in the PRC pertaining to our TCMs and biotech diagnostic kits and drugs,
as follows:





·
            Package
      foil bag design patent of Sumei slim patch, registered December 4,
      2001;




·
            Package
      box design patent for all TCM products, registered December 4,
      2001;




·
            Arts
      and crafts patent of Human Urinary Albumin Elisa Kit, registered August
      24, 2004;




·
            Arts
      and crafts patent of Sumei slim patch, registered in
  2001;




·
            Arts
      and crafts design patent of myocardial infarction testing kit, registered
      March 16, 2004;




·
            Arts
      and crafts patent of Suning cough removing patch, initially registered
      December 4, 2001; and




·
            Endothelin-1
      patent relating to anti-tumor technology (application for public
      instruction made), registered October 4,
2006;




We have
received awards and grants from the government of the PRC for R&D in 2007
for the below listed products, resulting in a total amount of $2,141,022
(15,000,000 RMB) of which $42,492 (300,000 RMB) has been paid with the remaining
amount anticipated to be available to us in 2008:





·
            High
      Technology products certificates by Heilongjiang High Technology Products
      Committee covering the following
products:




o
            The
      Coryza Spray;




o
            Dermatitis
      Spray;




o
            Pharyngitis
      Spray;




o
            Tinea
      Pedis spray;




o
            Gonorrhea
      Cleaning Spray;




o
            Wart-removing
      liquid;




o
            Sumei
      Slim patch;




- 16
-


o
            Suning
      Cough removing patch; and




o
            Psoriasis
      Spray.




·
            National
      Class Torch Project (pertaining to the Sumei slim
  patch);




·
            Excellence
      Products Award for Human Urinary Albumin Elisa Kit by The 6th New &
      High Technology Fruits Fair Shen Zhen and National Commercial
      Department;




·
            100
      important pre-phase projects in Heilongjiang Province covering various
      medical diagnostics kits;




·
            Material
      Medical Technology Research and Development Company (by Heilongjiang
      provincial Science and Technology Bureau);
and




·
            High
      Technology Industrialized Base of Medical Area, by Heilongjiang Provincial
      Development and Reform Committee (March of
  2006).




Trademarks





We have registered “Kang Xi” as our
trademark, which is used for all of our TCM products.





Employees





The number of our employees has
increased over the past two years, due to growth, increased research and
development and expanded marketing and distribution of products   Currently
we have a total of 1,804full time employees and
manufacturers’ representatives, generally falling into the following
categories:





By subsidiary company:





Company
                    
                    Number
      of
                      EmployeesTDR
                    
                    
                    1515Harbin
      Biotech
                    
                    
                    0Harbin
      Bio-Engineering
                    
                    
                    97Tianlong
                    
                    
                    97Haina
                    
                    
                    24Jin
      Chuang
                    
                    
                    71TOTAL:
                    
                    
                    1,804





By nature
of job:





Type
      of Job
                    
                    Number
      of
                      EmployeesExecutives
      and Managers
                    
                    
                    146Production
      and Clerical
                    
                    
                    359Sales
      and Marketing
                    
                    
                    1,261Research
      and Development, Technology
                    
                    
                    38TOTAL:
                    
                    
                    1,804





*    Includes manufacturers’
representatives.


**  Does not include 10 part time
technical researchers.


- 17
-


We do not
have any employment agreements in place with our executive officers.  None
of the employees are covered by a collective bargaining agreement, however, we
believe our relationship with employees is good.





Available
Information





We file various reports with the SEC,
including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and
Current Reports on From 8-K, which are available though the SEC’s electronic
data gathering, analysis and retrieval system by accessing the SEC’s home page
(http://www.sec.gov).  The documents are also available to be read or
copied at the SEC’s Public Reference Room located at 100 F Street, NE,
Washington, D.C., 20549.  Information on the Public Reference Room may be
obtained by calling the SEC at 1-800-SEC-0330.


- 18
-


Item
1A.  Risk Factors.





We are subject to certain risks and
uncertainties as described below.  These risks and uncertainties may not be
the only ones we face.  There may be additional risks that we do not
presently know of, or that we currently consider immaterial.  All of these
risks could adversely affect our business, financial condition, results of
operations and cash flows.  Our business and operations may be adversely
affected if any of such risks are realized.  All investors should consider
the following risk factors before deciding to purchase or sell our
securities.





Risks
Related to Our Business





Adverse economic conditions may harm
our business.





In 2008, general worldwide economic
conditions declined due to sequential effects of the sub prime lending crisis,
general credit market crisis, collateral effects on the finance and banking
industries, concerns about inflation, slower economic activity, decreased
consumer confidence, reduced corporate profits and capital spending, adverse
business conditions and liquidity concerns. This global economic downturn poses
a risk as consumers and businesses may postpone spending, or seek new ways to
eliminate spending, in response to these uncertain and challenging economic
conditions. In addition, there could be a number of follow-on effects including
foreign currency exchange rate fluctuations, insolvency of key suppliers and
customer insolvencies. We cannot predict the timing or duration of any economic
slowdown or recession or the timing or strength of a subsequent recovery,
worldwide, or in the specific markets we serve. If the markets for our products
significantly deteriorate due to these economic effects, our business, financial
condition and results of operations may be materially and adversely
affected.





Certain officers and directors have
significant control over our company.





Dr. Liu Yan-qing and Ms. Han Xiao-yan,
who are officers and directors of ours, also serve as officers and directors of
ACPG and TDR.   As of the date hereof, Dr. Liu and Ms. Han own, in the
aggregate, approximately 36.7% of the issued and outstanding shares of our
common stock.  As a result, these shareholders are effectively able to
control certain corporate governance matters requiring shareholders’ approval.
 Such matters may include transactions in which they have an interest other
than as a shareholder of ours, the approval of significant corporate
transactions such as increasing the authorized number of our shares to complete
acquisitions or raise capital, if necessary, and any other transactions
requiring a majority vote without seeking other shareholders’ approval. 
These persons also have the ability to control other matters requiring
shareholder approval including our election of directors which could result in
the entrenchment of management.





We depend on our key management
personnel and the loss of their services could adversely affect our
business.





We place
substantial reliance upon the efforts and abilities of our executive officers,
Liu Yan-qing, President, Chief Executive Officer and Chairman of the Board, Han
Xiao-yan, Vice Chairman, and Hao Yu-bo, Chief Financial Officer and
Secretary.  We do not have employment agreements with these members of
management. Accordingly, if any of these persons should leave the company we
would have no remedy or protections in place and would not be able to prevent
them from competing with us or working for competitors.  The loss of the
services of any of these executive officers could have a material adverse effect
on our business, operations, revenues or prospects. In addition, we do not
maintain key man life insurance on the lives of these individuals.





Our expansion plan may not be
successful.





Part of our strategy is to grow through
increasing the distribution and sales of our products by penetrating existing
markets in the PRC and Hong Kong, and entering new geographic markets in the PRC
as well as Asia, the United States and other countries.  However, many
obstacles to entering such new markets exist, including, but not limited to,
international trade and tariff barriers, regulatory constraints, product
liability concerns, shipping and delivery costs, costs associated with marketing
efforts abroad and maintaining attractive foreign exchange ratios.
 Moreover, our expansion strategy may be based on incorrect assumptions and
may be flawed, and may even damage our performance, competitive position in the
market and ultimately even our ability to survive in the marketplace.  Even
if the strategy is correct, we may never be able to successfully implement our
strategy.  We cannot, therefore, assure shareholders that we will be able
to successfully overcome such obstacles and establish our products in any
additional markets.  Our inability to implement this growth strategy
successfully may have a negative impact on growth, future financial condition,
results of operations or cash flows.


- 19
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There are many safety risks involved in
our products and services that could expose us to liability or inhibit our
ability to secure insurance.





Our products and services involve
direct or indirect impact on human health and life. The drugs, products and
services we manufacture and sell may be flawed and cause dangerous side effects
and even fatality in certain cases, and lead to major business losses and legal
and other liabilities and damages to our company.  In the event that any of
our products are alleged to have adverse side effects, we could be subject to
product liability claims.  In addition to the threat of liability, there
may be insurance costs if we enter into certain markets or may not be able to
obtain insurance for certain products in some countries.  Some distributors
may refuse to sell our products in certain countries if they perceive such
products to have a high risk or to be uninsurable.





We are highly dependent upon the public
perception and quality of our products.  Additionally, anti-corruption
measures taken by the government to correct corruptive practices in the
pharmaceutical industry could adversely affect our sales and
reputation.





We are highly dependent upon consumers’
perception of the safety and quality of our products as well as similar products
distributed by other companies.  Thus, the mere publication of reports
asserting that such products may be harmful could have a material adverse effect
on our business, regardless of whether these reports are scientifically
supported.





The government has recently taken
anti-corruption measures to correct corrupt practices. In the pharmaceutical
industry, such practices include, among others, acceptance of kickbacks, bribery
or other illegal gains or benefits by the hospitals and medical practitioners
from pharmaceutical distributors in connection with the prescription of a
certain drug.  Substantially all of our sales to our ultimate customers are
conducted through third-party distributors.  We have no control over our
third-party distributors, who may engage in corrupt practices to promote our
products.  While we maintain strict anti-corruption policies applicable to
our internal sales force and third-party distributors, these policies may not be
effective.  If any of our third-party distributors engage in such practices
and the government takes enforcement action, our products may be seized and our
own practices, and involvement in the distributors’ practices may be
investigated.  If this occurs, our sales and reputation may be materially
and adversely affected.





Our success will depend on our research
and the ability to develop new products.





Our growth depends on our ability to
consistently discover, develop and commercialize new products and find new and
improve on existing technologies, platforms and products.  As such, if we
fail to make sufficient investments in research, to be attentive to consumer
needs, or fail to focus on the most advanced technologies, our current and
future products could be surpassed by more effective or advanced products of
other companies.





Significant competition from existing
and new entities could adversely affect revenues and profitability.





We compete with other companies, many
of which are offering and/or developing, or can be expected to develop and
offer, products similar to ours.  Our market is a large market with many
competitors.  Many of our competitors are more established than we are, and
have significantly greater financial, technical, marketing and other resources
than our company.  Some of our competitors have greater name recognition
and a larger customer base.  These competitors may be able to respond more
quickly to new or changing opportunities and customer requirements and may be
able to undertake more extensive promotional activities, offer more attractive
terms to customers, and adopt more aggressive pricing policies.  We cannot
assure investors that we will be able to compete effectively with current or
future competitors or that the competitive pressures we face will not harm our
business.


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-


We may not be able to obtain sufficient
financing, and may not be able to develop our product candidates.





We may need to incur debt or issue
equity in order to fund research and other expenditures as well as to make
acquisitions and other investments. We cannot assure you that debt or equity
financing will be available to us on acceptable terms or at all.  If we
cannot or are limited in the ability to incur debt, issue equity or enter in
strategic collaborations, we may be unable to fund discovery and development of
our product candidates, address gaps in our product offerings or improve our
technologies.





We anticipate that we will need to
raise substantial amounts of money to fund a variety of future activities
integral to the development of our business, which may include but are not
limited to the following:





·
            obtaining
      regulatory approval for our products and conducting research and
      development to successfully develop our stem cell and other
      technologies;




·
            filing
      and prosecuting patent applications and defending and assessing patents to
      protect our technologies;




·
            retaining
      qualified employees, particularly in light of intense competition for
      qualified scientists;




·
            manufacturing
      products ourselves or through third
parties;




·
            marketing
      our products, either through building our own sales and distribution
      capabilities or relying on third
  parties; and




·
            acquiring
      new technologies, licenses or
products.




We cannot assure you that any needed
financing will be available to us on acceptable terms or at all. If we cannot
obtain additional financing in the future, our operations may be restricted and
we may ultimately be unable to continue to develop and potentially commercialize
our product candidates.





We are subject to market and channel
risks.





Over 85% of our sales are made in the
PRC, where we primarily sell our products through drug chain stores. 
Because of this, we are dependent to a large degree upon the success of our PRC
based distribution channel as well as the success of specific retailers in the
distribution channel.  Many of the drug stores are individual stores or
very small chains, and only a few are large chain drug stores.  We rely on
these distribution channels to purchase, market, and sell our products.
 Our success is dependent, to a large degree, on the growth and success of
the drug stores, which may be outside our control.  There can be no
assurance that the drug store distribution channels will be able to grow or
prosper as it faces price and service pressure from other channels, including
the mass market.  There can be no assurance that retailers in the drug
store distribution channel, in the aggregate, will respond or continue to
respond to our marketing commitment in these channels.





We may have difficulty in defending
intellectual property rights from infringement.





Our TCM products are generally not
protected by patents but by trade secrets.  Certain TCM license agreements
are made on a non-exclusive basis.  Our success depends, in large part, on
our ability to protect current and future technologies and products and to
defend our intellectual property rights.  If we fail to protect our
intellectual property adequately, competitors may manufacture and market similar
products.  We continually file, patent applications seeking to protect
newly developed technologies and products in various countries, particularly in
the PRC.  Some patent applications in the PRC are maintained in secrecy
until the patent is issued.  Because the publication of discoveries tends
to follow their actual discovery by many months, we may not be the first to
invent, or file patent applications on any of its discoveries.  Patents may
not be issued with respect to any of our patent applications and existing or
future patents issued to or licensed by us may not provide competitive
advantages for its products.  Patents that are issued may be challenged,
invalidated or circumvented by competitors.  Furthermore, our patent rights
may not prevent our competitors from developing, using or commercializing
products that are similar or functionally equivalent to our
products.


- 21
-





To the extent that we market products
in other countries, we may have to take additional action to protect our
intellectual property.  The measures we take to protect our proprietary
rights may be inadequate, and we cannot provide any assurance that our
competitors will not independently develop formulations and processes that are
substantially equivalent or superior to our products or copy our
products.





We also rely on trade secrets,
non-patented proprietary expertise and continuing technological innovation that
we seek to protect, in part, by entering into confidentiality agreements with
licensees, suppliers, employees and consultants.  These agreements may be
breached and there may not be adequate remedies in the event of a breach.
 Disputes may arise concerning the ownership of intellectual property or
the applicability of confidentiality agreements.  Moreover, trade secrets
and proprietary technology may otherwise become known or be independently
developed by competitors.  If patents are not issued with respect to
products arising from research, we may not be able to maintain the
confidentiality of information relating to these products.





We will be subject to risks relating to
third parties that may claim that we infringe on their proprietary rights and
may prevent us from manufacturing and selling certain of our
products.





There has been substantial litigation
in the pharmaceutical and nutraceutical industries with respect to the
manufacturing, use and sale of new products. These lawsuits relate to the
validity and infringement of patents or proprietary rights of third parties.
 We may be required to commence or defend against charges relating to the
infringement of patent or proprietary rights.  Any such litigation could
involve or result in:





·
            the
      incurrence of substantial expense, even if we are successful in the
      litigation;




·
            a
      diversion of significant time and effort of technical and management
      personnel;




·
            the
      loss of our rights to develop or make certain products;
  and




·
            the
      payment of substantial monetary damages or royalties in order to license
      proprietary rights from third
parties.




Although
patent and intellectual property disputes within these industries have often
been settled through licensing or similar arrangements, costs associated with
these arrangements may be substantial and could include the long-term payment of
royalties. These arrangements may be investigated by regulatory agencies and, if
improper, may be invalidated. Also, the required licenses may not be made
available to our company on acceptable terms.  Accordingly, an adverse
determination in a judicial or administrative proceeding or a failure to obtain
necessary licenses could prevent our company from manufacturing and selling some
of our products or increase costs to market these products.





In
addition, when seeking regulatory approval for some of our products, we are
required to certify to regulatory authorities, including the SFDA that such
products do not infringe upon third party patent rights.  Filing a
certification against a patent gives the patent holder the right to bring a
patent infringement lawsuit against our company.  Any lawsuit would delay
regulatory approval by the SFDA.  A claim of infringement and the resulting
delay could result in substantial expenses and even prevent us from
manufacturing and selling certain of our products.





The
launch of a product prior to a final court decision or the expiration of a
patent held by a third party may result in substantial damages to our company.
 Depending upon the circumstances, a court may award the patent holder
damages equal to three times their loss of income.  If our company is found
to infringe a patent held by a third party and become subject to such treble
damages, these damages could have a material adverse effect on our results of
operations and financial condition.


- 22
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Our
failure to comply with accounting policies and regulations in making reasonable
estimates and judgments could negatively impact our financial position and
results of operation.





We will
be subject to critical accounting policies and actual results may vary from
estimates.  We have followed, and will continue to follow, generally
accepted accounting principles for the United States in preparing financial
statements.  As part of this work, we must make many estimates and
judgments concerning future events.  These affect the value of the assets
and liabilities, contingent assets and liabilities, and revenue and expenses
reported in such financial statements.  We believe that these estimates and
judgments are reasonable, and we have made them in accordance with accounting
policies based on information available at the time. However, actual results
could differ from estimates, and this could require us to record adjustments to
expenses or revenues that could be material to our financial position and
results of operations in the future.





Our
business is subject to many governmental regulatory and policy
risks.





Our
business must be conducted in compliance with various government regulations and
in particular, the PRC SFDA regulations.  Government regulations may have
material impact on our operations, increase costs and could prevent or delay the
manufacturing and selling of our products.  Research, development, testing,
manufacturing and marketing activities are subject to various governmental
regulations in China, including health and drug regulations.  Government
regulations, among other things, cover the inspection of and controls over
testing, manufacturing, safety and environmental considerations, efficacy,
labeling, advertising, promotion, record keeping and sale and distribution of
pharmaceutical products.  We will not be able to license, manufacture, sell
and distribute the vast majority of its products without a proper approval from
government agencies and in particular the SFDA.  There is no assurance that
we will obtain such approvals.





In
addition, delays or rejections may be encountered based upon additional
government regulation from future legislation, administrative action or changes
in governmental policy and interpretation during the period of product
development and product assessment.  Although we have, so far, obtained the
rights to sell our products in the PRC, we may not continue to receive and
maintain regulatory approvals for the sales of these products.  Our
marketing activities are also subject to government regulations with respect to
the prices that it intends to charge or any other marketing and promotional
related activities.  Government regulations may substantially increase the
costs for developing, licensing, manufacturing and selling products, impacting
negatively our operations, revenue, income and cash flow.  For more
specific risks relating to doing business in the PRC see “Risks Related to Doing
Business in China” below.





There
could be changes in government regulations towards the pharmaceutical and
nutraceutical industries that may adversely affect our business.





The
manufacture and sale of pharmaceutical and nutraceutical products in the PRC is
heavily regulated by many state, provincial and local authorities.  These
regulations significantly increased the difficulty and costs involved in
obtaining and maintaining regulatory approvals for marketing new and existing
products.  Our future growth and profitability depends to a large extent on
our ability to obtain regulatory approvals.





The SFDA
of China implemented new guidelines for licensing of pharmaceutical products.
All existing manufacturers with licenses, which are currently valid under the
previous guidelines, were required to apply for the Good Manufacturing Practices
“GMP” certifications by June 30, 2004, and to receive approvals by December 31,
2004.  We received certifications for our current products.  However,
should we fail to maintain the GMP certifications under the new guidelines in
the future, or for new products, our businesses would be materially and
adversely affected.





Moreover,
the laws and regulations regarding acquisitions of the pharmaceutical and
nutraceutical industries in the PRC may also change and may significantly impact
our ability to grow through acquisitions.  For more specific risks relating
to doing business in the PRC see “Risks related to Doing Business in China”
below.


- 23
-


We
need to manage growth in operations to maximize our potential growth and achieve
our expected revenues.





Our
success depends on our ability to achieve continued growth.  In order to
maximize potential growth in current and potential markets, we believe that we
must expand our manufacturing and marketing operations.  This expansion
will place a significant strain on management and operational, accounting and
information systems and will require substantial additional capital.  We
will need to continue to improve financial controls, operating procedures, and
management information systems if and as we grow.  We will also need to
effectively train, motivate, and manage our employees.  A failure to manage
our growth could disrupt operations and ultimately prevent us from generating
the revenues we expect.





International
operations require our company to comply with a number of U.S. and international
regulations.





We are
required to comply with a number of international regulations in countries
outside of the United States.  In addition, we must comply with the Foreign
Corrupt Practices Act, or FCPA, which prohibits U.S. companies or their agents
and employees from providing anything of value to a foreign official for the
purposes of influencing any act or decision of these individuals in their
official capacity to help obtain or retain business, direct business to any
person or corporate entity or obtain any unfair advantage.  Any failure to
adopt appropriate compliance procedures and ensure that our employees and agents
comply with the FCPA and applicable laws and regulations in foreign
jurisdictions could result in substantial penalties and/or restrictions in our
ability to conduct business in certain foreign jurisdictions. The U.S.
Department of The Treasury’s Office of Foreign Asset Control, or OFAC,
administers and enforces economic and trade sanctions against targeted foreign
countries, entities and individuals based on U.S. foreign policy and national
security goals.  As a result, we are restricted from entering into
transactions with certain targeted foreign countries, entities and individuals
except as permitted by OFAC which may reduce our future growth.





We
may incur significant costs to ensure compliance with U.S. corporate governance
and accounting requirements.





We are a
public reporting company, and, as such, we will incur significant costs
associated with public company reporting requirements, costs associated with
newly applicable corporate governance requirements, including requirements under
the Sarbanes-Oxley Act of 2002 and other rules implemented by the U.S.
Securities and Exchange Commission.  All of these applicable rules and
regulations can be expected to increase legal and financial compliance costs and
to make some activities more time consuming and costly.  Management also
expects that these applicable rules and regulations may make it more difficult
and more expensive to obtain director and officer liability insurance and we may
be required to accept reduced policy limits and coverage or incur substantially
higher costs to obtain the same or similar coverage.  As a result, it may
be more difficult for our company to attract and retain qualified individuals to
serve on our board of directors or as executive officers.





We
may have difficulty raising necessary capital to fund operations as a result of
market price volatility for our shares of common stock.





In recent
years, the securities markets in the United States have experienced a high level
of price and volume volatility, and the market price of securities of many
companies have experienced wide fluctuations that have not necessarily been
related to the operations, performances, underlying asset values or prospects of
such companies.  For these reasons, our shares of common stock can also be
expected to be subject to volatility resulting from purely market forces over
which we will have no control.  If our business development plans are
successful, we may require additional financing to continue to develop and
exploit existing and new technologies and to expand into new markets.  The
exploitation of existing and new technologies may, therefore, be dependent upon
our ability to obtain financing through debt and equity or other
means.


- 24
-


We
are obligated to indemnify our officers and directors for certain losses they
suffer.





To the
fullest extent permitted by Chapter 78 of the Nevada Revised Statues, we may, if
and to the extent authorized by our board of directors, indemnify our officers
and any other persons who we have power to indemnify against liability,
reasonable expense or other matter whatsoever.  If we are required to
indemnify any persons under this policy, we may have to pay indemnity in a
substantial amount which we may be unable to recover at all.





Risks
Related to Doing Business in China





Our business will be affected by the
government regulation and Chinese economic environment because most of our sales
will be in the China market.





The manufacture and sale of
pharmaceutical products in China is heavily regulated by many state, provincial
and local authorities.  The SFDA of China requires pharmaceutical
manufacturers to obtain Good Manufacturing Practices, or GMP,
certifications.  We currently have the certifications needed for our
current operations.  However, should we fail to receive or maintain the GMP
certifications in the future, we would no longer be able to manufacture
pharmaceuticals in China, and our businesses would be materially and adversely
affected. These regulations significantly increase the difficulty and costs
involved in obtaining and maintaining regulatory approvals for marketing new and
existing products.  Our future growth and profitability depend to a large
extent on our ability to obtain regulatory approvals.  Additionally, the
law could change so as to prohibit the use of certain pharmaceuticals. If one of
our products becomes prohibited, this change would cease the productivity of
that product.  The China National Development and Reform Commission, or
CNDRC, has recently implemented price adjustments on many marketed
pharmaceutical products.  We have no control over such governmental
policies, which may impact the pricing and profitability of our
products.





Although we have started exporting
products to other countries, most of our sales are in the PRC and Hong Kong.
 It is anticipated that our products in the PRC will continue to represent
a significant portion of sales in the near future.  As a result of our
reliance on the PRC markets, our operating results and financial performance
could be affected by any adverse changes in economic, political and social
conditions in the PRC.





The modernization of regulations for
the pharmaceutical industry is relatively new in the PRC, and the manner and
extent to which it is regulated will continue to evolve.  As a
pharmaceutical company, we are subject to the Pharmaceutical Administrative Law,
which governs the licensing, manufacture, marketing and distribution of
pharmaceutical products in the PRC, and sets penalty provisions for violations
of provisions of the Pharmaceutical Administrative Law.  In addition as a
 “Foreign Owned Enterprise,” we will be subject to the Foreign Company
provisions of the Company Law of the PRC.  Changes in these laws or new
interpretations of existing laws may have a significant impact our methods and
our cost of doing business.  For example, if legislative proposals for
pharmaceutical product pricing, reimbursement levels, approval criteria or
manufacturing requirements should be proposed and adopted, such new legislation
or regulatory requirements may have a material adverse effect on our financial
condition, results of operations or cash flows.  In addition, we are
subject to varying degrees of regulation and licensing by governmental agencies
in China. At this time, we are unaware of any China legislative proposals that
could adversely affect our business. There can be no assurance that future
regulatory, judicial and legislative changes will not have a material adverse
effect on our operations, that regulators or third parties will not raise
material issues with regard to compliance or non-compliance with applicable laws
or regulations, or that any changes in applicable laws or regulations will not
have a material adverse effect on our business.





Certain political and economic
considerations relating to China could adversely affect our
company.





China is transitioning from a planned
economy to a market economy.  While the PRC government has pursued economic
reforms since its adoption of the open-door policy in 1978, a large portion of
the Chinese economy is still operating under five-year plans and annual state
plans.  Through these plans and other economic measures, such as control on
foreign exchange, taxation and restrictions on foreign participation in the
domestic market of various industries, the PRC government exerts considerable
direct and indirect influence on the economy.  Many of the economic reforms
carried out by the PRC government are unprecedented or experimental, and are
expected to be refined and improved. Other political, economic and social
factors can also lead to further readjustment of such reforms.  This
refining and readjustment process may not necessarily have a positive effect on
our operations or future business development.  Our operating results may
be adversely affected by changes in China’s economic and social conditions as
well as by changes in the policies of the PRC government, such as changes in
laws and regulations, or the official interpretation thereof, which may be
introduced to control inflation, changes in the interest rate or method of
taxation, and the imposition of additional restrictions on currency
conversion.


- 25
-


Accordingly, government actions in the
future, including any decision not to continue to support recent economic
reforms and to return to a more centrally planned economy or regional or local
variations in the implementation of economic policies, could have a significant
effect on economic conditions in China or particular regions thereof, and could
require us to divest ourselves of any interest we then hold in Chinese
properties or joint ventures.





There are risks inherent in doing
business in China.





The PRC is a developing country with a
young market economic system overshadowed by the state under heavy regulation
and scrutiny.  Its political and economic systems are very different from
the more developed countries.  China also faces many social, economic and
political challenges that may produce major shocks and instabilities and even
crises, in both its domestic arena and in its relationship with other countries,
including but not limited to the United States.  Such shocks, instabilities
and crises may in turn significantly and adversely affect our
performance.





The recent nature and uncertain
application of many PRC laws applicable to our company create an uncertain
environment for business operations and they could have a negative effect on our
business and operations.





The PRC legal system is a civil law
system. Unlike the common law system, the civil law system is based on written
statutes in which decided legal cases have little value as precedents.  In
1979, the PRC began to promulgate a comprehensive system of laws and has since
introduced many laws and regulations to provide general guidance on economic and
business practices in the PRC and to regulate foreign investment. Progress has
been made in the promulgation of laws and regulations dealing with economic
matters such as corporate organization and governance, foreign investment,
commerce, taxation and trade. The promulgation of new laws, changes of existing
laws and the abrogation of local regulations by national laws could have a
negative impact on our business, business prospects and operations.  In
addition, as these laws, regulations and legal requirements are relatively
recent, their interpretation and enforcement involve significant
uncertainty.





It may be difficult to effect service
of process and enforcement of legal judgments upon our company and its officers
and directors because they reside outside the United States.





As our operations are presently based
in the PRC and our directors and officers reside in the PRC, service of process
on our company and such directors and officers may be difficult to effect within
the United States.  Also, substantially all of our assets are located in
the PRC and any judgment obtained in the United States against our company may
not be enforceable outside the United States.





Our business may be affected by
unexpected changes in regulatory requirements in the jurisdictions in which we
operate.





Our company, and its subsidiaries, are
subject to many general regulations governing business entities and their
behavior in China and in other jurisdictions in which we and our subsidiaries
have, or plan to have, operations and market products.  In particular, we
are subject to laws and regulations covering food, dietary supplements and
pharmaceutical products.  Such regulations typically deal with licensing,
approvals and permits.  Any change in product licensing may make our
products more or less available on the market.  Such changes may have a
positive or negative impact on the sale of our products and may directly impact
the associated costs in compliance and our operational and financial
viability.  Such regulatory environment also covers any existing or
potential trade barriers in the form of import tariff and taxes that may make it
difficult for us to import our products to certain countries and regions, such
as Hong Kong, which would limit its international
expansion.


- 26
-


We may have difficulty attracting
talent in foreign countries.





Currently, over 85%of our sales are in the
PRC and in Hong Kong.  We are in the process of attempting to establish
marketing and sales presence in the United States and other countries.  We
expect to establish an office in the United States for investor relations.
 In the future, we may explore expanding its operations in the United
States, as well as other countries throughout the world.  Upon effecting
any such expansion, we may not be able to identify and retain qualified
personnel due to its lack of understanding of different cultures and lack of
local contacts. This may impede international expansion.





Currency conversion and exchange rate
volatility could adversely affect our financial condition, by making
acquisitions in China or of Chinese products more expensive.





The PRC government imposes control over
the conversion of RMB into foreign currencies. Under the current unified
floating exchange rate system, the People’s Bank of China publishes an exchange
rate, referred to as the PBOC exchange rate, based on the previous day’s
dealings in the inter-bank foreign exchange market. Financial institutions
authorized to deal in foreign currency may enter into foreign exchange
transactions at exchange rates within an authorized range above or below the
PBOC exchange rate according to market conditions.





Pursuant to the Foreign Exchange
Control Regulations of the PRC issued by the State Council which came into
effect on April 1, 1996, and the Regulations on the Administration of Foreign
Exchange Settlement, Sale and Payment of the PRC which came into effect on July
1, 1996, regarding foreign exchange control, conversion of RMB into foreign
exchange by Foreign Investment Enterprises, or FIE’s, for use on current account
items, including the distribution of dividends and profits to foreign investors,
is permissible.  FIEs are permitted to convert their after-tax dividends
and profits to foreign exchange and remit such foreign exchange to their foreign
exchange bank accounts in the PRC.





Conversion of RMB into foreign
currencies for capital account items, including direct investment, loans, and
security investment, is still subject to certain restrictions. On January 14,
1997, the State Council amended the Foreign Exchange Control Regulations and
added, among other things, an important provision, which provides that the PRC
government shall not impose restrictions on recurring international payments and
transfers under current account items.  These rules are subject to
change.





Enterprises in the PRC (including FIEs)
which require foreign exchange for transactions relating to current account
items, may, without approval of the State Administration of Foreign Exchange, or
SAFE, effect payment from their foreign exchange account or convert and pay at
the designated foreign exchange banks by providing valid receipts and
proofs.





Convertibility of foreign exchange in
respect of capital account items, such as direct investment and capital
contribution, is still subject to certain restrictions, and prior approval from
the SAFE or its relevant branches must be sought.





Our company is a FIE to which the
Foreign Exchange Control Regulations are applicable.  There can be no
assurance that we will be able to obtain sufficient foreign exchange to pay
dividends or satisfy other foreign exchange requirements in the
future.





Since 1994, the exchange rate for RMB
against the United States dollars has remained relatively stable, most of the
time in the region of approximately RMB8.00 to US$1.00.  However, in 2005,
the Chinese government announced that would begin pegging the exchange rate of
the Chinese RMB against a number of currencies, rather than just the U.S.
dollar.  Currently, exchange rates are approximately RMB 1.44to US$1.00 resulting in
the increase in price of Chinese products to U.S purchasers.  As our
operations are primarily in China, any significant revaluation of the Chinese
RMB may materially and adversely affect cash flows, revenues and financial
condition.  For example, to the extent that we need to convert United
States dollars into Chinese RMB for operations, appreciation of this currency
against the United States dollar could have a material adverse effect on our
business, financial condition and results of operations.  Conversely, if we
decide to convert Chinese RMB into United States dollars for other business
purposes and the United States dollar appreciates against this currency, the
United States dollar equivalent of the Chinese RMB that we convert would be
reduced.


- 27
-


We are required to be in compliance
with the registered capital requirements of the PRC.





Under the Company Law of the PRC, our
company will be required to contribute a certain amount of  “registered
capital” to our wholly owned subsidiary.  By law, our subsidiaries are
required to contribute at least 10% of after tax net income (as determined in
accordance with Chinese GAAP) into a statutory surplus reserve until the reserve
is equal to 50% of the Company and its subsidiaries’ registered capital, and
between 5% and 10% of its after tax net income, as determined by our board of
directors, into a public welfare fund. These reserve funds are recorded as part
of shareholders’ equity but are not available for distribution to shareholders
other than in the case of liquidation.  As a result of this requirement,
the amount of net income available for distribution to shareholders will be
limited.





Since most of our assets are located in
the PRC, any dividends or proceeds from liquidation are subject to the approval
of the relevant PRC government agencies.  We are not likely to declare
dividends in the near future and would need regulatory approval to do
so.





Because our assets are predominantly
located inside the PRC, we will be subject to the law of the PRC in determining
dividends.  Under the laws governing foreign invested enterprises in the
PRC, dividend distribution and liquidation are allowed but subject to special
procedures under the relevant laws and rules.  Any dividend payment will be
subject to the decision of the board of directors and subject to foreign
exchange rules governing such repatriation. Any liquidation is subject to both
the relevant government agency’s approval and supervision as well the foreign
exchange control.  This may generate additional risk for investors in case
of dividend payment and liquidation.





Risks
Relating to the Market for Our Common Stock





Our stock price is likely to be highly
volatile.





The trading price of our common stock
has been highly volatile. Failure to meet market expectations in our financial
results could cause our stock price to decline. Moreover, factors that are not
related to our operating performance could cause our stock price to decline. The
stock market has recently experienced significant price and volume fluctuations
that have affected the market prices for securities of technology and
communications companies. Consequently, you may experience a decrease in the
market value of your common stock, regardless of our operating performance or
prospects.





We do not plan to declare or pay any
dividends to our shareholders in the near future and would need regulatory
approval to do so.





We have not declared any dividends in
the past, and we do not intend to distribute dividends in the near future. The
declaration, payment and amount of any future dividends will be made at the
discretion of the board of directors and subject to PRC law, and will depend
upon, among other things, the results of operations, cash flows and financial
condition, operating and capital requirements, and other factors as the board of
directors considers relevant. There is no assurance that future dividends will
be paid, and if dividends are paid, there is no assurance with respect to the
amount of any such dividend.





We
have the right to issue up to 5,000,000  shares of "blank check" preferred
stock, which may adversely affect the voting power of the holders of other of
our securities and may deter hostile takeovers or delay changes in management
control.





Our
articles of incorporation provides that we may issue up to 5,000,000 shares of
preferred stock from time to time in one or more series, and with such rights,
preferences and designations as our board of directors may determinate from time
to time. Our board of directors, without further approval of our common
stockholders, is authorized to fix the dividend rights and terms, conversion
rights, voting rights, redemption rights, liquidation preferences and other
rights and restrictions relating to any series of our preferred stock. Issuances
of shares of preferred stock could, among other things, adversely affect the
voting power of the holders of other of our securities and may, under certain
circumstances, have the effect of deterring hostile takeovers or delaying
changes in management control.  Such an issuance would dilute existing
stockholders, and the securities issued could have rights, preferences and
designations superior to our Common Stock.


- 28
-


Sales of our common stock may have an
adverse effect on the market price of our common stock.  Additionally, we
may issue shares upon exercise of outstanding warrants and stock options that
are exercisable at prices that are below current market prices which will be
dilutive to the common stock.





As of March 31, 2009, we had 16,446,467
shares of common stock outstanding, many of which are freely transferable under
Rule 144.  The sale of these shares may have an adverse effect on the
market price for our common stock.





In
addition, we currently have issued and outstanding warrants and stock options to
purchase an aggregate of 1,013,500 shares of our common stock, of which (i)
750,000 are exercisable at a price of $12.50 per share; (ii) 150,000 are
exercisable at a price of $2.00 per share; and (iii) 113,500 are exercisable at
a price of $3.65 per share.  All of these warrants are also exercisable on
a “cashless” basis under certain circumstances.  Our issuance of additional
shares of common stock upon exercise of our outstanding warrants will
substantially reduce the percentage equity ownership of holders of shares of our
common stock.  Further, the exercise of a significant number of warrants,
and subsequent sale of shares of common stock received upon such exercise, could
cause a sharp decline in the market price of our common stock.





FORWARD-LOOKING
STATEMENTS





Some of the statements contained in
this prospectus are not statements of historical or current fact. As such, they
are "forward-looking statements" based on our current expectations, which are
subject to known and unknown risks, uncertainties and assumptions. They include
statements relating to:





·
            future
      sales and financings;




·
            the
      future development of our business;




·
            our
      ability to execute our business
strategy;




·
            projected
      expenditures; and




·
            the
      market for our products.




You can identify forward-looking
statements by terminology such as "may," "will," "should," "could," "expects,"
"intends," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of these terms or other comparable
terminology. These statements are not predictions.  Actual events or
results may differ materially from those suggested by these forward-looking
statements.  In evaluating these statements and our prospects generally,
you should carefully consider the factors set forth below.  All
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by these cautionary factors and to
others contained throughout this prospectus.  We are under no duty to
update any of the forward-looking statements after the date of this prospectus
or to conform these statements to actual results.





Although it is not possible to create a
comprehensive list of all factors that may cause actual results to differ from
the results expressed or implied by our forward-looking statements or that may
affect our future results, some of these factors are set forth under "Risk
Factors" in this report and in our periodic filings made with the
SEC.


- 29
-


Item.
1B.  Unresolved Staff Comments.





None.





Item
2.  Properties.





Our
facilities are located on approximately 92,000 square meters of land, including
two buildings in the city of Harbin, Heilongjiang Province, PRC.   We also
have a sales and marketing facility in Beijing, PRC.





Under
Chinese law, the government owns all of the land in the PRC and companies and
individuals are authorized to use the land only through land use rights granted
by the PRC government.  The PRC has granted TDR a land use grant covering
the land and facilities in which its headquarters are located in downtown Harbin
City, which expires in 2046.  The PRC has granted land use rights on TDR’s
two production and warehouse facilities, expiring in 2048 and 2053,
respectively.   TDR’s two buildings contain GMP production certified
facilities, and are used for manufacturing office, warehousing and staff
operations.





Description
of Production and Other Facilities





We have two separate facilities,
headquartered in the city of Harbin in the Heilongjiang Province of China.
 The older facility includes 3,000 square meters of production space, and
1,000 square meters of warehouse.  The facility also includes an extraction
workshop (approximately 1,200 square meters) and filling workshop (approximately
500 square meters) for traditional Chinese medicines; a patches production line
(approximately 500 square meters), packing workshop (approximately 500 square
meters), testing workshop (approximately 50 square meters), examination
laboratory (approximately 100 square meters), sample laboratory (approximately
50 square meters), refining room (approximately 100 square meters), and a
work-in-process warehouse (approximately 300 square meters); finished product
warehouse (approximately 200 square meters); materials warehouse (approximately
100 square meters); and a packing warehouse (approximately 400 square
meters).





The newer facility consists of a four
floor office building (1,500 square meters for office purpose, 1,200 square
meters for R&D center, 800 square meters for central examination lab,
dormitory and eatery 1,000 square meters), total 4,500 square meters
construction area, and a factory of 3,500 square meters.  The facility also
include: an enzyme immunity reagent kit production workshop (1,500 square
meters) and a colloid gold production workshop (600 square meters); a packing
workshop (800 square meters); and an examination lab (500 square meters). The
newer facility also includes a research center covering approximately 1,200
square meters, for research pertaining to the development of various products,
including traditional Chinese medicinals (TCM), biological medicine, gene
medicine, immune body research, and vitro diagnosis reagent.  These
facilities also include an electricity room, heating and boiler room and garage.
 Our enzyme immunity examination reagent kit production workshop includes
antigen and immune body areas, disinfection room, aseptic clothes room, cushion
room, weighing room, separation room, cleaning equipment room, a Wan Ji flow
cushion room, and antigen and immune body sign room.  The enzyme sign
processing area has a cushion room, cloth cleaning room, cleaning equipment
room, packing material temporary storage room, raw material temporary storage
room, equipment storage room, weighing room, seal protection room, seal foster
room, drying room, packing room, and middle cooler room.  The work fluid
separation loading room includes a disinfection clean room, storage room,
weighting room, loading room, and immune body purification room.  The
colloid gold production workshop has a darkroom, sample room, seal room,
cementation room, cutting room, and a packing room.  The packing workshop
includes a central equipment room, a cooler room, material relay room, label and
temporary storage room, a packing material temporary storage room, two
examination cooler rooms, and two finished product cooler rooms.





We also
have a sales office in Beijing, which TDR acquired in December of 2006, when it
completed the acquisition of the products, dealership and marketing network of
Heilongjiang.   In addition to the above, our properties include
GMP-certified manufacturing facilities of Heilongjiang and manufacturing
equipment which was acquired on April 3, 2008.  (See “Corporate History”
above and “Recent Developments” and  “Management’s Discussion and Analysis
or Plan of Operation” below).


- 30
-


Our
production facilities are operated in accordance with “good manufacturing
practices” (“GMP”).





Item
3.  Legal Proceedings.





We are not a party to any material
pending legal proceedings, and to the best of our knowledge, no such proceedings
by or against the Company have been threatened.





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





During the fourth quarter of the fiscal
year ended December 31, 2008, and subsequent periods through the date hereof, no
matters were submitted to a vote of our security holders, except as
follows:





On September 30, 2008 (the “Record
Date”), we obtained the written consent of the holders of 8,158,251 shares of
our common stock, which as of the Record Date represented 51.3% of our
outstanding voting securities, to increase our number of authorized shares of
common stock from 20,000,000 shares to 50,000,000 shares.  The increase was
effective upon filing of the Certificate of Amendment with the Secretary of
State of the State of Nevada on November 17, 2008.


- 31
-


PART II





Item
5.  Market for Common Equity, Related Stockholder Matters and Small
Business Issuer Purchases of Equity Securities.





Market
Information





Until May 28, 2008, our common stock
was traded on FINRA’s Over-the-Counter Bulletin Board under the trading symbol
“CSKI.”  The range of high and low sales prices for each quarter during the
last two fiscal years, as quoted on the OTC Bulletin Board for the periods
discussed below, reflect inter-dealer prices, without retail mark-up, mark-down,
or commission and may not necessarily represent actual transactions.  On
May 28, 2008, our common stock commenced trading on the American Stock Exchange
under the trading symbol “CSY”.  As of September 14, 2008, we terminated
our listing on the American Stock Exchange and became listed on the Nasdaq
Global Market under the trading symbol “CSKI.” The high and low prices for
our common stock in the two prior fiscal years were as follows:





Year
      Ended December 31, 2008
                        
                        
                        Year
      Ended December 31, 2007High
                        
                        
                        Low
                        
                        
                        High
                        
                        
                        Low1st
      Quarter
                        
                        $
                        13.75
                        
                        
                        $
                        9.40
                        
                        
                        $
                        10.00
                        
                        
                        $
                        7.002nd
      Quarter
                        
                        $
                        17.10
                        
                        
                        $
                        9.50
                        
                        
                        $
                        14.20
                        
                        
                        $
                        6.003rd
      Quarter
                        
                        $
                        14.95
                        
                        
                        $
                        9.48
                        
                        
                        $
                        14.35
                        
                        
                        $
                        10.004th
      Quarter
                        
                        $
                        16.09
                        
                        
                        $
                        6.77
                        
                        
                        $
                        15.50
                        
                        
                        $
                        9.00





As of March 31, 2009, the closing price
for our common stock was $11.50.





Dividends





Since inception, no dividends have been
paid on our common stock.  We intend to retain any earnings for use in our
business, so it is not expected that any dividends on the common stock will be
declared and paid in the foreseeable future.  We do not currently have any
restrictions that would limit our ability to pay dividends, and we are not
currently aware of any restrictions that are likely to limit our ability to pay
dividends in the future.





Holders





At March 31, 2009, there were
approximately 379 holders of record of our common stock, with 16,446,467shares issued and
outstanding.





Securities
Authorized For Issuance Under Equity Compensation Plan





As of December 31, 2008, we had only
one stock option, bonus, profit sharing, pension or similar plan in place, which
is our 2006 Stock Incentive Plan.


- 32
-





EQUITY
COMPENSATION PLAN INFORMATION





(a)
                  
                  (b)
                  
                  (c)Plan
      Category
                  
                  Number
      of securities
                    to
      be issued upon
                    exercise
      of
                    outstanding
      options,
                    warrants
      and rights
                  
                  Weighted-
                    averageexercise
                    price of
                    outstanding
                    options,
                    warrants and
                    rights
                  
                  Number
      of
                    securities
                    remaining
                    available
      for future
                    issuance
      under
                    equity
                    compensation
      plans
                    (excluding
                    securities
      reflected
                    in
      column (a))Equity
      compensation plans approved by security holders (1)
                  
                  
                  113,500
                  
                  $3.65
                  
                  
                  1,326,437
                  (3)Equity
      compensation plans not approved by security holders (2)
                  
                  
                  -0-
                  
                  N/A
                  
                  
                  -0-Total
                  
                  
                  113,500
                  
                  $3.65
                  
                  
                  1,326,437





(1)
              The
      Company’s board of directors adopted the 2006 Stock Incentive Plan (the
      “Plan”), to be effective on July 31, 2006.  The Plan was approved by
      the shareholders on July 31,
2006.




(2)
              We
      do not have any equity compensation plans not approved by the security
      holders.





(3)
              The
      Plan reserves an aggregate of 1,500,000 shares of our common stock for
      awards of stock options, stock appreciation rights, restricted stock,
      performance stock and bonus stock granted thereunder.  As of the date
      hereof, 60,063 shares of restricted stock have been granted under the
      Plan.





Sales
of Unregistered Securities





The
following is a list of securities we have sold or issued during the past year.
We believe that each of these transactions was exempt from registration under
the Securities Act of 1933, as amended, pursuant to Section 4(2), or Regulation
D promulgated thereunder, as a transaction by an issuer not involving a public
offering. There were no underwriting discounts or commissions paid in connection
with the sale of these securities, except as otherwise noted.





Private
Offering





On January 31, 2008 (the “Closing
Date”), we entered into a Securities Purchase Agreement (the “Purchase
Agreement”) with certain accredited investors (the “Investors”), for the
purchase and sale of 2,500,000 units of our securities (“Units”) consisting of
an aggregate of: (i) 2,500,000 shares of our common stock (the “Purchased
Shares”), and (ii) Class A Warrants to purchase 750,000 additional shares of our
common stock, at an exercise price of $12.50 per share (the “Purchased
Warrants”), for a purchase price of $10.00 per unit (the “Unit Purchase Price”),
or aggregate of $25,000,000 (the “Offering”).





Pursuant to the Purchase Agreement,
among other things:





·
            The
      lead investor in the Offering (the “Investor Agent”), was granted a right
      of first refusal, for a period of eighteen (18) months after the later of
      the Closing Date, or the effective date of the Registration Statement
      (defined below), to purchase up to a maximum of $15,000,000 of any
      securities we offer in any proposed offering of our common stock, or other
      securities or debt obligations, except certain Excepted Issuances (as
      defined in the Purchase Agreement);
and




- 33
-


·
            We
      agreed that, if and whenever, within twelve (12) months of the Closing
      Date, it issues or sells, or is deemed to have issued or sold, any shares
      of common stock, or securities convertible into or exercisable for shares
      of common stock, or modifies any of the foregoing which may be outstanding
      (with the exception of certain excluded securities), to any person or
      entity at a price per share, or conversion or exercise price per share
      less than the Unit Purchase Price, then we shall issue, for each such
      occasion, additional shares of our common stock to the Investors in such
      number so that the average per share purchase price of the shares of
      common stock purchased by the Investors in the Offering shall
      automatically be reduced to such other lower price per share (in each
      case, the “Additional Shares”). In addition, the Investors will have the
      registration rights described in the Registration Rights Agreement with
      respect to such Additional Shares.




In connection with the Initial
Placement, we paid a placement agent (the “Placement Agent”) a fee of five
percent (5%) of the Offering Proceeds. In addition, we paid the Placement
Agent’s legal fees and additional out-of-pocket expenses related to the
Offering.





We used the net proceeds from the
Offering primarily for: (a) acquisitions, (b) new product marketing, (c)
expenses related to the Offering and the Registration Statement (defined below),
and (d) general working capital purposes.





As of the Closing Date, we entered
into a Registration Rights Agreement (the “Registration Rights Agreement”) with
the Investors, pursuant to which it agreed that within sixty (60) calendar days
of the Closing Date (the “Filing Date”), we would file a registration statement
(the “Registration Statement”) with the SEC, on the appropriate form, covering
the resale of (i) the Purchased Shares, and (ii) the common stock issuable upon
exercise of the Purchased Warrants (the “Warrant Shares”) (collectively (i) and
(ii), the “Registrable Securities”). Further, we agreed to use our best efforts
to (a) cause the Registration Statement to be declared effective within one
hundred twenty (120) calendar days from the Filing Date, or, if reviewed by the
Commission, within one hundred fifty (150) calendar days after the Filing Date,
and (b) keep the Registration Statement continuously effective until all of the
Registrable Securities have been sold, or may be sold without volume
restrictions pursuant to Rule 144. We have not yet satisfied these registration
requirements.





Notwithstanding anything to the
contrary stated in the Registration Rights Agreement, the Company shall be
entitled to limit the Registrable Securities to the extent necessary to avoid
any issues arising from the recent interpretations by the Commission of Rule 415
of the Securities Act of 1933, as amended.





In addition, as of the Closing Date,
we entered into a Make Good Agreement (the “Make Good Agreement”) with Liu
Yan-Qing, our Chairman, Chief Executive Officer and President, and a principal
shareholder of ours (the “CSKI Shareholder”) and the Investor Agent
(collectively, the “Make Good Parties”), pursuant to which the CSKI Shareholder
placed 3,000,000 shares of our common stock (the “Escrow Shares”) into escrow
for the benefit of the Investors, in the event that we failed to attain Earnings
Per Share, as adjusted (“Adjusted EPS”) of at least (i) $1.05 per share for the
fiscal year ending December 31, 2007, based on fully diluted shares outstanding
(an aggregate of 13,907,696 shares, including all outstanding common shares,
preferred shares, any convertible security, options, and warrants) and/or (ii)
$1.63 per share for the fiscal year ending December 31, 2008, based on fully
diluted shares outstanding (an aggregate of 16,907,696 shares, including all
outstanding common shares, preferred shares, any convertible security, options,
and warrants, excluding the 750,000 warrants issued in the Offering), based upon
annual audits conducted in conformity with United States generally accepted
accounting principles.





In each case, the Investors shall
have the right to receive a pro rata share of any Escrow Shares released
pursuant to the terms and conditions of the Make Good Agreement and a Make Good
Escrow Agreement (the “Make Good Escrow Agreement”), which the Make Good Parties
entered into with our transfer agent, as escrow agent. Notwithstanding anything
to the contrary set forth in the Make Good Agreement, upon any Investor’s
exercise of its Put Right (defined below), such Investor’s right to receive a
pro rata share of the Escrow Shares automatically and permanently
terminates.




We deem
the Escrow Shares arrangement as analogous to the issuance of a fixed number of
warrants in an equity transaction.  Under the Make Good Agreement
these Escrow Shares would have been  reallocated on a pro rata basis
to the Investors only if the Adjusted EPS targets were not achieved in years
2007 and 2008.  If the earnings targets were met, the Escrow Shares
would automatically be released to the CSKI Shareholder.  As of
January 31, 2008, the date the common shares were placed into escrow, we
achieved the 2007 earnings target and, based upon internal forecasts, we were
confident the 2008 target would also be met.  Based upon certain
assumptions, including the low probability that the Escrow Shares would be
released to the Investors and not be returned to the CSKI Shareholder, we
considered the fair value of the right held by the Investors through the Escrow
Shares provision under the Make Good Agreement to be immaterial.  As
of December 31, 2008, we satisfied the earnings per common share targets for
each of fiscal 2007 and 2008 as defined under the Make Good Agreement and, as
such, the Escrow Shares shall be released to the CSKI Shareholder in
2009.




- 34
-


Further, as of the Closing Date, we
entered into a Put Agreement (the “Put Agreement”) with the Investors, pursuant
to which each Investor has the right to cause us to repurchase all, but not less
than all of its Purchased Shares (the “Put Right”), for a price of $10.00 per
share (the “Repurchase Price”), in the event that:





·
            our
      Adjusted EPS for the fiscal year ending December 31, 2007 is less than
      $0.80 per share, as set forth in our audited financial statements;
      or




·
            our
      accounts receivable exceeds $12,000,000 at the end of fiscal 2007, as set
      forth in our audited financial
statements.




Upon our receipt of a notice of
exercise from any Investor, (i) such Investor’s right to receive a pro rata
shares of the Escrow Shares shall automatically and permanently terminate,
subject only to the satisfaction of our obligations under the Put Agreement; and
(ii) such Investor’s right to exercise the Purchased Warrants shall be suspended
pending the satisfaction of our obligation to pay the Repurchase Price in full,
and any interest accrued thereon, to the applicable Investor.





After exercise of the Put Right, and
upon delivery to the Investor of the applicable Repurchase Price, such Investor
shall no longer be deemed to be the owner of the Purchased Shares or Purchased
Warrants. The Purchased Shares shall be placed in our treasury and the Purchased
Warrants shall be cancelled on our books.





We satisfied the Adjusted EPS and
accounts receivable requirements as of the end of fiscal 2007.  Therefore,
the Investors’ Put Right has terminated.





Lastly, as of the Closing Date, we
entered into a Lock-up Agreement (the “Lock-up Agreement”) with two of our
stockholders, whom are also members of our management (the “Principal
Stockholders”), pursuant to which the Principal Stockholders agreed not to sell,
assign, transfer, pledge, hypothecate, or otherwise dispose of any of their
aggregate of 6,063,502 shares of our common stock (the “Lock-up Shares”) until
twelve (12) months from the effective date of the Registration Statement (the
“Lock-Up Period”). Anything to the contrary notwithstanding, the Principal
Stockholders are entitled to sell, in the aggregate, 136,000 of the Lock-up
Shares pursuant to Rule 144 under the Securities Act of 1933, as amended (“Rule
144”).





If any of the Escrow Shares are
released to the Investors pursuant to the terms and conditions of the Make Good
Agreement and Make Good Escrow Agreement (“Released Shares”), the Lock-Up Period
shall be deemed to have automatically and permanently terminated with respect to
such Released Shares.





The Class A Warrants represent the
right to purchase an aggregate of 750,000 shares of our Common Stock, at an
exercise price of $12.50 per share (the “Exercise Price”), and have the
following additional characteristics:





·
            The
      Class A Warrants shall be exercisable beginning on the six-month
      anniversary of the Closing Date and will expire three years thereafter
      (the “Expiration Date”).




·
            Commencing
      on one-year anniversary of the Closing Date, in the event the Warrant
      Shares may not be freely sold by the holders (the “Warrantholders”) due to
      our failure to satisfy our registration requirements, and an exemption for
      such sale is not otherwise available to the Warrantholders under Rule 144,
      the Class A Warrants will be exercisable on a cashless
    basis.




·
            The
      Exercise Price and number of Warrant Shares will be subject to adjustment
      for standard dilutive events, including the issuance of common stock, or
      securities convertible into or exercisable for shares of common stock, at
      a price per share, or conversion or exercise price per share less than the
      Exercise Price.




·
            At
      anytime following the date a Registration Statement covering the Warrant
      Shares is declared effective, we will have the ability to call the Class A
      Warrants at a price of $0.01 per Class A Warrant, upon thirty (30) days
      prior written notice to the holders of the Class A Warrants, provided (i)
      the closing price of the common stock exceeded $18.75 for each of the ten
      (10) consecutive trading days immediately preceding the date that the call
      notice is given by us, and (ii) we have attained an Adjusted EPS of at
      least $1.75 per share for the fiscal year ending December 31, 2008, as set
      forth in our audited financial
statements.




- 35
-


·
            If,
      among other things, we fail to cause a Registration Statement covering the
      Warrant Shares to be declared effective prior to the applicable dates set
      forth in the Registration Rights Agreement (the “Effectiveness
      Deadlines”), the Expiration Date of the Class A Warrants shall be extended
      one day for each day beyond the Effectiveness
  Deadlines.




·
            If
      a Warrantholder exercises its Put Right, such Warrantholder’s right to
      exercise the Class A Warrants shall be suspended, pending the satisfaction
      of our obligations to pay the Warrantholder the applicable Repurchase
      Price. Upon receipt of the Repurchase Price in full by the Warrantholder,
      the Warrantholder’s right to exercise the Class A Warrants shall
      automatically and permanently terminate and expire, and the Class A
      Warrants shall be immediately cancelled on our
  books.




·
            The
      Warrantholder shall not be entitled to exercise a number of Class A
      Warrants in excess of the number of Class A Warrants upon exercise of
      which would result in beneficial ownership by the Warrantholder and its
      affiliates of more than 9.9% of the outstanding shares of our common
      stock. This limitation on exercise may be waived by written agreement
      between the Warrantholder and us; provided, however, such waiver may not
      be effective less than sixty-one (61) days from the date
      thereof.




Exercises of Warrants and Stock
Options





In fiscal 2008, we issued an aggregate
of 1,142,302 shares of our common stock in connection with their exercise of
outstanding warrants and stock options of ours, as follows:





·
            Between
      February 2008 and October 2008, warrants to purchase an aggregate of
      355,002 shares of our common stock, which we issued to “accredited”
      investors in connection with the private offering we completed in October
      2006 (the “2006 Offering”), were exercised at a price of $3.50 per share,
      for an aggregate of $1,642,091.




·
            In
      April 2008, warrants to purchase an aggregate of 100,000 shares of our
      common stock, which we issued to a consultant in consideration for
      services rendered in connection with the 2006 Offering, were exercised at
      a price of $3.00 per share, for an aggregate of $300,000.  In October
      2008, warrants to purchase an additional 50,000 shares of our common stock
      were exercised by the consultant, at a price of $3.50 per share, for an
      aggregate of $475,000.




·
            In
      September 2008, warrants to purchase an aggregate of 500,000 shares of our
      common stock, which we issued to a consultant in consideration for
      services rendered in connection with the 2006 Offering, were exercised on
      a cashless basis. In connection with the cashless exercise, the warrant
      holder was deemed to have paid an amount equal to the difference between
      the exercise price ($2.00 per share) and the average closing price of a
      share of our common stock during the ten (10) trading days ending on the
      date of exercise ($12.67 per share). As a result of the cashless exercise,
      we issued an aggregate of 421,055 shares of our common stock to the
      warrant holder and its designees.




·
            In
      October 2008, stock options to purchase 50,000 shares of our common stock,
      which we issued to a former executive officer in fiscal 2006 in
      consideration for consulting services he performed following the
      termination of his employment, were exercised at a price of $3.00 per
      share, for an aggregate of
$150,000.




- 36
-


·
            In
      October 2008, warrants to purchase an aggregate of 200,000 shares of our
      common stock, which we issued to a consultant in consideration for
      services rendered in connection with the share exchange transaction we
      consummated in May 2006, were exercised on a cashless basis. In connection
      with the cashless exercise, the warrant holder was deemed to have paid an
      amount equal to the difference between the exercise price ($2.00 per
      share) and the average closing price of a share of our common stock during
      the ten (10) trading days ending on the date of exercise ($11.85 per
      share). As a result of such cashless exercise, we issued an aggregate of
      166,245 shares of our common stock to the warrant holder. Following this
      exercise, the warrant holder still held warrants to purchase an additional
      300,000 shares of our common stock, which could be exercised in whole, or
      in part, for cash, or on a cashless
basis.




Shares Issued in Connection with
Acquisitions





In fiscal 2008, we issued an aggregate
of 408,456 shares of our common stock in connection with acquisitions we
completed, as follows:





·
            On
      April 3, 2008, Harbin Tian Di Ren Medical Science and Technology Company,
      our indirect subsidiary (“TDR”), acquired 100% of the equity of
      Heilongjiang Tianlong Pharmaceutical, Inc., a corporation organized under
      the laws of the PRC, from its sole shareholder, in consideration for a
      purchase price of $8.3 million, consisting of: (i) approximately $8.0
      million in cash, and (ii) 23,850 shares of our common stock (valued at
      $12.00 per share).




·
            On
      September 5, 2008, TDR acquired 100% of the equity of Peng Lai Jin Chuang
      Pharmaceutical Company, a corporation organized under the laws of the PRC,
      from its sole shareholder, in consideration for a purchase price of $7.1
      million, consisting of (i) $2.5 million in cash, and (ii) 381,606 shares
      of our common stock (valued at $12.00 per
  share).




Restricted Shares Issued Under 2006
Equity Incentive Plan





As of July 15, 2008, we issued 30,063
“restricted” shares of our common stock to certain employees, directors and
advisors of ours, pursuant to our 2006 Stock Incentive Plan.





Item
6.  Selected Financial Data.





We are a smaller reporting company as
defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not
required to provide the information under this item.


- 37
-


Item
7.  Management’s Discussion and Analysis of Financial Condition and Results
of Operation.





The financial and business analysis in
this Annual Report on Form 10-K (the “Report”) provides information we believe
is relevant to an assessment and understanding of our financial condition and
results of operations. The following discussion should be read in conjunction
with our consolidated financial statements and related notes included in Part
II, Item 8 of this Report.





FORWARD
LOOKING STATEMENTS




The following discussion should be read
in conjunction with the information contained in our consolidated financial
statements and the notes thereto appearing elsewhere herein and in the risk
factors and “Forward Looking Statements” summary set forth in the forepart of
this Annual Report as well as the “Risk Factors” section above and are afforded
the safe harbor provisions of Section 27A of the Securities Act and Section 21E
of the Securities Exchange Act of 1934, as amended. Readers should carefully
review the risk factors disclosed in this Annual Report and other documents
filed by us with the SEC.





DISCUSSION





We primarily generate revenues, through
our China based indirect subsidiaries described below, in the development,
manufacture, marketing and sale of over-the-counter, branded nutritional
supplements and over-the-counter plant and herb based pharmaceutical and
medicinal products.  Our principal products are external use Traditional
Chinese Herbal Remedies/Medicines commonly referred to in the industry as
“TCM.”  We have evolved into an integrated manufacturer, marketer and
distributor of external use Chinese medicine products sold primarily in China
and through Chinese domestic pharmaceutical chains and have been expanding our
worldwide sales effort as well.  We sell both our own manufactured
products, as well as medicinal and pharmaceutical products manufactured by
others in China.





We achieved continuing growth on the
sale of both our own product line and a contract service line of manufacturer’s
products which we sell through our distribution channel.  For the year
ended December 31, 2008, total revenue was $91,816,183, an 86% increase over the
same period in 2007, and net income was $28,835,207, or $1.87 per share
compared to net income of $15,332,945, or $1.15 per share on a diluted basis in
the same period in 2007.




All of our business is conducted
through our wholly-owned subsidiary, ACPG which, in turn, wholly owns Harbin
Tian Di Ren Medical Science and Technology Company (referred to herein as
“TDR”), a company organized in the PRC, and TDR’s subsidiaries.





TDR, formerly known as “Harbin City
Tian Di Ren Medical Co.,” was originally formed in 1994 with its principal
executive office in Harbin City of Heilongjiang Province, in the PRC.  TDR
was reorganized and incorporated as a limited liability company on December 29,
2000, under the “Corporation Laws and Regulations” of the PRC.  At the time
of the TDR Acquisition by ACPG in December of 2005, TDR had two wholly-owned
subsidiaries, Harbin First Bio-Engineering Company Limited and Kangxi Medical
Care Product Factory, until July, 2006, when the two were merged, with Harbin
First Bio-Engineering Company Limited (“First” or “Harbin Bio Engineering”) as
the surviving subsidiary of TDR.





As of October 16, 2006, we organized
Harbin Tian Qing Biotech Application Company as a wholly-owned PRC subsidiary of
TDR, to conduct research and development in the areas of tissue and stem cell
banks, which is described in more detail below.





Recent
Developments





On April 3, 2008, TDR completed its
acquisition of Heilongjiang Tianlong Pharmaceutical, Inc., a corporation with a
variety of SFDA approved medicines and new medicine applications, organized
under the laws of the PRC (“Tianlong”), which is in the business of
manufacturing external-use pharmaceuticals. TDR previously acquired the Beijing
sales office of Tianlong in mid-2006.  TDR acquired 100% of the issued and
outstanding capital stock of Tianlong from its sole stockholder, in
consideration for an aggregate purchase price of approximately $8,300,000,
consisting of (i) $8,000,000 in cash, and (ii) 23,850 shares of our common
stock.


- 38
-


On April 18, 2008, TDR consummated its
acquisition of Heilongjiang Haina Pharmaceutical Inc., a recently formed
corporation organized under the laws of the PRC (“Haina”) licensed as a
wholesaler of TCD, bio-medicines, bio-products, medicinal devices, antibiotics
and chemical medicines. Haina did not have an established sales network and was
acquired for its primary asset, a Good Supply Practice (GSP) license (License
No. A-HLJ03-010), issued by the Heilongjiang province office of the SFDA. The
SFDA recently started issuing such licenses to resellers of medicines that
maintain certain quality controls. The GSP license was issued as of December 21,
2006 and will expire on January 29, 2012 and will enable us to expand its sales
of medicinal products without having to go through a lengthy license application
process.  TDR acquired 100% of the issued and outstanding capital stock of
Haina from its three stockholders in consideration for payment of approximately
$437,375. TDR had been overseeing the operations of Haina Pharmaceutical since
January of 2008, as part of our due diligence prior to closing of this
acquisition.





On September 5, 2008, TDR acquired Peng
Lai Jin Chuang Pharmaceutical Company (“Jin Chuang”), a corporation organized
under the laws of the PRC, from Peng Lai Jin Chuang Group Corporation (the
“Seller”). Jin Chuang, which has received Good Manufacturing Practice
certification from the SFDA, was organized to develop, manufacture and
distribute pharmaceutical, medicinal and diagnostic products in the PRC. In
connection with the acquisition of Jin Chuang, TDR acquired all of Jin Chuang’s
assets, including, without limitation, franchise, production and operating
rights to a portfolio of twenty (20) medicines approved by the SFDA, for an
aggregate purchase price of approximately $7.1 million, consisting of (i)
approximately $2.5 million in cash, and (ii) 381,606 shares of our common
stock.





Summary
of Our Research and Development Activities





We currently conduct all of our
research and development (“R&D”) activities, either internally or through
collaborative arrangements with universities and research institutions in the
PRC. We have our own research, development and laboratory facilities located at
TRD’s principal executive.





Additionally, we have established
several long-term partnerships with well-known universities and enterprises in
the PRC. We have built a gene medicine laboratory through a collaborative effort
with Harbin Medical University; established a cell laboratory with North East
Agricultural University; and founded a monoclonal antibody laboratory with Jilin
University.   Under our partnership arrangements with other
universities and research institutions, we will generally hold the intellectual
property rights to any developed technology. As a result of one of these
collaborations with Harbin Medical University, a product known as “Endothelin-1”
is currently under development as a cancer suppressing product. Additional
information relating to this product and other products being developed is set
forth under “Products Under Development” below and under the general product
descriptions in the “Business” section above, which is incorporated by reference
herein.





In collaboration with Harbin Medical
University, we have completed a laboratory experimental study pertaining to
Endothelin-1, which is required prior to clinical trials, and we are currently
applying for approval to enter clinical experiments.  This medicine has
been recognized by the PRC as the “Top Category in New Medicine.”  In order
to qualify as the “Top Category in New Medicine,” a company must have
intellectual property rights, high technology involvement, strong innovation,
and the medicine must be the first of its kind to be introduced to the PRC.
 We hold the intellectual property rights pertaining to this technology,
and we have obtained an invention patent to this intellectual property in the
PRC.  Under our partnership arrangements with other universities and
research institutions, we will generally hold the intellectual property rights
to any developed technology.





At present, our ongoing research is
divided into five general areas:





·
            the
      development of an enzyme linked immune technique to prepare extraneous
      diagnostic kits (see table below);




- 39
-


·
            the
      development of an enzyme linked gold colloid technique to prepare
      extraneous rapid diagnostic test
strip;




·
            the
      development of a gene recombination technique to prepare gene
      drug;




·
            the
      development of a biology protein chip for various tumor diagnostic
      applications; and




·
            the
      development of a cord blood stem cell bank, as more fully described in
      other reports we have filed.




We currently have eight biological
products under development:   HIV detection kit; a uterus cancer diagnostic
kit; a breast cancer diagnostic kit; a liver cancer diagnostic kit; a rectum
cancer diagnostic kit; a gastric cancer diagnostic kit; a gene recombination
drug; and a multi-tumor marker protein chip detection kit.  We are also
working to establish additional sales networks and cell banks covering domestic
and international markets.





Testing
Kits and Other Products in Production





We also have three products: AMI
Diagnostic Kit, Human Urinary Albumin Elisa Kit and Early Pregnancy Diagnostic
Kit that passed the final stages of national inspection in 2006 or 2007. 
These diagnostic kits are being sold through drug stores, hospitals, examination
stations and independent sales agents throughout the PRC.  We also plan to
market these products in Vietnam, Indonesia, Philippines and eventually in
Africa. Our sales in this product category increased in mid 2008.




Our AMI Diagnostic Kit,
which entered markets in 2007, is used for early diagnosis of
Myocardial Infarction (MI), also known as heart disease. All the test kits
require users to place a blood or urine sample on the marker and a positive (+)
or negative (-) reaction signal will result, showing if a user should consult
his or her doctor for further testing.  According to the China Medical
Newspaper, Several million people die from MI every year.  MI often occurs
to people who are, but not limited to, smokers, over-weight and diabetic.
 There are approximately 8 million new MI patients in China every year.
 Recent medical studies have shown that heart failure or heart attacks are
increasing among younger people in China. This is a result from a more modern
life style, the fast pace of city life and increased pressure from work or
school.  The use of AMI Diagnostic Kits will help in early detection that
can help in reducing these statistics.





We are continuing our marketing efforts
with respect to these testing kits which resulted in continued increased sales
of these products in 2008.





Significant Accounting Estimates and
Policies




The discussion and analysis of our
financial condition and results of operations is based upon our financial
statements which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets and liabilities. On an on-going basis, we evaluate our
estimates including the allowance for doubtful accounts and inventories, the
salability and recoverability of our products, income taxes and contingencies
and remaining useful lives of our tangible and certain intangible assets. We
base our estimates on historical experience and on other assumptions that we
believes to be reasonable under the circumstances, the results of which form our
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.




Property and equipment are evaluated
for impairment whenever indicators of impairment exist. Accounting standards
require that if an impairment indicator is present, we must assess whether the
carrying amount of the asset is unrecoverable by estimating the sum of the
future cash flows expected to result from the asset, undiscounted and without
interest charges. If the recoverable amount is less than the carrying amount, an
impairment charge must be recognized based on the fair value of the
asset.




- 40
-


As part of the process of preparing our
financial statements, we are required to estimate our income taxes. This process
involves estimating our current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities. We
must then assess the likelihood that our deferred tax assets will be recovered
from future taxable income, and, to the extent we believe that recovery is not
likely, we must establish a valuation allowance. To the extent that we establish
a valuation allowance or increase this allowance in a period, we must include a
tax provision or reduce our tax benefit in the statements of operations. We use
our judgment to determine our provision or benefit for income taxes, deferred
tax assets and liabilities and any valuation allowance recorded against our net
deferred tax assets. We believe, based on a number of factors including
historical operating losses, which we will not realize the future benefits of a
significant portion of our net deferred tax assets and we have accordingly
provided a full valuation allowance against our deferred tax assets. However,
various factors may cause those assumptions to change in the near
term.




We cannot predict what future laws and
regulations might be passed that could have a material effect on our results of
operations. We assess the impact of significant changes in laws and regulations
on a regular basis and update the assumptions and estimates used to prepare our
financial statements when we deem it necessary.




We have determined the significant
principles by considering accounting policies that involve the most complex or
subjective decisions or assessments. Our most significant accounting policies
are those related to intangible assets and research and
development.




Intangible assets





Intangible assets consist of patents
and goodwill. Patent costs are being amortized over the remaining term of the
patent.




Intangible assets are accounted for in
accordance with Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible
Assets (“SFAS 142”).  Intangible assets with finite useful lives are
amortized while intangible assets with indefinite useful lives are not
amortized. As prescribed by SFAS 142, goodwill and intangible assets are tested
periodically for impairment. The Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long- Lived Assets," effective January 1, 2002.
Accordingly, the Company reviews its long-lived assets, including property and
equipment and finite-lived intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be fully recoverable. To determine recoverability of its long-lived assets, the
Company evaluates the probability that future undiscounted net cash flows will
be less than the carrying amount of the assets. Impairment costs, if any, are
measured by comparing the carrying amount of the related assets to their fair
value.




Research and development





Research and development expenses
include the costs associated with the Company’s internal research and
development as well as research and development conducted by third parties.
These costs primarily consist of salaries, clinical trials, outside consultants,
and materials. All research and development costs are expensed as incurred.





Third-party expenses were reimbursed
under non-refundable research and development contracts, and are recorded as a
reduction to research and development costs in the statement of
operations.




We recognize in-process research and
development in accordance with FASB Interpretation No. 4,Applicability of FASB Statement No.
2 to Business Combinations Accounted for by the Purchase Method and
theAICPA
Technical Practice Aid, Assets Acquired in a Business Combination to be used in
Research and Development Activities:  A Focus on Software, Electronic
Devices, and Pharmaceutical Industries. Assets to be used in research and
development activities, specifically, compounds that have yet to receive new
drug approval and would have no alternative use, should approval not be given,
are immediately charged to expense when acquired.  Certain assets and high
technologies acquired that has a foreseeable future cash flows are capitalized
as intangible assets.  Such intangible assets are amortized starting from
the year revenue is generated and amortize over a period of 10 years.


- 41
-


For the year ended December 31, 2008
and 2007, the Company incurred $7,412,895 and $3,158,351, respectively, in
research and development expenditures.




Results
Of Operations





For
the year ended December 31, 2008 as compared to December 31, 2007





Our principal business operations are
conducted through our wholly owned subsidiary, TDR, and TDR’s wholly-owned
subsidiaries.





December
      312008
                                                        
                                                        
                                                        Variance
                                                        
                                                        
                                                        2007REVENUESProduct
      Sales (net of sales allowance)
                                                        
                                                        $
                                                        86,161,098
                                                        
                                                        
                                                        
                                                        137
                                                        %
                                                        
                                                        $
                                                        36,320,156Contract
      Sales
                                                        
                                                        
                                                        5,655,085
                                                        
                                                        
                                                        
                                                        (57
                                                        )%
                                                        
                                                        
                                                        12,998,152Total
      revenues
                                                        
                                                        $
                                                        91,816,183
                                                        
                                                        
                                                        
                                                        86
                                                        %
                                                        
                                                        
                                                        49,318,308COST
      OF GOODS SOLDCost
      of goods sold
                                                        
                                                        
                                                        22,403,303
                                                        
                                                        
                                                        
                                                        105
                                                        %
                                                        
                                                        
                                                        10,939,531Gross
      Profit
                                                        
                                                        $
                                                        69,412,880
                                                        
                                                        
                                                        
                                                        81
                                                        %
                                                        
                                                        $
                                                        38,378,777





Total revenues increased by 86% in the
year ended December 31, 2008 compared to 2007.  The $42.5 million increase
in revenue is attributable to strong performances from our sales distribution
channels.





Product sales increased by 137% in the
year ended December 31, 2008, to $86,161,098 from $36,320,156 in 2007.
 This growth in sales is attributable to volume and our efforts to continue
to develop our distribution channels by hiring additional direct territory
managers and sales agents to assure that our products and their associated
benefits are seen by those making or influencing the purchasing decisions.
..




Contract sales of non-manufactured
products amounted to $5,655,085 in the year ended December 31, 2008, or a
significant decrease of $7,343,067 from sales of $12,998,152 in 2007.  In
2008, TDR began to discontinue contract sales as part of its strategic
goals.


- 42
-


Sales
by Product Line





A break-down of our sales by major
product line for each of the years ended December 31, 2008 and 2007 is as
follows:




For
      the Year Ended December 312008
                                                                
                                                                
                                                                2007Product
      Category
                                                                  (97
      products)
                                                                
                                                                Subsidiary
                                                                
                                                                Quantity
                                                                  (Unit)
                                                                
                                                                
                                                                Sales
      USD
                                                                
                                                                
                                                                %
      of Sales
                                                                
                                                                
                                                                Quantity
                                                                  (Unit)
                                                                
                                                                
                                                                Sales
      USD
                                                                
                                                                
                                                                %
      of SalesPatch
      (5 products)
                                                                
                                                                TDR
                                                                
                                                                
                                                                9,494,535
                                                                
                                                                
                                                                $
                                                                35,484,230
                                                                
                                                                
                                                                
                                                                39
                                                                %
                                                                
                                                                
                                                                2,294,901
                                                                
                                                                
                                                                $
                                                                19,690,051
                                                                
                                                                
                                                                
                                                                39
                                                                %Ointment (20
      products)
                                                                
                                                                TDR
      & TL
                                                                
                                                                
                                                                11,478,130
                                                                
                                                                
                                                                
                                                                23,068,210
                                                                
                                                                
                                                                
                                                                25
                                                                %
                                                                
                                                                
                                                                3,037,022
                                                                
                                                                
                                                                
                                                                6,190,003
                                                                
                                                                
                                                                
                                                                13
                                                                %Spray
      (19 products)
                                                                
                                                                TDR
      & TL
                                                                
                                                                
                                                                3,941,295
                                                                
                                                                
                                                                
                                                                10,612,679
                                                                
                                                                
                                                                
                                                                12
                                                                %
                                                                
                                                                
                                                                3,580,266
                                                                
                                                                
                                                                
                                                                9,210,233
                                                                
                                                                
                                                                
                                                                19
                                                                %Diagnostic
      Kits (3 products)
                                                                
                                                                First
                                                                
                                                                
                                                                2,184,013
                                                                
                                                                
                                                                
                                                                8,780,990
                                                                
                                                                
                                                                
                                                                10
                                                                %
                                                                
                                                                
                                                                739,151
                                                                
                                                                
                                                                
                                                                2,990,664
                                                                
                                                                
                                                                
                                                                6
                                                                %Contract
      Sales (7 products)
                                                                
                                                                Haina
                                                                
                                                                
                                                                3,837,578
                                                                
                                                                
                                                                
                                                                5,655,085
                                                                
                                                                
                                                                
                                                                6
                                                                %
                                                                
                                                                
                                                                5,718,652
                                                                
                                                                
                                                                
                                                                8,197,758
                                                                
                                                                
                                                                
                                                                17
                                                                %others
      (43 products)
                                                                
                                                                
                                                                
                                                                
                                                                4,306,972
                                                                
                                                                
                                                                
                                                                8,214,989
                                                                
                                                                
                                                                
                                                                8
                                                                %
                                                                
                                                                
                                                                1,896,193
                                                                
                                                                
                                                                
                                                                3,039,599
                                                                
                                                                
                                                                
                                                                6
                                                                %Total
                                                                
                                                                
                                                                
                                                                
                                                                35,242,523
                                                                
                                                                
                                                                $
                                                                91,816,183
                                                                
                                                                
                                                                
                                                                100
                                                                %
                                                                
                                                                
                                                                17,266,185
                                                                
                                                                
                                                                $
                                                                49,318,308
                                                                
                                                                
                                                                
                                                                100
                                                                %


During the year 2008, we acquired
Tianlong Pharmaceutical.  As a result, Tianlong’s contract sales prior to
the business acquisition have been realocated to the applicable product category
of sale to enhance financial data analysis.


- 43
-




Cost of Goods Sold and Product Gross
Margin





For
      the Year ended December 312008
                                      
                                      
                                      Variance
                                      
                                      
                                      2007Revenues
                                      
                                      $
                                      91,816,183
                                      
                                      
                                      
                                      86
                                      %
                                      
                                      $
                                      49,318,308Cost
      of goods sold
                                      
                                      
                                      22,403,303
                                      
                                      
                                      
                                      105
                                      %
                                      
                                      
                                      10,939,531Gross
      profit
                                      
                                      $
                                      69,412,880
                                      
                                      
                                      
                                      171
                                      %
                                      
                                      $
                                      38,378,777Products
      gross margin
                                      
                                      
                                      76
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      78
                                      %




- 44
-


Operating Expenses




The following table summarizes the
changes in our operating expenses from $19,764,991 to $33,753,502 for each of
the year ended December 31, 2007 and 2008, respectively:





For the Year ended December
    312008
                                            
                                            
                                            Variance
                                            
                                            
                                            2007Operating
      ExpensesSelling
      , General and Administrative expenses
                                            
                                            $
                                            25,482,201
                                            
                                            
                                            
                                            58
                                            %
                                            
                                            $
                                            16,163,577Depreciation
      and amortization
                                            
                                            
                                            858,406
                                            
                                            
                                            
                                            94
                                            %
                                            
                                            
                                            443,063R&D
      Expenses
                                            
                                            
                                            7,412,895
                                            
                                            
                                            
                                            135
                                            %
                                            
                                            
                                            3,158,351Total
      operating expenses
                                            
                                            $
                                            33,753,502
                                            
                                            
                                            
                                            71
                                            %
                                            
                                            $
                                            19,764,991





Total operating expenses for the
year ended December 31, 2008 increased approximately $14 million or 71% over the
same period in 2007. The higher operating expenses were primarily
attributable to the increased costs of marketing and distribution of our
products for sale to generate our increased product sales from $49,318,308 in
2007 to $91,816,183 in 2008.




Research and development expenses were
$7,412,895 in the year ended December 31, 2008 compared to $3,158,351 for 2007.
 The increased R&D expenses in 2008 were primarily due to additional
clinical trials and development of patents to generate continued sales
growth.





2009 Outlook





We estimate our total revenues in 2009
versus 2008 to increase by 40% or approximately $37 million with growth in all
categories of our product sales. Our gross profit margin in 2009 is expected to
be approximately 74% due to raw material inflation. Operating expenses will
increase due to higher percentage of R&D investment as well as expanding our
own distribution channels. We estimate our overall 2009 net profit margins to be
approximately 30%.




Liquidity
and Capital Resources





The following table summarizes our cash
and cash equivalents position, our working capital, and our cash flow activity
as of December 31, 2008 and 2007 and for each of the years then
ended:




2008
                        
                        
                        2007As
      of December 31:Cash
      and cash equivalents
                        
                        $
                        40,288,116
                        
                        
                        $
                        9,190,870Working
      capital
                        
                        $
                        58,022,750
                        
                        
                        $
                        15,447,162Inventories
                        
                        $
                        462,351
                        
                        
                        $
                        371,672Year
      Ended December 31:Cash
      provided by (used in):Operating
      activities
                        
                        $
                        27,538,021
                        
                        
                        $
                        11,601,480Investing
      activities
                        
                        $
                        (23,114,522
                        )
                        
                        $
                        (10,260,933
                        )Financing
      activities
                        
                        $
                        25,355,470
                        
                        
                        $
                        (32,516
                        )




- 45
-


As of December 31, 2008, cash and cash
equivalents were approximately $40.3 million as compared to $9.2 million at
December 31, 2007. The increased cash and cash equivalents position of
approximately $31.1 million at December 31, 2008 was primarily due to our
cash flows provided by operating activities in 2008 of approximately $27.5
million and the receipt of net proceeds of approximately $23.5 million from the
2008 issuance of 2,500,000 shares of our common stock.  These favorable
variances were partially offset by the outlay of funds of approximately $10.9
million related to our 2008 business acquisitions and our construction in
progress expenditures of approximately $2.0 million for our new corporate
headquarters being built in Harbin.  Our Corporate headquarters is expected
to be completed in 2009 at an additional estimated cost of approximately $5
million.





We plan to fund our corporate
headquarters construction project using internal funds.





Our current ratio was 10.17
versus 4.07 and the quick ratio was 8.80 versus 4.05 at December
31, 2008 and 2007, respectively.  Management endeavors to ensure that funds
are available to take advantage of new investment opportunities and that funds
are sufficient to meet future liquidity and capital needs.





At December 31, 2008, there are no
restrictive bank deposits pledged as security.





Cash flows provided by operating
activities was approximately $27.5 million for the year ended December 31, 2008
compared to $11.6 million for the same period in 2007.  The increase in
cash provided by operating activities of approximately $15.9 million is
primarily attributable to the increased net income of approximately $28.8
million in 2008 versus $15.3 million in 2007.





Our working capital position at
December 31, 2008 was approximately $58.0 million, compared to $15.4 million at
December 31, 2007. Our increased working capital position in 2008 was
principally funded by the increased cash flows generated from our operating
activities ($15.9 million) and the rate of our common stock under the
January 2008 private placement (23.5 million) in 2008.  Management
considers current working capital and borrowing capabilities adequate to cover
our current operating and capital requirements for the full year
2009.





Currency
Exchange Fluctuations





All of our revenues and majority of the
expenses during the year ended December 31, 2008 were denominated primarily in
Renminbi (“RMB”), the currency of China, and was converted into US dollars at
the exchange rate of 6.96225 RMB to 1 U.S. Dollar.  In the third quarter of
2005, the Renminbi began to rise against the US dollar.  There can be
no assurance that RMB-to-U.S. dollar exchange rates will remain stable. A
devaluation of RMB relative to the U.S. dollar would adversely affect our
business, financial condition and results of operations. We do not engage in
currency hedging.





Off-Balance
Sheet Arrangements





We do not have any off-balance sheet
arrangements that are currently material or reasonably likely to be material to
our financial position or results of operations.


- 46
-


Item
7A.  Quantitative and Qualitative Disclosures About Market
Risk





We are a smaller reporting company as
defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not
required to provide the information under this item.


- 47
-


Item
8.  Financial Statements and Supplementary Data.





INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS





Report
      of Independent RegisteredPublic Accounting Firm
              
              F-2Report
      of Independent Registered Public Accounting Firm
              
              F-3Consolidated
      Balance Sheets
              
              F-4Consolidated
      Statements of Operations and Comprehensive Income
              
              F-5Consolidated
      Statements of Stockholders’ Equity
              
              F-6Consolidated
      Statements of Cash Flows
              
              F-7Notes
      to Consolidated Financial Statements
              
              F-8
      - F-24




F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To
the Board of Directors and Stockholders of


China
Sky One Medical, Inc. and Subsidiaries





We have
audited the accompanying consolidated balance sheet of China Sky One Medical,
Inc. and Subsidiaries (the “Company”) as of
December 31, 2008 and the related consolidated statements of operations and
comprehensive income, stockholders' equity, and cash flows for the year then
ended. These consolidated financial statements are the responsibility of the
Company's management.  Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Sky One Medical, Inc.
and Subsidiaries as of December 31, 2008 and the results of their operations and
their cash flows for the year then ended in conformity with United States
generally accepted accounting principles.





We were
not engaged to examine management’s assessment of the effectiveness of the
Company’s
internal control over financial reporting as of December 31, 2008, included in the
accompanying  Management’s Report on Internal Control Over
Financial Reporting and
accordingly, we do not
express an opinion thereon.





/s/ MSPCMSPCCertified
      Public Accountants and AdvisorsA
      Professional CorporationNew
      York, New YorkMarch
      25, 2009


F-2


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





[Letterhead
of Sherb & Co., LLP]





To
the Board of Directors and Stockholders of


China Sky One Medical,
Inc.





We have
audited the accompanying consolidated balance sheets of China Sky One Medical,
Inc. and its Subsidiaries as of December 31, 2007 and the related consolidated
statements of operations, stockholders’ equity and cash flows for the year ended
December 31, 2007. China Sky One Medical, Inc. management is responsible for
these financial statements. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.


We
conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, and audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purposes of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Sky One Medical, Inc.
as of December 31, 2007 and the results of its operations and its cash flows for
the year ended December 31, 2007 in conformity with accounting principles
generally accepted in the United States.





/s/ Sherb & Co., LLPCertified
      Public
Accountants





Boca
Raton, Florida


March 25,
2008


F-3


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Balance Sheets




December 31, 2008
                            
                            
                            December 31, 2007ASSETSCurrent
      AssetsCash
      and cash equivalents
                            
                            $
                            40,288,116
                            
                            
                            $
                            9,190,870Accounts
      receivable, net
                            
                            
                            14,978,648
                            
                            
                            
                            10,867,106Inventories
                            
                            
                            462,351
                            
                            
                            
                            371,672Prepaid
      and other current assets
                            
                            
                            106,386
                            
                            
                            
                            57,907Land
      and construction deposit
                            
                            
                            8,513,284
                            
                            
                            
                            -Total
      current assets
                            
                            
                            64,348,785
                            
                            
                            
                            20,487,555Property
      and equipment, net
                            
                            
                            21,058,779
                            
                            
                            
                            6,861,432Land
      and construction deposit
                            
                            
                            -
                            
                            
                            
                            8,003,205Intangible
      assets, net
                            
                            
                            15,851,765
                            
                            
                            
                            1,933,014$
                            101,259,329
                            
                            
                            $
                            37,285,206LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
                            
                            $
                            2,937,068
                            
                            
                            $
                            3,448,701Taxes
      payable
                            
                            
                            3,362,888
                            
                            
                            
                            1,567,188Deferred
      revenues
                            
                            
                            26,079
                            
                            
                            
                            24,504Total
      current liabilities
                            
                            
                            6,326,035
                            
                            
                            
                            5,040,393Commitments
      and ContingenciesStockholders'
      EquityPreferred
      stock ($0.001 par value, 5,000,000 shares authorized, none issued and
      outstanding)
                            
                            
                            -
                            
                            
                            
                            -Common
      stock ($0.001 par value, 50,000,000 shares authorized, 16,306,184 and
      12,228,363 issued and outstanding, respectively)
                            
                            
                            16,306
                            
                            
                            
                            12,228Additional
      paid-in capital
                            
                            
                            40,105,134
                            
                            
                            
                            9,572,608Accumulated
      other comprehensive income
                            
                            
                            5,566,806
                            
                            
                            
                            2,271,843Retained
      earnings
                            
                            
                            49,245,048
                            
                            
                            
                            20,388,134Total
      stockholders' equity
                            
                            
                            94,933,294
                            
                            
                            
                            32,244,813$
                            101,259,329
                            
                            
                            $
                            37,285,206





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


F-4


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Statements of Operations and Comprehensive Income




Year Ended December 31,2008
                          
                          
                          2007Revenues
                          
                          $
                          91,816,183
                          
                          
                          $
                          49,318,308Cost
      of Goods Sold
                          
                          
                          22,403,303
                          
                          
                          
                          10,939,531Gross
      Profit
                          
                          
                          69,412,880
                          
                          
                          
                          38,378,777Operating
      ExpensesSelling,
      general and administrative
                          
                          
                          25,482,201
                          
                          
                          
                          16,163,577Depreciation
      and amortization
                          
                          
                          858,406
                          
                          
                          
                          443,063Research
      and development
                          
                          
                          7,412,895
                          
                          
                          
                          3,158,351Total
      operating expenses
                          
                          
                          33,753,502
                          
                          
                          
                          19,764,991Income
      From Operations
                          
                          
                          35,659,378
                          
                          
                          
                          18,613,786Other
      IncomeMiscellaneous
      income
                          
                          
                          813,705
                          
                          
                          
                          38,332Net
      Income Before Provision for Income Tax
                          
                          
                          36,473,082
                          
                          
                          
                          18,652,118Provision
      for Income TaxesCurrent
                          
                          
                          7,616,169
                          
                          
                          
                          3,319,173Net
      Income
                          
                          
                          28,856,914
                          
                          
                          
                          15,332,945The
      Components of Other Comprehensive IncomeForeign
      currency translation adjustment
                          
                          
                          3,294,963
                          
                          
                          
                          1,849,724Comprehensive
      Income
                          
                          $
                          32,151,877
                          
                          
                          $
                          17,182,669Basic
      Earnings Per Share
                          
                          $
                          1.91
                          
                          
                          $
                          1.27Basic
      Weighted  Average Shares Outstanding
                          
                          
                          15,101,833
                          
                          
                          
                          12,094,949Diluted
      Earnings Per Share
                          
                          $
                          1.87
                          
                          
                          $
                          1.15Diluted
      Weighted  Average Shares Outstanding
                          
                          
                          15,429,136
                          
                          
                          
                          13,370,528




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


F-5


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Statements of Stockholders' Equity


For
the Years Ended December 31, 2008 and 2007





AccumulatedOther
                                
                                
                                TotalCommon
      Stock
                                
                                
                                Additional
                                
                                
                                Retained
                                
                                
                                Comprehensive
                                
                                
                                Stockholders'Shares
                                
                                
                                Amount
                                
                                
                                Paid-in
      Capital
                                
                                
                                Earnings
                                
                                
                                Income
                                
                                
                                EquityBalance
      at January 1, 2007
                                
                                
                                12,031,536
                                
                                
                                $
                                12,032
                                
                                
                                $
                                8,821,502
                                
                                
                                $
                                5,055,189
                                
                                
                                $
                                422,119
                                
                                
                                $
                                14,310,842Issuance
      of common stock for service
                                
                                
                                30,000
                                
                                
                                
                                30
                                
                                
                                
                                194,970
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                195,000Warrants
      exercised
                                
                                
                                166,827
                                
                                
                                
                                167
                                
                                
                                
                                515,667
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                515,834Employee
      stock options
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                40,468
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                40,468Foreign
      currency translation adjustment
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,849,724
                                
                                
                                
                                1,849,724Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                15,332,945
                                
                                
                                
                                
                                
                                
                                
                                15,332,945Balance
      at December 31, 2007
                                
                                
                                12,228,363
                                
                                
                                
                                12,229
                                
                                
                                
                                9,572,607
                                
                                
                                
                                20,388,134
                                
                                
                                
                                2,271,843
                                
                                
                                
                                32,244,813Issuance
      of common stock through private placement
                                
                                
                                2,500,000
                                
                                
                                
                                2,500
                                
                                
                                
                                23,485,463
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                23,487,963Warrants
      and options exercised under cash and cashless options
                                
                                
                                1,142,302
                                
                                
                                
                                1,142
                                
                                
                                
                                1,866,365
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,867,507Issuance
      of common stock for acquistions
                                
                                
                                405,456
                                
                                
                                
                                405
                                
                                
                                
                                4,865,067
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                4,865,472Stock-based
      compensation
                                
                                
                                30,063
                                
                                
                                
                                30
                                
                                
                                
                                315,632
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                315,662Foreign
      currency translation adjustment
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,294,963
                                
                                
                                
                                3,294,963Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                28,856,914
                                
                                
                                
                                
                                
                                
                                
                                28,856,914Balance
      at December 31, 2008
                                
                                
                                16,306,184
                                
                                $
                                
                                16,306
                                
                                
                                $
                                40,105,134
                                
                                
                                $
                                49,245,048
                                
                                
                                $
                                5,566,806
                                
                                
                                $
                                94,933,294





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


F-6


China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


For
the Years Ended December 31, 2008 and 2007





2008
                                                            
                                                            
                                                            2007CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
                                                            
                                                            $
                                                            28,856,914
                                                            
                                                            
                                                            $
                                                            15,332,945Adjustments
      to reconcile net income to net cash provided (used) by operating
      activities:Allowance
      for bad debt
                                                            
                                                            
                                                            37,883
                                                            
                                                            
                                                            
                                                            -Depreciation
      and amortization
                                                            
                                                            
                                                            858,406
                                                            
                                                            
                                                            
                                                            443,063Stock-based
      compensation
                                                            
                                                            
                                                            315,662
                                                            
                                                            
                                                            
                                                            235,468Decrease
      (increase) in operating assets:Accounts
      receivable
                                                            
                                                            
                                                            (3,398,228
                                                            )
                                                            
                                                            
                                                            (7,478,964
                                                            )Inventories
                                                            
                                                            
                                                            (65,762
                                                            )
                                                            
                                                            
                                                            (73,142
                                                            )Prepaid
      expenses and others
                                                            
                                                            
                                                            (23,840
                                                            )
                                                            
                                                            
                                                            93,463Increase
      (decrease) in operating liabilities:Accounts
      payable and accrued liabilities
                                                            
                                                            
                                                            (677,722
                                                            )
                                                            
                                                            
                                                            2,136,356Taxes
      payable
                                                            
                                                            
                                                            1,660,382
                                                            
                                                            
                                                            
                                                            960,170Deferred
      revenues
                                                            
                                                            
                                                            (25,674
                                                            )
                                                            
                                                            
                                                            (47,879
                                                            )Net
      cash provided by operating activities
                                                            
                                                            
                                                            27,538,021
                                                            
                                                            
                                                            
                                                            11,601,480CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of property, plant and equipment
                                                            
                                                            
                                                            (11,167,396
                                                            )
                                                            
                                                            
                                                            (2,222,448
                                                            )Land
      and construction deposits
                                                            
                                                            
                                                            4,084
                                                            
                                                            
                                                            
                                                            (8,003,205
                                                            )Purchase
      of intangible assets
                                                            
                                                            
                                                            (11,951,210
                                                            )
                                                            
                                                            
                                                            (35,280
                                                            )Net
      cash used in investing activities
                                                            
                                                            
                                                            (23,114,522
                                                            )
                                                            
                                                            
                                                            (10,260,933
                                                            )CASH
      FLOWS FROM FINANCING ACTIVITIESSales
      of common stock for cash, net of offering costs
                                                            
                                                            
                                                            23,487,963
                                                            
                                                            
                                                            
                                                            -Proceeds
      from warrants and options exercised
                                                            
                                                            
                                                            1,867,507
                                                            
                                                            
                                                            
                                                            515,834Payment of
      short-term loan
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            (548,350
                                                            )Net
      cash provided (used) by financing activities
                                                            
                                                            
                                                            25,355,470
                                                            
                                                            
                                                            
                                                            (32,516
                                                            )Effect
      of exchange rate changes on cash
                                                            
                                                            
                                                            1,318,277
                                                            
                                                            
                                                            
                                                            1,296,039NET
      INCREASE IN CASH AND
      CASH EQUIVALENTS
                                                            
                                                            $
                                                            31,097,246
                                                            
                                                            
                                                            $
                                                            2,604,070CASH
      AND CASH EQUIVALENTS AT BEGINNING OF YEAR
                                                            
                                                            
                                                            9,190,870
                                                            
                                                            
                                                            
                                                            6,586,800CASH
      AND CASH EQUIVALENTS AT END OF YEAR
                                                            
                                                            $
                                                            40,288,116
                                                            
                                                            
                                                            $
                                                            9,190,870Supplemental
      disclosure of cash flow informationInterest
      paid
                                                            
                                                            $
                                                            135,136
                                                            
                                                            
                                                            $
                                                            10,457Taxes
      paid
                                                            
                                                            $
                                                            6,630,480
                                                            
                                                            
                                                            $
                                                            2,359,003On
      April 3, 2008, the Company acquired a 100% ownership interest in
      Heilongjiang Tianlong Pharmaceutical.  Approximate net assets
      acquired (see note 2) consisted of the following:Fixed
      assets
                                                            
                                                            $
                                                            6,314,871Intangible
      assets
                                                            
                                                            
                                                            1,786,990Other
                                                            
                                                            
                                                            170,000Net
      assets acquired
                                                            
                                                            $
                                                            8,271,861On
      April 18, 2008, the Company acquired Heilongjiang Haina ("Haina")
      Pharmaceutical Inc. Approximate net assets acquired (see note 2) consisted
      of the following:Intangible
      assets
                                                            
                                                            $
                                                            437,375On
      September 5, 2008, the Company acquired a 100% ownership interest in Peng
      Lai Jin Chuang Company.  Approximate net assets acquired (see
      note 2) consisted of the following:Fixed
      assets
                                                            
                                                            $
                                                            4,176,922Intangible
      assets
                                                            
                                                            
                                                            2,917,386Net
      assets acquired
                                                            
                                                            $
                                                            7,094,308





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


F-7




China
Sky One Medical, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements




1.
            Description
      of Business




China Sky
One Medical Inc., ("China Sky One" or the “Company”), a Nevada corporation, was
formed on February 7, 1986, and formerly known as Comet Technologies, Inc.
(“Comet”).  On July 26, 2006, the Company changed the name of the reporting
company from "Comet Technologies, Inc." to "China Sky One Medical, Inc."





American
California Pharmaceutical Group, Inc. (“ACPG”), our non operating United
States holding company subsidiary, was incorporated on December 16, 2003, in the
State of California, under the name “QQ Group, Inc.”  QQ Group, Inc.
changed its name to “American California Pharmaceutical Group, Inc.” in
anticipation of the Stock Exchange Agreement with China Sky One (then known as
“Comet Technologies, Inc.”) and TDR, described herein. On December 8, 2005, ACPG
completed a stock exchange transaction with TDR a People’s Republic of China
(“PRC”) based operating company and TDR’s subsidiaries (the “TDR Acquisition”),
each of which were fully operating companies in the PRC. Under the terms of the
agreement, ACPG exchanged 100% of its issued and outstanding common stock for
100% of the capital stock of TDR and its subsidiaries, described
below.





Thereafter,
on May 11, 2006, ACPG entered into a Stock Exchange Agreement (the “Exchange
Agreement”) with the shareholders of China Sky One. The terms of the Exchange
Agreement were consummated and the acquisition was completed on May 30, 2006. As
a result of the transaction, the Company issued a total of 10,193,377 shares of
its common voting stock to the stockholders of ACPG, in exchange for 100% of the
capital stock of ACPG resulting in ACPG becoming our wholly-owned subsidiary.
The transaction is treated as a reverse merger for accounting
purposes.





TDR,
formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed
in 1994 and maintained its principal executive office in Harbin City of
Heilongjiang Province, in the People’s Republic of China (“PRC”). TDR was
reorganized and incorporated as a limited liability company on December 29,
2000, under the “Corporation Laws and Regulations” of the PRC. At the time of
the TDR Acquisition by ACPG in December of 2005, TDR had two wholly-owned
subsidiaries, Harbin First Bio-Engineering Company Limited and Kangxi Medical
Care Product Factory, until July, 2006, when the two were merged, with Harbin
First Bio-Engineering Company Limited (“First”) as the surviving subsidiary of
TDR. The principal activities of TDR and First are the research, manufacture and
sale of over-the-counter non-prescription health care products. TDR commenced
its business in the sale of branded nutritional supplements and over-the-counter
pharmaceutical products in the Heilongjiang Province. TDR has subsequently
evolved into an integrated manufacturer, marketer, and distributor of external
use natural Chinese medicine products sold primarily to and through China’s
various domestic pharmaceutical chain stores.





China Sky
One is a holding company whose principal operations are through its wholly-owned
subsidiaries; it has no revenues separate from its subsidiaries, and has nominal
expenses related to its status as a public reporting company and to its
ownership interest in ACPG and TDR.





On
September 30, 2008 (the “Record Date”), we obtained the written consent of the
holders of 8,158,251 shares of our common stock, which as of the Record Date,
represented 51.3% of our outstanding voting securities, to increase our number
of authorized shares of common stock from twenty million (20,000,000) to fifty
million (50,000,000) shares.





2.
            Acquisition
      of Businesses





On April
3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement
dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical,
Inc., a corporation with a multitude of SFDA approved medicines and new medicine
applications, organized under the laws of the PRC (“Tianlong”), which is in the
business of manufacturing external-use pharmaceuticals. Our TDR subsidiary
previously acquired the Beijing sales office of Tianlong in mid 2006. Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Tianlong from Heilongjiang’s sole stockholder Wu
Jiechen, a resident of China, in consideration for an aggregate purchase price
of approximately $8,300,000, consisting of (i) $8,000,000 in cash, and (ii)
23,850 shares of China Sky One (fair value at April 3, 2008 of approximately
$270,000).  The acquisition received regulatory approval and closed on
April 3, 2008.





The
following table summarizes the approximate estimated fair values of the assets
acquired in the Tianlong acquisition.





Fixed
      assets
                          
                          $
                          6,314,871Intangible
      assets
                          
                          
                          1,786,990Other
                          
                          
                          170,000Net
      assets acquired
                          
                          $
                          8,271,861




F-8





China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


2.
            Acquisition
      of Businesses (Continued)





On April
18, 2008, China Sky One through its subsidiary TDR consummated a share
acquisition pursuant to an Equity Transfer Agreement with the shareholders of
Heilongjiang Haina Pharmaceutical Inc., a recently formed corporation organized
under the laws of the PRC (“Haina”) licensed as a wholesaler of TCD,
bio-medicines, bio-products, medicinal devices, antibiotics and chemical
medicines. Haina does not have an established sales network and was acquired for
its primary asset, a Good Supply Practice (GSP) license (License No.
A-HLJ03-010) issued by the Heilongjian office of the SFDA. The SFDA recently
started issuing such licenses to resellers of medicines that maintain certain
quality controls. The GSP license was issued as of December 21, 2006 and will
expire on January 29, 2012 and will enable the Company to expand its sales of
medicinal products without having to go through a lengthy license application
process.





The
following table summarizes the approximate estimated fair values of the assets
acquired in the Haina acquisition.





Intangible
      assets
                      
                      $
                      437,375





Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Haina from its three stockholders in consideration
for payment of 3,000,000 RMB (approximately $437,375). TDR has been overseeing
the operations of Haina since January of 2008 as part of its due diligence prior
to closing of this acquisition.





On June
9, 2008, TDR entered into a Merger and Acquisition Agreement (the “Acquisition
Agreement”) with Peng Lai Jin Chuang Company, a corporation organized under the
laws of the People’s Republic of China (“Peng Lai”), which was recently
organized to develop, manufacture and distribute pharmaceutical, medicinal and
diagnostic products in the PRC. Pursuant to the Acquisition Agreement, TDR
acquired all of the assets of Peng Lai in consideration for an aggregate of
approximately (i) US$2.5 million in cash, and (ii) 381,606 shares of the
Company’s common stock with a fair value of approximately $4.6 million (at $12
per share).  The acquisition of Peng Lai closed on September 5,
2008.





The
following table summarizes the approximate estimated fair values of the assets
acquired in the Peng Lai acquisition.





Fixed
      assets
                  
                  $
                  4,176,922Intangible
      assets
                  
                  
                  2,917,386Net
      assets acquired
                  
                  $
                  7,094,308





The
following table contains pro forma condensed consolidated statement of
operations information assuming the Tianlong, Haina and Jin Chuang transactions
closed on January 1, 2007, for the years ended December 31, 2008 and 2007.
Jin Chuang had dormant operations until October 2008.





2008
                      
                      
                      2007Revenue
                      
                      $
                      92,377,568
                      
                      
                      $
                      51,334,371Operating
      income
                      
                      $
                      35,746,742
                      
                      
                      $
                      17,143,333Net
      income
                      
                      $
                      28,933,581
                      
                      
                      $
                      13,822,150Basic
      earnings per common share
                      
                      $
                      1.92
                      
                      
                      $
                      1.14Basic
      weighted average shares outstanding
                      
                      
                      15,358,843
                      
                      
                      
                      12,500,405Diluted
      earnings per common share
                      
                      $
                      1.88
                      
                      
                      $
                      1.03Diluted
      weighted average shares outstanding
                      
                      
                      15,686,146
                      
                      
                      
                      13,775,984




F-9





China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies





Principles of Consolidation –
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, ACPG, TDR, First, Haina, Tianlong,
and Peng Lai. All significant inter-company transactions and balances were
eliminated.





These
financial statements are stated in U.S. Dollars and have been prepared in
accordance with accounting principles generally accepted in the United States of
America. This basis of accounting differs from that used under applicable
accounting requirements in the PRC.  No material adjustment was
required.





Certain
items in the 2007 financial statements have been reclassified to conform with
the 2008 financial statements presentation.





Use of estimates– The
preparation of these financial statements in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
dates of the financial statements, and the reported amounts of revenues and
expenses during the reported periods.





Significant
estimates include values and lives assigned to acquired tangible and intangible
assets under our business acquisitions, reserves for customer returns and
allowances, uncollectible accounts receivable, share-based compensation,
impairment testing of goodwill and other intangible assets and slow moving
and/or obsolete/damaged inventory. Actual results may differ from these
estimates.




Earnings per share -Basic
earnings per common share is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common shares outstanding
during the period. When applicable, diluted earnings per common share is
determined using the weighted-average number of common shares outstanding during
the period, adjusted for the dilutive effect of common stock equivalents,
consisting of shares that might be issued upon exercise of common stock options
and warrants.





Potential
common shares issued are calculated using the treasury stock method, which
recognizes the use of proceeds that could be obtained upon the exercise of
options and warrants in computing diluted earnings per share. It assumes that
any proceeds would be used to purchase common stock at the average market price
of the common stock during the period.





Cash and cash equivalents –TheCompany
considers all highly liquid debt instruments purchased with maturity period of
six months or less to be cash equivalents. The carrying amounts reported in the
accompanying consolidated balance sheets for cash and cash equivalents
approximate their fair value.





Accounts receivable –Accounts
receivable are stated at net realizable value, net of an allowance for doubtful
accounts. Provision of allowance is made for estimated bad debts based on a
periodic analysis of individual customer balances including an evaluation of
days of sales outstanding, payment history, recent payment trends, and perceived
credit worthiness. At December 31, 2008, the Company’s allowance for doubtful
accounts was approximately $50,000. At December 31, 2007, the Company had no
allowance for doubtful accounts.




Inventories– Inventories
include finished goods, raw materials, freight-in, packing materials, labor, and
overhead costs and are valued at the lower of cost or market using the first-in,
first-out method.  Inventory units are valued using the weighted
average method. Provisions are made for slow moving, obsolete and/or damaged
inventory based on a periodic analysis of individual inventory items including
an evaluation of historical usage and/or movement, age, expiration date, and
general conditions. There was no inventory reserve provision recorded at
December 31, 2008 and December 31, 2007.





F-10





China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies
(Continued)





Property and equipment–
Property and equipment are stated at historical cost less accumulated
depreciation. Depreciation on property and equipment is provided using the
straight-line method over the estimated useful lives of the assets.  The
Company uses an estimated residual value of 5% of cost, or valuation for both
financial and income tax reporting purposes. The estimated lengths of useful
lives are as follows:





Building
      and Improvements
                30
      yearsLand
      use rights
                50
      yearsFurniture
      & Equipment
                5
      to 7 yearsTransportation
      Equipment
                5
      to 15 yearsMachinery
      and Equipment
                7
      to 14 years





Expenditures
for renewals and betterments are capitalized while repairs and maintenance costs
are normally charged to the statement of operations in the year in which they
were incurred. In situations where it can be clearly demonstrated that the
expenditure has resulted in an increase in the future economic benefits expected
to obtain from the use of the asset, the expenditure is capitalized as an
additional cost of the asset. Upon sale or disposal of an asset, the historical
cost and related accumulated depreciation or amortization of such asset is
removed from their respective accounts, and any gain or loss is recorded in the
Consolidated Statement of Operations.





Property
and equipment are evaluated for impairment in value whenever an event or change
in circumstances indicates that the carrying values may not be recoverable. If
such an event or change in circumstances occurs and potential impairment is
indicated because the carrying values exceed the estimated future undiscounted
cash flows of the asset, the Company will measure the impairment loss as the
amount by which the carrying value of the asset exceeds its fair
value.  The Company did not record any impairment charges during each
of the years ended December 31, 2008 and 2007.





Construction-in-progress–
Properties currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditures, professional fees,
and capitalized interest costs during the course of construction.





Upon
completion and readiness for use of the project, the cost of
construction-in-progress is transferred to the facility. In the case of
construction-in-progress, management takes into consideration the estimated cost
to complete the project when making the lower of cost or market
calculation.





Intangible assets –Intangible
assets consists of patents and goodwill. Patent costs are amortized over an
estimated life of ten years.





Intangible
assets are accounted for in accordance with Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible
Assets (“SFAS 142”).  Intangible assets with finite useful lives are
amortized while intangible assets with indefinite useful lives are not
amortized. As prescribed by SFAS 142, goodwill and intangible assets are tested
periodically for impairment. The Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long- Lived Assets," effective January 1, 2002.
Accordingly, the Company reviews its long-lived assets, including property and
equipment and finite-lived intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be fully recoverable. To determine recoverability of its long-lived assets, the
Company evaluates the probability that future undiscounted net cash flows will
be less than the carrying amount of the assets. Impairment costs, if any, are
measured by comparing the carrying amount of the related assets to their fair
value.  The Company recognizes an impairment loss based on the excess
of the carrying amount of the assets over their respective fair values. Fair
value is determined by discounted future cash flows, appraisals or other
methods. If  the assets determined to be impaired are to be held and
used, the Company recognizes an impairment loss thru a charge to operating
results to the extent the present value of anticipated cash flows attributable
to the assets are less than the asset’s carrying value. The Company would
depreciate the remaining the remaining value over the remaining estimated useful
life of the asset to operating results.  There were no impairments
during each of the years ended December 31, 2008 and 2007.





Foreign Currency- The
Company’s principal country of operations is in The People’s Republic of China.
The financial position and results of operations of the Company are recorded in
RMB as the functional currency. The results of operations denominated in foreign
currency are translated at the average rate of exchange during the reporting
period.




F-11




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies
(Continued)





Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the market rate of exchange at that date. The registered equity
capital denominated in the functional currency is translated at the historical
rate of exchange at the time of the capital contribution. All translation
adjustments resulting from the translation of the financial statements into the
reporting currency (“US Dollars”) are recorded as accumulated other
comprehensive income, a component of stockholders’ equity.





Revenue recognition– Revenue
is recognized when the following criteria are met: (1) persuasive evidence
of an arrangement exists; (2) the product has been shipped and the customer
takes ownership and assumes the risk of loss; (3) the selling price is
fixed or determinable; and (4) collection of the resulting receivable is
reasonably assured. The Company believes that these criteria are satisfied upon
shipment from its facilities. Revenue is reduced by provisions for estimated
returns and allowances as well as specific known claims, if any, which are based
on historical averages that have not varied significantly for the periods
presented.





The
Company occasionally applies to various government agencies for research grants.
Revenue from such research grants is recognized when earned. In situations where
TDR receives payment in advance for the performance of research and development
services, such amounts are deferred and recognized as revenue as the related
services are performed.





Deferred revenues -The
Company recognizes revenues as earned. Amounts billed in advance of the period
in which goods are delivered are recorded as a liability under “Deferred
revenues.”





Research and
development—Research and development expenses include the costs
associated with the Company’s internal research and development as well as
research and development conducted by third parties. These costs primarily
consist of salaries, clinical trials, outside consultants, and materials. All
research and development costs are expensed as incurred.





Third-party
expenses reimbursed under non-refundable research and development contracts are
recorded as a reduction to research and development expense in the statement of
operations.





The
Company recognizes in-process research and development in accordance with FASB
Interpretation No. 4, Applicability of FASB Statement No.
2 to Business Combinations Accounted for by the Purchase Methodand
theAICPA
Technical Practice Aid, Assets Acquired in a Business Combination to be used in
Research and Development Activities:  A Focus on Software, Electronic
Devices, and Pharmaceutical Industries. Assets to be used in research and
development activities, specifically, compounds that have yet to receive new
drug approval and would have no alternative use, should approval not be given,
are immediately charged to expense when acquired.  Certain assets and
high technologies acquired that has a foreseeable future cash flows are
capitalized as intangible assets.  Such intangible assets are
amortized starting from the year revenue is generated and amortize over a period
of 10 years.




For the
year ended December 31, 2008, the Company incurred $7,412,895 in research and
development costs and $3,158,351 for the year ended December 31,
2007.





Advertising—Advertising and
promotion costs are expensed as incurred.  Total advertising costs for the
years ended December 31, 2008 and 2007 was $7,299,367 and $4,385,045,
respectively. Advertising costs are reported as part of selling, general and
administrative expenses in the statements of operations.





Slotting fees— From time to
time, the Company enters into arrangements with customers in exchange for
obtaining rights to place our products on customers' shelves for resale.
 The Company also engages in promotional discount programs in order to
enhance sales in specific channels.  These payments, discounts and
allowances reduce our reported revenue in accordance with the guidelines set
forth in EITF 01-9 and SEC Staff Accounting Bulletin No. 104





The
Company records its obligations under each arrangement at inception and
amortizes the total required payments using the straight-line method over a term
of time, which is normally the minimum time that we are allowed to sell our
products in given retail outlets.  The Company records the balance of the
amortized slotting fee not used in the current period as prepaid expenses. As
the Company applies the amortized slotting fee as contra revenue, it reduces the
reported gross revenue by an amount equal to the reduction in prepaid
expenses.  For the years ended December 31, 2008 and 2007, the Company
did not incur any slotting fees.





F-12




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies
(Continued)





Taxation– The Company uses
the asset and liability method of accounting for deferred income taxes.
 The Company’s provision for income taxes includes income taxes currently
payable and those deferred because of temporary differences between the
financial statement and tax bases of assets and liabilities.  The Company
records liabilities for income tax contingencies based on our best estimate of
the underlying exposures.




The
Company periodically estimates its tax obligations using historical experience
in tax jurisdictions and informed judgments. There are inherent uncertainties
related to the interpretation of tax regulations in the jurisdictions in which
the Company transacts business. The judgments and estimates made at a point in
time may change based on the outcome of tax audits, as well as changes to, or
further interpretations of, regulations.  The Company adjusts income tax
expense in the period in which these events occur.




Provision
for the PRC’s enterprise income tax is calculated at the prevailing rate based
on the estimated assessable profits less available tax relief for losses brought
forward.





Provision
for the PRC enterprise income tax is calculated at the prevailing rate based on
the estimated assessable profits less available tax relief for losses brought
forward.The
Company does not accrue taxes on unremitted earnings from foreign operations as
it is the Company’s intention to invest these earnings in the foreign operations
indefinitely.





Enterprise income
tax





Under the
Provisional Regulations of PRC Concerning Income Tax on Enterprises promulgated
by the PRC, income tax is payable by enterprises at a rate of 25% of their
taxable income. Preferential tax treatment may, however, be granted pursuant to
any law or regulations from time to time promulgated by the State
Council.





According
to “Enterprise Income Tax and Certain Preferential Policies Notice” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. The income tax rate for TDR and Tianlong is 15% and
12% respectively, based on State Council approval.





Value added
tax





The
Provisional Regulations of PRC 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.





Value
added tax payable in the PRC 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.





According
to “Agriculture Product Value Added Tax Rate Adjustment and Certain Items’ Value
Added Tax Waiver” published by the Ministry of Finance and the National Tax
Affairs Bureau, the value added tax for agriculture related products is to be
taxed at 13%. Furthermore, traditional Chinese medicine and medicinal plant are
by definition agriculture related products.





Accounting for uncertainty in income
taxes –In June 2006, the Financial Accounting Standards Board (FASB)
issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes - an Interpretation of FASB Statement No. 109(FIN 48). FIN 48 is
intended to clarify the accounting for uncertainty in income taxes recognized in
a company’s financial statements and prescribes the recognition and measurement
of a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.





Under FIN
48, evaluation of a tax position is a two-step process. The first step is to
determine whether it is more-likely-than-not that a tax position will be
sustained upon examination, including the resolution of any related appeals or
litigation based on the technical merits of that position. The second step is to
measure a tax position that meets the more-likely-than-not threshold to
determine the amount of benefit to be recognized in the financial statements. A
tax position is measured at the largest amount of benefit that is greater than
50% likely of being realized upon ultimate settlement.





F-13




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies
(Continued)





Tax
positions that previously failed to meet the more-likely-than-not recognition
threshold should be recognized in the first subsequent period in which the
threshold is met. Previously recognized tax positions that no longer meet the
more-likely-than-not criteria should be de-recognized in the first subsequent
financial reporting period in which the threshold is no longer met.





The
adoption of FIN 48 at January 1, 2007 did not have a material effect on the
Company’s results of operations and financial position.




Comprehensive income –Comprehensive income consists of net income and other gains and losses
affecting stockholders’ equity that, under generally accepted accounting
principles are excluded from net income. For the Company, such items consist
entirely of foreign currency translation gains and losses.





Related companies – A
related company is a company in which the director has beneficial interests in
and in which the Company has significant influence.





Retirement benefit costs–
According to the PRC regulations on pension plans, the Company contributes to a
defined contribution retirement plan organized by municipal government in the
province in which the Company was registered and all qualified employees as
defined by statutory regulations are eligible to participate in the plan. Retirement
benefit costs incurred by the Company for each of years ended December 31, 2008
and 2007, respectively, amounted to $53,476 and $30,717.





Contributions
to the pension or retirement plan are calculated at 22.5% of the employees’
salaries above a fixed threshold amount.  The employees contribute between
2% to 8% to the pension plan, and the Company contributes the balance. The
Company has no other material obligations for the payment of retirement benefits
beyond the annual contributions under this plan.




Fair value of financial instruments –The carrying amounts of certain financial instruments, including cash and
cash equivalents, accounts receivable, other receivables, accounts payable,
accrued expenses, and other payables approximate their fair values
at December 31, 2008 and 2007 because of the relatively short-term maturity
of these instruments.





Recent
accounting pronouncements:




-
            In
      June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”)
      Issue No. 03-6-1, “Determining Whether Instruments Granted in
      Share-Based Payment Transactions Are Participating Securities.” The EITF
      addresses whether instruments granted in share-based payment transactions
      are participating securities prior to vesting and, therefore, need to be
      included in the earnings allocation in computing earnings per share under
      the two-class method. The EITF affects entities that accrue dividends on
      share-based payment awards during the awards’ service period when the
      dividends do not need to be returned if the employees forfeit the award.
      This EITF is effective for fiscal years beginning after December 15,
      2008. The Company is currently assessing the impact of FSP EITF 03-6-1 on
      its financial position and results of
  operations.




-
            In
      June 2008, the FASB ratified EITF Issue No. 07-5, "Determining
      Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity's
      Own Stock" (EITF 07-5). EITF 07-5 provides that an entity should use a two
      step approach to evaluate whether an equity-linked financial instrument
      (or embedded feature) is indexed to its own stock, including evaluating
      the instrument's contingent exercise and settlement provisions. It also
      clarifies on the impact of foreign currency denominated strike prices and
      market-based employee stock option valuation instruments on the
      evaluation. EITF 07-5 is effective for fiscal years beginning after
      December 15, 2008. The Company is currently assessing the impact of
      EITF 07-5 on its financial position and results of
    operations.




-
            In
      May 2008, the FASB issued SFAS No. 162, "The Hierarchy of
      Generally Accepted Accounting Principles" (FAS No.162). SFAS No. 162
      identifies the sources of accounting principles and the framework for
      selecting the principles used in the preparation of financial statements.
      SFAS No. 162 is effective 60 days following the SEC's approval of the
      Public Company Accounting Oversight Board amendments to AU
      Section 411, "The Meaning of Present Fairly in Conformity with
      Generally Accepted Accounting Principles". The implementation of this
      standard will not have a material impact on the Company's financial
      position and results of operations.




F-14





China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies
(Continued)




-
            In
      April 2008, the FASB issued FASB Staff Position on Financial
      Accounting Standard (“FSP FAS”) No. 142-3, “Determination of the
      Useful Life of Intangible Assets”, which amends the factors that should be
      considered in developing renewal or extension assumptions used to
      determine the useful life of intangible assets under SFAS
      No. 142 “Goodwill and Other Intangible Assets”. The intent of this
      FSP is to improve the consistency between the useful life of a recognized
      intangible asset under SFAS No. 142 and the period of the expected
      cash flows used to measure the fair value of the asset under SFAS
      No. 141 (revised 2007) “Business Combinations” and other U.S.
      generally accepted accounting principles.  The Company is currently
      evaluating the potential impact of FSP FAS No. 142-3 on its financial
      statements.




-
            In
      March 2008, the FASB issued Statement No. 161,Disclosures about Derivative
      Instruments and Hedging Activities an amendment of SFAS 133 ("SFAS
      161"). This Statement will require enhanced disclosures about derivative
      instruments and hedging activities to enable investors to better
      understand their effects on an entity's financial position, financial
      performance, and cash flows. It is effective for financial statements
      issued for fiscal years and interim periods beginning after November 15,
      2008, with early application encouraged.  The Company does not
      expect the adoption of SFAS 161 to have a material impact on its financial
      position, results of operations or cash
flows.




-
            In
      December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
      Combinations” (“SFAS 141(R)”). SFAS 141(R) will change the accounting for
      business combinations. Under SFAS No. 141(R), an acquiring entity
      will be required to recognize all the assets acquired and liabilities
      assumed in a transaction at the acquisition-date fair value with limited
      exceptions. SFAS No. 141(R) will change the accounting treatment and
      disclosure for certain specific items in a business
      combination.  SFAS 141R requires earn-outs and other contingent
      consideration to be recorded at fair value on acquisition date and
      contingencies to be recorded at fair value on acquisition date with
      subsequent remeasurement. SFAS 141R requires acquisition costs to be
      expensed as incurred and generally requires restructuring costs to be
      expensed in periods after the acquisition date. SFAS 141R requires amounts
      previously called “negative goodwill” which result from a bargain purchase
      in which acquisition date fair value of identifiable net assets acquired
      exceeds the fair value of consideration transferred plus any non
      controlling interest in the acquirer to be recognized in earnings as a
      gain attributable to the acquirer.  SFAS No. 141(R) applies
      prospectively to business combinations for which the acquisition date is
      on or after the beginning of the first annual reporting period beginning
      on or after December 15, 2008. SFAS 141(R) will impact the Company in
      the event of any acquisition after December 31,
  2008.




-
            In
      December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
      Consolidated Financial Statements—an amendment of Accounting Research
      Bulletin No. 51” (“SFAS 160”). SFAS 160 requires noncontrolling interests
      to be reported in the equity section of financial statements and requires
      that net earnings include the amounts attributable to both the parent and
      the noncontrolling interests with disclosure on the face of the statement
      of operations of the net earnings attributable to the parent and to the
      noncontrolling interests, with any losses attributable to the
      noncontrolling interests in excess of the noncontrolling interests’ equity
      to be allocated to the noncontrolling interest. Calculation of earnings
      per share amounts in the financial statements will continue to be based on
      amounts attributable to the parent.  SFAS No. 160 is
      effective for fiscal years beginning on or after December 15, 2008.
      The Company does not believe that SFAS 160 will have a material impact on
      the Company’s financial statements.




-
            In
      February 2007, the FASB issued Statement No. 159 “The Fair Value Option
      for Financial Assets and Financial Liabilities” (SFAS 159). This statement
      permits companies to choose to measure many financial assets and
      liabilities at fair value. Unrealized gains and losses on items for which
      the fair value option has been elected are reported in earnings. SFAS 159
      is effective for fiscal years beginning after November 15, 2007. The
      adoption of SFAS 159, effective January 1, 2008, did not have a material
      impact on the Company’s financial
statements.




F-15





China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


3.
            Summary
      of Significant Accounting Policies
(Continued)





-
            In
      September 2006, the FASB issued Statement of Financial Accounting
      Standards No. 157,Fair
      Value Measurements (“SFAS 157”).  The statement provides
      enhanced guidance for using fair value to measure assets and liabilities
      and also responds to investors’ requests for expanded information about
      the extent to which company’s measure assets and liabilities at fair
      value, the information used to measure fair value, and the effect of fair
      value measurements on earnings.  While the standard applies whenever
      other standards require (or permit) assets or liabilities to be measured
      at fair value, it does not expand the use of fair value in any new
      circumstances.  Statement No. 157 is effective for financial
      statements issued for fiscal periods beginning after November 15,
      2007.  The Company adopted SFAS 157 effective January 1, 2008,
      except for the nonfinancial assets and liabilities that are subject to a
      one-year deferral allowed by FASB Staff Position (FSP) SFAS 157-2 (“ FSP
      SFAS 157-2”). FSP SFAS 157-2 delays the effective date of SFAS 157 until
      fiscal years beginning after November 15, 2008 for nonfinancial assets and
      liabilities that are not recognized or disclosed at fair value in the
      financial statements on a recurring basis (at least annually). The
      adoption of SFAS 157 did not have a material effect on our financial
      statements. The Company does not expect the adoption of SFAS 157 will have
      a material effect on  our financial statements beginning in year
      2009 as it relates to the items subject to the one-year deferral allowed
      by FSP SFAS 157-2.




4.
            Concentrations
      of Business and Credit risk





The
Company maintains certain bank accounts in the PRC which are not protected by
FDIC insurance or other insurance. As of December 31, 2008 the Company held
approximately $2,729,000 of cash balances within the United States of which
approximately $577,000 was in excess of FDIC insurance
limits.   At December 31, 2008, the Company had approximately
$37,579,000, in China bank deposits, which is not insured. As of
December 31, 2007, the Company held $583,495 of cash balances within the United
States of which $432,798 was in excess of FDIC insurance limits. At December 31,
2007, the Company had approximately $8,605,000 in China bank deposits, which may
not be insured.Historically, the Company has not experienced any losses
in such accounts.





A
significant amount of the Company’s sales are concentrated in
China.  Accordingly, the Company is susceptible to fluctuations in its
business caused by adverse economic conditions in this country. Difficult
economic conditions in other geographic areas into which the Company may expand
may also adversely affect its business, operations and finances.





The
Company provides credit in the normal course of business. 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.





Substantially
all of the Company's fixed assets and operations are located in the
PRC.




The
Company is self-insured for all risks and carries no liability or property
insurance coverage of any kind.




Major
Customers




For the
year ended December 31, 2008, Shanxi Xintai and Harbin Shiji Baolong accounted
for 15% and 12% respectively of sales revenues.  Harbin Shiji Baolong
and Shanxi Xintai accounted for 29% and 11% respectively of all accounts
receivable.  For the year ended December 31, 2007, Ningbo Yuehua
Trading Co. and Guangzhou Xinghe Trading Co. accounted for approximately 14% and
11% of sales revenue respectively.  One customer accounted for 10% of
all accounts receivable.


Major
Suppliers





Heilongjiang
Kangda Medicine Co. accounted for approximately 33% of the Company’s inventory
purchases for the year ended December 31, 2008.  Purchases from Harbin
Yongheng Printing Ltd. for the year ended December 31, 2007 represented
approximately 23%.





Payments
of dividends may be subject to some restrictions due to the Company’s operating
subsidiaries all being located in the PRC.





F-16




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


5.
            Earnings
      per Share




We have
applied SFAS No. 128, “Earnings Per Share” in our calculation and presentation
of earnings per share - “basic” and “diluted”. Basic earnings per share are
computed by dividing net earnings  available to common shareholders
(the numerator) by the weighted average number of common shares (the
denominator) for the period presented. The computation of diluted earnings per
share is similar to basic earnings per share, except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potentially dilutive common shares had been
issued.




Stock
warrants and options to purchase 1,151,000 shares of common stock were
outstanding and exercisable as of December 31, 2008.  Stock warrants and
options to purchase 1,617,483 shares of common stock, all were exercisable and
outstanding during the year ended December 31, 2007.  These
common stock equivalents were included in the computation of diluted earnings
per share because the option exercise prices were less than the average market
price of our common stock during these periods.





The
dilutive potential common shares on warrants and options is calculated in
accordance with the treasury stock method, which assumes that proceeds from the
exercise of all warrants and options are used to repurchase common stock at
market value. The amount of shares remaining after the proceeds are exhausted
represent s the potential dilutive effect of the securities.





The
following table sets forth our computation of basic and diluted net income per
share:





For
      the year ended December 31,2008
                                  
                                  
                                  2007Numerator:Net
      income  used in calculation of basic and diluted
      earnings  per share
                                  
                                  $
                                  28,856,914
                                  
                                  
                                  $
                                  15,332,945Denominator:Weighted-average
      common shares outstanding used in calculation of basic
      earnings  per share
                                  
                                  
                                  15,101,833
                                  
                                  
                                  
                                  12,094,949Effect
      of dilutive securities:Stock
      options and equivalents
                                  
                                  
                                  327,303
                                  
                                  
                                  
                                  1,275,579Weighted-average
      common shares used in calculation of diluted earnings per
      share
                                  
                                  
                                  15,429,136
                                  
                                  
                                  
                                  13,370,528Net
      income per share:Basic
                                  
                                  $
                                  1.91
                                  
                                  
                                  $
                                  1.27Diluted
                                  
                                  $
                                  1.87
                                  
                                  
                                  $
                                  1.15





6.
            Equity
      and Share-based Compensation





Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS
No. 123R, Share-Based Payment (“SFAS No. 123R”), for options granted
to employees and directors, using the modified prospective transition method,
and therefore have not restated results from prior periods. Compensation cost
for all stock-based compensation awards granted is based on the grant date fair
value estimated in accordance with the provisions of SFAS No. 123R. Under
the fair value recognition provisions of SFAS No. 123R, we recognize
stock-based compensation net of an estimated forfeiture rate and only recognize
compensation cost for those shares expected to vest on a straight-line prorated
basis over the requisite service period of the award. In March 2005, the SEC
issued Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment (“SAB
No. 107”), regarding the SEC’s guidance on SFAS No. 123R and the
valuation of share-based payments for public companies. We have applied the
provisions of SAB No. 107 in the adoption of SFAS
No. 123R.





F-17




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


6.
            Equity
      and Share-based Compensation
(Continued)





In July
2006, the Company’s stockholders approved the 2006 Stock Incentive Plan (the
“2006 Plan”). The 2006 Plan, provides for the grant of stock options, restricted
stock awards, and performance shares to qualified employees, officers,
directors, consultants and other service providers. The 2006 Plan originally
authorized the Company to grant options and/or rights to purchase up to an
aggregate of 1,500,000 shares of common stock.  As of December 31, 2008,
non-qualified options to purchase a total of 113,500 shares have been granted
under the 2006 Stock Incentive Plan. All options were granted in October 2006.
All options have an exercise price of $3.65 per share, the weighted fair market
value on the date of grant was $4.25 per share. Of these 113,500 options a total
of 60,500 were granted to employees and a total of 53,000 were granted to
consultants. These options were valued using the Black-Scholes option-pricing
model with the following assumptions: no dividends; risk-free interest rate of
4%; a contractual life of 5 years and volatility of 39%.  All 113,500
options vest over various periods for the options granted to employees and
consultants. There were no options granted during the years ended December 31,
2007 and 2008. In accordance with FAS 123(R), "Share-Based Payment," compensation expenses to
employees for the years ended December 31, 2007 and 2008 were $235,468 and
$315,662, respectively.




Options
or stock awards issued to non-employees and consultants are recorded at their
fair value as determined in accordance with SFAS No. 123R and EITF
No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, and
recognized over the related vesting or service period. In connection with
closing of the Stock Exchange Agreement, the Company agreed to grant warrants to
advisors for the services they already performed for the reverse merger in July
2006, entitling them to purchase up to 500,000 shares on or before July 31,
2009, at a price of $2.00 per share and options to purchase up to 50,000 shares
on or before December 20, 2008 at a price of $3.00 per share.  The fair
value of these warrants and options were determined to be $772,275 and deducted
as expenses using the Black-Scholes option-pricing model with the following
weighted assumptions:  no dividends; risk-free interest rate of 4%; a
contractual life of 2.5-3.5 years and volatility of 39%. The Company based its
estimate of expected volatility on the historical, expected or implied
volatility of similar entities whose share or option prices are publicly
available.




On
January 3, 2007, the holder of 50,000 options dated March 11, 1999, granted
prior to the May 30, 2006 company reorganization, exercised the warrants by
electing to use cashless conversion provision of the warrants and acquired 5,160
shares of the Company common stock (after giving effect to the 8 to 1 reverse
stock split effected after the warrants were issued). .




At
various times during the year ended December 31, 2008, warrant holders exercised
warrants for 505,002 shares of the Company’s common stock, at various exercise
prices, for total proceeds of approximately $1,717,507.  Warrant
holders also exercised 700,000 shares of warrants on a cashless basis for a
total of 587,300 shares of the Company’s common stock. During the year ended
December 31, 2008, option holders exercised 50,000 stock options for 50,000
shares of the Company’s common stock at an exercise price of $3.00 per share for
total proceeds of $150,000.





7.
              Securities
      Purchase Agreement and Related Transaction


On
January 31, 2008 (the “Closing Date”), the Company entered into a Securities
Purchase Agreement (the “Purchase Agreement”) with certain accredited investors
(the “Investors”), for the purchase and sale of units consisting of an aggregate
of: (i) 2,500,000 shares of the Company’s common stock, and (ii) Class A
Warrants to purchase 750,000 additional shares of the Company’s common stock
exercisable at $12.50 per share, and expiring on July 31, 2011 (the “Class A
Warrants”), for a purchase price of $10.00 per unit (the “Unit Purchase Price”),
or gross offering proceeds of $25.0 million (the “2008
Offering”).  The Company received net proceeds of approximately $23.5
million in connection with the 2008 Offering.


Pursuant
to the Purchase Agreement, among other things, if, and whenever, within twelve
(12) months of the Closing Date, the Company issues or sells, or is deemed to
have issued or sold, any shares of common stock, or securities convertible into
or exercisable for shares of common stock, or modifies any of the foregoing
which may be outstanding (with the exception of certain excluded securities), to
any person or entity at a price per share, or conversion or exercise price per
share less than the Unit Purchase Price, then the Company shall issue, for each
such occasion, additional shares of its common stock to the Investors in such
number so that the average per share purchase price of the shares of common
stock purchased by the Investors in the 2008 Offering shall automatically be
reduced to such other lower price per share.






F-18




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


7.
              Securities
      Purchase Agreement and Related Transaction (Continued)


In
addition, as of the Closing Date, the Company entered into a Make Good Agreement
(the “Make Good Agreement”) with Liu Yan-Qing, its Chairman, Chief Executive
Officer and President, and a principal shareholder of the Company, (the
“Principal Shareholder”) and the Investors (collectively, the “Make Good
Parties”), pursuant to which the Principal Shareholder deposited 3,000,000
shares of his common stock of the Company (the “Escrow Shares”) into escrow, to
be released to the Investors in an amount pro rata pro to their initial
investments in the 2008 Offering, in the event the Company failed to attain
earnings per share, as adjusted, of at least (i) $1.05 per share for the fiscal
year ending December 31, 2007 (based on an aggregate of 13,907,696 shares
outstanding), and/or (ii) $1.63 per share for the fiscal year ending December
31, 2008 (based on 16,907,696 shares outstanding).


The
Company deems the Escrow Shares arrangement as analogous to the issuance of a
fixed number of warrants in an equity transaction.  Under the Make
Good Agreement these Escrow Shares would have been  reallocated on a
pro rata basis to the Investors only if certain earnings targets were not
achieved in years 2007 and 2008.  If the earnings targets were met,
the Escrow Shares would automatically be released to the Principal
Shareholder.  As of January 31, 2008, the date the common shares were
placed into escrow, the Company achieved the 2007 earnings target and, based
upon internal forecasts, was confident the 2008 target would also be
met.  Based upon certain assumptions, including the low probability
that the Escrow Shares would be released to the Investors and not be returned to
the Principal Shareholder, the Company considered the fair value of the right
held by the Investors through the Escrow Shares provision under the Make Good
Agreement to be immaterial.  As of December 31, 2008, the Company
satisfied the earnings per common share targets for each of fiscal 2007 and 2008
as defined under the Make Good Agreement and, as such, the Escrow Shares shall
be released to the Principal Shareholder in 2009.





The Class
A Warrants represent the right to purchase an aggregate of 750,000 shares of
common stock, at an exercise price of $12.50 per share. Additional information
relating to these Class A Warrants is provided in Note 8.





8.
            Outstanding
      Warrants and Options





Shares
                                    Underlying
                                    Warrants
                                  
                                  
                                  Weighted
                                    average
                                    Exercise
                                    Price
                                    Warrants
                                  
                                  
                                  Shares
                                    underlying
                                    Options
                                  
                                  
                                  Weighted
                                    average
                                    Exercise
                                    Price
                                    OptionsOutstanding
      as of January 1, 2006
                                  
                                  
                                  25,000
                                  
                                  
                                  $
                                  1.50
                                  
                                  
                                  
                                  -Granted
                                  
                                  
                                  1,650,000
                                  
                                  
                                  
                                  2.58
                                  
                                  
                                  
                                  163,500
                                  
                                  
                                  $
                                  3.45Exercised
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Expired
      or cancelled
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Outstanding
      as of December 31, 2006
                                  
                                  
                                  1,675,000
                                  
                                  
                                  
                                  2.57
                                  
                                  
                                  
                                  163,500
                                  
                                  
                                  
                                  3.45Granted
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Exercised
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Expired
      or cancelled
                                  
                                  
                                  (161,667
                                  )
                                  
                                  
                                  3.19
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Outstanding
      as of December 31, 2007
                                  
                                  
                                  1,513,333
                                  
                                  
                                  $
                                  2.48
                                  
                                  
                                  
                                  163,500
                                  
                                  
                                  $
                                  3.45Granted
                                  
                                  
                                  750,000
                                  
                                  
                                  
                                  12.50
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Exercised
      (See Note 6)
                                  
                                  
                                  (1,205,002
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  (50,000
                                  )
                                  
                                  
                                  -Expired
      or cancelled
                                  
                                  
                                  (8,331
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Outstanding
      as of December 31, 2008
                                  
                                  
                                  1,050,000
                                  
                                  
                                  $
                                  9.50
                                  
                                  
                                  
                                  113,500
                                  
                                  
                                  $
                                  3.45




F-19




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


8.
            Outstanding
      Warrants and Options (Continued)





The
following table summarizes information about stock warrants outstanding and
exercisable as of December 31, 2008.





Exercise
                                                        Price
                                                      
                                                      Outstanding
                                                        December
      31,
                                                        2008
                                                      
                                                      
                                                      Weighted
                                                        Average
                                                        Remaining
                                                        Life
      in
                                                        Years
                                                      
                                                      
                                                      Number
                                                        exercisable$
                                                      2.00
                                                      
                                                      
                                                      300,000
                                                      
                                                      
                                                      
                                                      0.50
                                                      
                                                      
                                                      
                                                      300,000$
                                                      12.50
                                                      
                                                      
                                                      750,000
                                                      
                                                      
                                                      
                                                      2.50
                                                      
                                                      
                                                      
                                                      750,0001,050,000
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      1,050,000





Out of
the 1,050,000 outstanding warrants, all were exercisable as of December 31,
2008. The remaining Class A Warrants represent the right to purchase an
aggregate of 750,000 shares of Common Stock of the Company granted with the
Securities Purchase Agreement, at an exercise price of $12.50 per share, and
have the following additional characteristics:





The Class
A Warrants issued in our January 2008 Offering described in Note 7 above,
represent the right to purchase an aggregate of 750,000 shares of common stock,
at an exercise price of $12.50 per share, and have the following additional
characteristics:




·
              The
      Class A Warrants are exercisable beginning on the six-month anniversary of
      the closing of the January 2008 Offering and will expire July 31,
      2011.




·
              Commencing
      on one-year anniversary of the Closing Date, in the event the Warrant
      Shares may not be freely sold by the holders of the Class A Warrants due
      to the Company’s failure to satisfy its registration requirements, and an
      exemption for such sale is not otherwise available to the Warrant-holders
      under Rule 144, the Class A Warrants will be exercisable on a cashless
      basis.




·
              The
      Exercise Price and number of Warrant Shares will be subject to adjustment
      for standard dilutive events, including the issuance of common stock, or
      securities convertible into or exercisable for shares of common stock, at
      a price per share, or conversion or exercise price per share less than the
      Class A Warrant exercise price of $12.50 per
  share.




·
              At
      anytime following the date a Registration Statement covering the Warrant
      Shares is declared effective, we will have the ability to call the Class A
      Warrants at a price of $0.01 per Class A Warrant, upon thirty (30) days
      prior written notice to the holders of the Class A Warrants, provided (i)
      the closing price of the Common stock exceeded $18.75 for each of the ten
      (10) consecutive trading days immediately preceding the date that the call
      notice is given by the Company, and (ii) the Company has attained an
      Adjusted EPS of at least $1.75 per share for the fiscal year ending
      December 31, 2008, as set forth in our audited financial statements of the
      Company.




·
              If,
      among other things, we fail to cause a Registration Statement covering the
      Warrant Shares to be declared effective prior to the applicable dates set
      forth in the Registration Rights Agreement, the expiration date of the
      Class A Warrants shall be extended one day for each day beyond the
      Effectiveness Deadlines.




·
              If
      a Warrant-holder exercises its Put Right under the Put Agreement (as
      previously defined above), such Warrant-holder’s right to exercise the
      Class A Warrants shall be suspended, pending the satisfaction of our
      obligations to pay the Warrant-holder the applicable Repurchase Price.
      Upon receipt of the Repurchase Price in full by the Warrant-holder, the
      Warrant-holder’s right to exercise the Class A Warrants shall
      automatically and permanently terminate and expire, and the Class A
      Warrants shall be immediately cancelled on the books of the
      Company.




F-20




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


8.
            Outstanding
      Warrants and Options (Continued)





The
following table summarizes information about stock options outstanding and
exercisable as of December 31, 2008.





Exercise
                                            Price
                                          
                                          Outstanding
                                            December
      31,
                                            2008
                                          
                                          
                                          Weighted
                                            Average
                                            Remaining
                                            Life
      in
                                            Years
                                          
                                          
                                          Exercisable
                                            Options
                                          
                                          
                                          Unvested
                                            Options$
                                          3.65
                                          
                                          
                                          113,500
                                          
                                          
                                          
                                          3.00
                                          
                                          
                                          
                                          101,000
                                          
                                          
                                          
                                          12,500113,500
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          101,000
                                          
                                          
                                          
                                          12,500





9.
            Inventories





The
Company values its inventories at the lower of cost and market method.
Inventories are accounted for using the first-in, first-out
method.  Inventories include packing materials, raw materials,
supplemental materials, work-in-process, and finished products.





As of
December 31, 2008 and 2007, inventories consist of the following:





December
      31,
                              2008
                            
                            
                            December
      31,
                              2007Raw
      Material
                            
                            $
                            330,275
                            
                            
                            $
                            284,614Work-in-Process
                            
                            
                            76,462
                            
                            
                            
                            57,337Finished
      Products
                            
                            
                            55,614
                            
                            
                            
                            29,721Total
      Inventories
                            
                            $
                            462,351
                            
                            
                            $
                            371,672





10.
            Property
      and Equipment





As
of December 31, 2008 and 2007, Property and Equipment, net consist of the
following:





December
      31,
                            2008
                          
                          
                          December
      31,
                            2007Buildings
      and improvements
                          
                          $
                          9,961,820
                          
                          
                          
                          2,861,011Machinery
      and equipment
                          
                          
                          4,946,247
                          
                          
                          
                          1,568,958Land
      use rights
                          
                          
                          1,945,209
                          
                          
                          
                          563,469Transportation
      equipment
                          
                          
                          885,880
                          
                          
                          
                          318,779Furniture
      and equipment
                          
                          
                          299,467
                          
                          
                          
                          96,501Construction
      in progress (See Note 14)
                          
                          
                          4,317,265
                          
                          
                          
                          2,113,957Total
      Property and Equipment
                          
                          
                          22,355,888
                          
                          
                          
                          7,522,675Less:
      Accumulated Depreciation
                          
                          
                          (1,297,109
                          )
                          
                          
                          (661,243
                          )Property
      and Equipment, Net
                          
                          $
                          21,058,779
                          
                          
                          $
                          6,861,432





For the
year ended December 31, 2008 and 2007, annual depreciation expense totaled
$584,171 and $187,231 respectively.   Depreciation expense
recorded under Cost of Goods Sold for 2008 amounted to $225,884.





F-21




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


11.
            Intangible
      Assets





As of
December 31, 2008 and 2007, the Company’s net unamortized intangible assets
consist of:





December
      31,
                            2008
                          
                          
                          December
      31,
                            2007Patents
                          
                          $
                          15,093,718
                          
                          
                          $
                          1,599,814Goodwill
                          
                          
                          758,047
                          
                          
                          
                          333,200Total
      Intangible Assets, net
                          
                          $
                          15,851,765
                          
                          
                          $
                          1,933,014





Amortization
expense for the year ended December 31, 2008 and 2007 was $274,235 and $255,832
respectively. Future
amortization of the patents with finite useful lives are as
follows: 
 Year
      ended December 31,2009
                    
                    $
                    695,3002010
                    
                    
                    695,3002011
                    
                    
                    695,3002012
                    
                    
                    695,3002013
                    
                    
                    695,300Thereafter
                    
                    $
                    11,617,20015,093,700





12.
            Taxes
      Payable





Taxes
payable consists of the following:





December
                            31,
      2008
                          
                          
                          December
                            31,
      2007Value
      Added Tax, net
                          
                          $
                          1,179,383
                          
                          
                          $
                          612,602Enterprise
      Income Tax
                          
                          
                          2,106,956
                          
                          
                          
                          940,819City
      Tax
                          
                          
                          32,013
                          
                          
                          
                          4,789Other
      Taxes and additions
                          
                          
                          44,536
                          
                          
                          
                          8,978Total
      Taxes Payable
                          
                          $
                          3,362,888
                          
                          
                          $
                          1,567,188





13.
            Income
      Taxes





Under the
Provisional Regulations of PRC Concerning Income Tax on Enterprises promulgated
by the PRC, income tax is payable by enterprises at a rate of 25% of their
taxable income. Preferential tax treatment may, however, be granted pursuant to
any law or regulations from time to time promulgated by the State
Council.





According
to “Enterprise Income Tax and Certain Preferential Policies Notice” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. The income tax rate for TDR and Tianlong in fiscal
2008 was 15% and 12%, respectively, based on State Council
approval.





We record
a full valuation allowance to reduce our deferred tax assets to the amount that
is more likely than not to be realized. While we have considered future taxable
income and ongoing prudent and feasible tax planning strategies in assessing the
need for the valuation allowance, in the event we were to determine that we
would be able to realize our deferred tax assets in the future in excess of its
net recorded amount, an adjustment to the deferred tax asset would increase
income in the period such determination was made.





Pursuant
to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of the
Company’s net operating losses and tax credit carryforwards may be limited
because of cumulative changes in ownership of more than 50% that have occurred.
As of December 31, 2008, the Company has US net operating loss carryforward’s of
approximately $4.84 million which will begin to expire in 2028. Accordingly, as
mentioned above, any deferred tax asset that would result from these
carryforwards have been fully reserved as of December 31, 2008.





Significant
components of the Company’s deferred tax assets are shown below.  Nil
valuation allowance has been established to offset the deferred tax assets, as
realization of such assets is certain per the management valuation.





Provision
for the PRC enterprise income tax is calculated at the prevailing rate based on
the estimated assessable profits less available tax relief for losses brought
forward.The
Company does not accrue taxes on unremitted earnings from foreign operations as
it is the Company’s intention to invest these earnings in the foreign operations
indefinitely.





F-22




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


13.
            Income
      Taxes (Continued)





Net
deferred tax assets consist of the following components as of December 31, 2008
and 2007:





December
      31,2008
                                      
                                      
                                      2007Deferred tax assets:NOL
      Carryover from China Sky One (formerly known as Comet)
                                      
                                      $
                                      4,840,994
                                      
                                      
                                      $
                                      246,000Share-based
      compensation expenses based on SFAS123R
                                      
                                      
                                      356,130
                                      
                                      
                                      
                                      639,0005,197,124
                                      
                                      
                                      
                                      885,000Less
      valuation allowance
                                      
                                      
                                      (5,197,124
                                      )
                                      
                                      
                                      (885,000
                                      )Net
      deferred tax asset
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -





As of
December 31, 2008, the Company has US net operating loss carryforward’s of
approximately $4.84 million which will begin to expire in 2028.




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 December 31, 2008, 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
December 31, 2008, 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 position or
cash flows.





14.
            Land
      Use Rights Purchase Agreement and Construction in
  progress





During
the second quarter in 2007 TDR entered into an agreement with the Development
and Construction Administration Committee of Harbin Song Bei New Development
district to purchase the land use rights for 50 years for development of a new
biotech engineering project. Terms of the agreement called for a deposit of 30%
of the total land price within 15 days after signing the agreement, 40% payment
7 days prior to the start of construction and the balance of 30% 7 days after
getting the formal land use right.





The
project consists of two phases:




(1)
              Construction
      of main workshop, R&D center and office using land area of 30,000
      square meters. Construction started in May 2007 and is estimated to be
      completed by the end of 2009.
  (2)
              Construction
      of Second workshop and show room using land area of 20,000 square meters.
      Construction is expected to start in September 2008 to be completed by
      December 2009.




TDR has
committed to the Development and Construction Administration Committee of the
Harbin Song Bei New Development District that the minimum investment per square
meter will be $394.





Management
plans to use the internal generated funds to fund the project.  The
estimated additional cost is approximately $5 million.





As of
December 31, 2008 and 2007, the Company has deposits totaling $8,513,284 and
8,003,205 respectively, related to the land and construction
deposits.





F-23




China
Sky One Medical, Inc. and Subsidiaries
 Notes
to Consolidated Financial Statements


15.
            Commitments
      and Contingencies





The
formulation, manufacturing, processing, packaging, labeling, advertising,
distribution and sale of external use Chinese medicine such as those sold by the
Company are subject to regulations by one or more federal agencies. The
principal federal agencies include the State Food and Drug Administration of the
Government of the Peoples Republic of China, the Food and Drug Administration
(the “FDA”), Heilongjiang Provincial Food and Drug Administration of the
People's Republic of China (PFDA), National Biology Products Inspection
Institute (NBPI) and the National Food and Drug Administration (NFDA) of the
People's Republic of China and, to a lesser extent, the Consumer Product Safety
Commission. These activities are also regulated by various governmental agencies
for the countries, states and localities in which the Company’s products are
sold.





Although
management believes that the Company is in material compliance with the
statutes, laws, rules and regulations of every jurisdiction in which it
operates, no assurance can be given that the Company’s compliance with the
applicable statutes, laws, rules and regulations will not be challenged by
governing authorities or private parties, or that such challenges will not lead
to material adverse effects on the Company’s financial position, results of
operations, or cash flows.





The
Company, like any other distributor or manufacturer of products is exposed to
the inherent risk of product liability claims in the events of possible injuries
caused by the use of its products. The Company does not have liability insurance
with respect to product liability claims; the insurance environment of China is
neither sufficient nor mature. Inadequate insurance or lack of contractual
indemnification from parties supplying raw materials or marketing its products,
and product liabilities related to defective products could have a material
adverse effects on the Company.




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 the Company might be involved
in the future are not expected to have a material adverse effect on the
Company’s financial position, results of operations, or cash flows.




Rental
expense is approximately $25,000 per year for each of the years ended December
31, 2008 and 2007 respectively.  The rental commitment for the year
2009 is approximately $25,000.  The Company is expecting the corporate
headquarters currently under construction to be completed by 2009.  As
a result, there is no rental commitment made by the Company for the year 2010
and thereafter.





16.
            Quarterly
      Results (Unaudited)





The
following table presents the Company’s selected unaudited quarterly operating
results for the eight quarters ended December 31, 2008.  The Company
believes that all adjustments of a normal recurring natural have been made to
present fairly the related quarterly results:





Year 2008
                          
                          First
      Quarter
                          
                          
                          Second
      Quarter
                          
                          
                          Third
      Quarter
                          
                          
                          Fourth
      Quarter
                          
                          
                          TotalRevenues
                          
                          $
                          12,413,430
                          
                          
                          $
                          23,748,592
                          
                          
                          $
                          29,699,282
                          
                          
                          $
                          25,954,879
                          
                          
                          $
                          91,816,183Gross
      profit
                          
                          $
                          9,553,002
                          
                          
                          $
                          18,226,278
                          
                          
                          $
                          22,333,223
                          
                          
                          $
                          19,300,377
                          
                          
                          $
                          69,412,880Income
      from operations
                          
                          $
                          4,850,026
                          
                          
                          $
                          10,127,636
                          
                          
                          $
                          11,751,105
                          
                          
                          $
                          8,930,611
                          
                          
                          $
                          35,659,378Net
      income
                          
                          $
                          3,864,911
                          
                          
                          $
                          8,110,667
                          
                          
                          $
                          9,943,435
                          
                          
                          $
                          6,937,901
                          
                          
                          $
                          28,856,914Basic
      EPS
                          
                          $
                          0.26
                          
                          
                          $
                          0.54
                          
                          
                          $
                          0.66
                          
                          
                          $
                          0.45
                          
                          
                          $
                          1.91Diluted
      EPS
                          
                          $
                          0.25
                          
                          
                          $
                          0.53
                          
                          
                          $
                          0.64
                          
                          
                          $
                          0.45
                          
                          
                          $
                          1.87





Year 2007
                      
                      First
      Quarter
                      
                      
                      Second
      Quarter
                      
                      
                      Third
      Quarter
                      
                      
                      Fourth
      Quarter
                      
                      
                      TotalRevenues
                      
                      $
                      5,179,116
                      
                      
                      $
                      14,645,247
                      
                      
                      $
                      16,770,570
                      
                      
                      $
                      12,723,375
                      
                      
                      $
                      49,318,308Gross
      profit
                      
                      $
                      4,052,421
                      
                      
                      $
                      11,336,599
                      
                      
                      $
                      13,101,558
                      
                      
                      $
                      9,888,199
                      
                      
                      $
                      38,378,777Income
      from operations
                      
                      $
                      1,910,080
                      
                      
                      $
                      5,164,183
                      
                      
                      $
                      6,589,801
                      
                      
                      $
                      4,949,722
                      
                      
                      $
                      18,613,786Net
      income
                      
                      $
                      1,549,321
                      
                      
                      $
                      4,227,524
                      
                      
                      $
                      5,446,271
                      
                      
                      $
                      4,109,829
                      
                      
                      $
                      15,332,945Basic
      EPS
                      
                      $
                      0.13
                      
                      
                      $
                      0.35
                      
                      
                      $
                      0.45
                      
                      
                      
                      0.34
                      
                      
                      $
                      1.27Diluted
      EPS
                      
                      $
                      0.12
                      
                      
                      $
                      0.34
                      
                      
                      $
                      0.44
                      
                      
                      
                      0.25
                      
                      
                      $
                      1.15




F-24




Item
      9.
            Changes
      In and Disagreements With Accountants on Accounting and Financial
      Disclosure.





None.





Item
      9A.
            Controls
      and Procedures.





Management’s
Evaluation of Disclosure Controls and Procedures





Our management, with the participation
of our chief executive officer and chief financial officer, evaluated the
effectiveness of our disclosure controls and procedures as of December 31, 2008.
The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act, means controls and other procedures
of a company that are designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the
Securities Exchange Act are recorded, processed, summarized and reported within
the time periods specified in the SEC’s rules and forms.  Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act are accumulated and
communicated to the company’s management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding
required disclosure. Our management recognizes that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Our disclosure controls and procedures are designed to provide reasonable
assurance of achieving their objectives as described above. Based on this
evaluation, our management, including our chief executive officer and chief
financial officer, concluded that as of December 31, 2008, our disclosure
controls and procedures were effective at the reasonable assurance
level.





Management’s
Annual Report on Internal Control over Financial Reporting





Our management is responsible for
establishing and maintaining adequate internal control over our financial
reporting. Internal control over financial reporting is defined in Rule
13a-15(f) or 15d-15(f) under the Securities Exchange Act as a process designed
by, or under the supervision of, a company’s principal executive and principal
financial officers and effected by a company’s board of directors, management
and other personnel to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements in accordance
with U.S. generally accepted accounting principles and includes those policies
and procedures that:





·
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of the assets of a
      company;




·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with U.S. generally
      accepted accounting principles and that receipts and expenditures of a
      company are being made only in accordance with authorizations of
      management and directors of a company;
and




·
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use, or disposition of a company’s assets that
      could have a material effect on the financial
  statements.




Our internal control system was
designed to provide reasonable assurance to our management and board of
directors regarding the preparation and fair presentation of published financial
statements. All internal control systems, no matter how well designed, have
inherent limitations which may not prevent or detect misstatements. Therefore,
even those systems determined to be effective can provide only reasonable
assurance with respect to financial statement preparation and presentation.
Projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.


- 48
-


Our management assessed the
effectiveness of our internal control over financial reporting as of December
31, 2008. In making this assessment, management used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission in Internal
Control-Integrated Framework.





Based on this assessment, management
concluded that, as of December 31, 2008, our internal control over financial
reporting was effective based on those criteria.





Attestation
Report of the Registered Public Accounting Firm





This annual report does not include an
audit report of our registered public accounting firm regarding internal control
over financial reporting.  In addition, management’s report on
internal control over financial reporting is not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the SEC that
require us to provide only management’s report in this annual
report.





Changes
in Internal Control Over Financial Report





During our fourth fiscal quarter, there
was no change in our internal control over financial reporting that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.





Item
9B.  Other Information.





Except as set forth below, there was no
information we were required to disclose in a report on Form 8-K during the
fourth quarter of our fiscal year ended December 31, 2008, or subsequent period
through the date hereof, which was not so reported.


- 49
-


PART
III





Item10.
              Directors,
      Executive Officers and Corporate
Governance.





Directors
and Officers





The
following table sets forth certain information regarding our directors and
executive officers during the fiscal year ended December 31, 2008, and the
subsequent period through the date hereof:





Name
                                    
                                    Age
                                    
                                    PositionLiu
      Yan-qing
                                    
                                    44
                                    
                                    Chief
      Executive Officer, President and DirectorHan
      Xiao-yan
                                    
                                    41
                                    
                                    Vice
      Chairman and DirectorHao
      Yu-Bo
                                    
                                    38
                                    
                                    Chief
      Financial Officer and SecretarySong
      Chun Fan
                                    
                                    69
                                    
                                    DirectorJiang
      Qi Feng
                                    
                                    26
                                    
                                    DirectorZhao
      Jie
                                    
                                    46
                                    
                                    DirectorQian
      Xu Feng
                                    
                                    41
                                    
                                    Director





The
following information reflects the business background and experience of each
director and officer.





Liu Yan-qing is our Chief
Executive Officer and President, Director of TDR, and General Manager of our
Harbin Bio-Engineering subsidiary.  Mr. Liu graduated from Prophylactic
Department of Harbin Medicine University, where he obtained his bachelor’s
degree.  In 2005, he studied at Tsing Hua University and earned an
Executive Masters of Business.  Before establishing his own company, he had
8 years of experience as a reporter of Family Health Newspaper, and has over 10
years of experience in drug marketing, research and development of new drugs and
enterprise management. Mr. Liu has been instrumental in establishing TDR’s sales
program and sales network covering the PRC.





Han Xiao-yan is our Vice
Chairman and Director, General Manager of TDR, and Vice Director of Harbin
Bio-Engineering.  Ms. Han received a master of business administration at
Harbin Industrial University.  She had five years of hygiene and medical
media experience before becoming employed by TDR, and has been instrumental in
developing and marketing TDR’s products and expanding its sales.  She also
serves as our senior marketing manager and administrative
manager.  She has over 10 years of financial management experience.
 In 2004, she was appointed the general manager of TDR, with responsibility
for financing, production, quality control and purchasing.  In 2003, she
was appointed vice director of Harbin Bio-Engineering.





HaoYu-bohas been employed by us
in various capacities since June 2008. From January 2006 through June 2008, Mr.
Hao served as President’s Assistant and Financial Officer for Sumitomo Group
Canadian Branch, an integrated trading company. Prior to this, commencing in
September 2004, Mr. Hao served as Marketing Executive and Canadian Market
Analyst for MGM Mirage, an entertainment company which owns and operates casino
properties. From September 1997 through the time he joined MGM Mirage, he was
Chief Executive Officer of SunnyZone Consulting Co. Ltd., a financial consulting
company he co-founded. Mr. Hao holds Bachelor’s degrees in Economics and Arts
from Beijing Union University and an MBA from the University of
Phoenix.


- 50
-


Song Chun Fan joined our board
of directors on February 22, 2008. From 1964 to the present, Mr. Song has been
employed by the First Clinical College of Harbin Medical University in
Heilongjiang, China, where he has served as the Director of the Surgery Research
Room and the Director of graduate students of the Surgery Department since
1996.  From 1998 to the present, he has been the acting Director of
the Heilongjiang Professional Surgery Committee, the Commissary of the Degree
Commission of China, the Director of the Key Laboratory of Cell Transplantation
of the Ministry of Public Health of China, the Vice-Chairman of the Heilongjiang
Medicine Association, the Vice-Chairman of the Heilongjiang Physician
Association, and the Director of Heilongjiang (Special) Medical Treatment
Application Administration Committee.  Mr. Song received a Bachelor’s
Degree in Medical Treatment from Harbin Medical University in 1964.





Jiang Qi Feng joined our board
of directors on February 22, 2008.  From September 2006 to the
present, Mr. Jiang has served as a Teaching Assistant and a Research Assistant
at Simon Fraser University in Canada, where he specializes in biology
statistics, biology research and probability.  He received a Masters
Degree in Computer Science from Simon Fraser University in 2006, and Bachelor’s
Degrees in Bio-Statistics and Mathematics from the University of British
Columbia in 2005.





Zhao Jie joined our board of
directors on February 22, 2008.  From 1999 to the present, Mr. Zhao
has served as the Tissue Specialist of the Replant Department of Capital Health
Transplant Services in Alberta, Canada, responsible for various aspects of
tissue transplantation, including determining donee acceptability, processing
and preserving tissue, performing surgical procedures, and quality
control.  In addition, he has written and published several books and
articles regarding tissue transplantation.  Mr. Zhao has received
awards from Capital Health for Quality and Safety (2006), Recognition of
Excellence and Achievement (2002), and Teamwork (2002).  He received a
Bachelor’s Degree in Medicine from Harbin Medical University in
1988.





Qian Xu Feng joined our board
of directors on February 22, 2008.  From March 2005 to the present,
Mr. Qian has been employed by Moody’s Investors Service; from May 2007 to the
present, as the Vice President and Senior Analyst, from May 2006 to May 2007, as
the Assistant Vice President and Quantitative Analyst, and from March 2005 to
April 2006, as the Quantitative Analyst. Prior to that, from June 2004 until
February 2005, he was the Research Fellow of the Furman Center for Real Estate
and Urban Policy of New York University, where she conducted empirical
quantitative research in various aspects of commercial and residential
properties. From September 1990 to July 1996, Mr. Qian was an Assistant
Professor of Economics at the Beijing Normal University. He received a Ph.D. in
Economics from Rutgers University in 2004, a Masters Degree in Economics from
Rutgers University in 2001, a Masters Degree in Accounting from City University
of New York in 1999, and a Bachelor’s Degree in Economics from Beijing Normal
University in 1990.





Significant
Employees





As of
December 31, 2008, we had 1,804 employees.  Other than our members of
management, only the individuals listed below are expected to make significant
contributions to our business:





Zhang Wen Chaohas been our
Director of Scientific and Technological Development since 2005.  Mr.
Zhang graduated with a PhD in biology pharmaceuticals from South China
University of Technology in 1997.  He has been employed in various
R&D roles since his graduation.  Mr. Zhang completed our gene
recombination medicine independently and has been responsible for researching
and developing various products that have been launched by the Company since
2005.





Family
Relationships





There are no family relationships among
our directors, executive officers, or persons nominated to become directors of
executive officers.


- 51
-


Involvement
in Certain Legal Proceedings





There have been no events under any
bankruptcy act, no criminal proceedings and no judgments, injunctions, orders or
decrees material to the evaluation of the ability and integrity of any director,
executive officer, promoter or control person of Registrant during the past five
years.





Compliance
with Section 16(a) of the Exchange Act





To our knowledge, based solely on a
review of such materials as are required by the Securities and Exchange
Commission, none of our officers, directors or beneficial holders of more than
10% of our issued and outstanding shares of common stock failed to timely file
with the Securities and Exchange Commission any form or report required to be so
filed pursuant to Section 16(a) of the Securities Exchange Act of 1934, during
the fiscal year ended December 31, 2008.





Code
of Ethics





We have adopted a Code of Ethics that
applies to our principal chief executive officer, principal financial officer,
principal accounting officer or controller, or persons performing similar
functions, as well as other employees (the “Code of Ethics”).  A copy of
the Code of Ethics is appended as an exhibit to our Amended Report on Form
10-KSB for the year ended December 31, 2006.  The Code of Ethics is
being designed with the intent to deter wrongdoing, and to promote the
following:





·
            Honest
      and ethical conduct, including the ethical handling of actual or apparent
      conflicts of interest between personal and professional
      relationships,




·
            Full,
      fair, accurate, timely and understandable disclosure in reports and
      documents that a small business issuer files with, or submits to, the
      Commission and in other public communications made by the small business
      issuer,




·
            Compliance
      with applicable governmental laws, rules and
  regulations,




·
            The
      prompt internal reporting of violations of the code to an appropriate
      person or persons identified in the
code,




·
            Accountability
      for adherence to the code.




Board
of Directors





We have 6 members serving on our Board
of Directors.  Each board member is nominated for election at our
annual meeting to serve until the next annual meeting of stockholders and until
their successors are duly elected and qualified.





Board
Committees





The Board of Directors has an Audit
Committee, Nominating and Governance Committee, Executive Committee, a Finance
Committee and a Compensation Committee, all of which were created on February
22, 2008.  A description of each committee follows.


- 52
-





Audit Committee





We have a separately designated
standing Audit Committee and adopted an Audit Committee Charter on February 22,
2008.  The purpose of the Audit Committee is to recommend to the board
of directors the annual engagement of a firm of independent accountants and
reviews with the independent accountants the scope and results of audits, our
internal accounting controls and audit practices and professional services
rendered to us by our independent accountants.  The Audit Committee
has been created after the appointment of the auditors however, have approved
the inclusion of their report herewith.  The Audit Committee also
reviews and discusses with management and the board of directors, such matters
as accounting policies, internal accounting controls and procedures for
preparation of financial statements. The Audit Committee is required, at all
times to be composed exclusively of directors who, in the opinion of our board
of directors, are free from any relationship that would interfere with the
exercise of independent judgment as a committee member and who posses an
understanding of financial statements and generally accepted accounting
principles.  The Audit Committee is comprised of solely independent
directors, Messrs. Jiang Qi Feng, Zhao Jie and Qian Xu
Feng.  Management believes, in good faith, that each of these members
are considered “independent” under applicable Nasdaq
rules, and that Jiang Qi Feng qualifies as an “audit committee financial
expert” as defined under Item 401(c) of Regulation S-K.  A copy of the
Audit Committee Charter is filed as an exhibit to this report and can be made
available in print free of charge to any shareholder who requests
it.





Compensation Committee





We have designated a Compensation
Committee of Board of Directors and adopted a Compensation Committee Charter on
February 22, 2008. The Compensation Committee is responsible for
(a) reviewing and recommending to the board of directors on matters
relating to employee compensation and benefit plans, and (b) assisting the
board in determining the compensation of the CEO and other executives and make
recommendations to the board with respect to the compensation of the CFO, other
executive officers of the Company and independent directors.  The
Compensation Committee is comprised independent directors, Messrs. Jiang Qi
Feng, Qian Xu Feng and Song Chun Fan.





Nominating and Governance
Committee





We created a Nominating and Governance
Committee and adopted a Nominating and Governance Committee Charter on February
22, 2008.  The purpose of this committee is to assist the board of
directors in identifying qualified individuals to become board members, in
determining the composition of the board of directors and in monitoring the
process to assess Board effectiveness.  The Nominating and Governance
Committee of the board of directors comprised of independent directors Zhao Jie,
Qian Xu Feng and Song Chun Fan.  A copy of the Nominating and
Governance Committee Charter is filed as an exhibit to this prospectus and can
be made available in print free of charge to any shareholder who requests
it.





Executive Committee





We have
created an Executive Committee of the Board of Directors, comprised solely of
independent directors. Song Chun Fan, Zhao Jie and Jiang Qi Feng serve as
members of the Executive Committee.


Finance Committee





We have created a Finance Committee of
the Board of directors, comprised solely of independent
directors.  Qian Xu Feng, Jiang Qi Feng and Song Chun Fan serve as
members of the Finance Committee.





Director
Independence





Our common stock trades on
the Nasdaq Global Market.Under applicable Nasdaq rules, a director will
only qualify as an “independent director” if, in the opinion of our board, that
person does not have a relationship which would interfere with the exercise of
independent judgment in carrying out the responsibilities of a
director.





Our board of directors has determined
that none of Song
Chun Fan, Jiang Qi Feng, ZhaoJie and Qian Xu
Feng has a relationship which would interfere with the exercise of
independent judgment in carrying out the responsibilities of a director, and
that each of these directors is an “independent director,” as defined under
Rule 4200(a)(15) of the Nasdaq Stock Market, Inc. Marketplace
Rules.


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-


Indemnification





Under Chapter 78 of the Nevada Revised
Statutes, we have broad powers to indemnify and insure our directors and
officers against liabilities they may incur in their capacities as
such.  Article VII of our articles of incorporation provides, in part,
that we must indemnify our directors and officers, and their respective heirs,
administrators, successors and assigns against any and all expenses, including
amounts paid upon judgments, counsel fees and amounts paid in settlement by
reason of their being or having been directors of officers.  This
indemnification is in addition to any rights to which those indemnified may be
entitled under any law, by law, agreement, vote of shareholder or
otherwise.





This indemnification provisions may be
sufficiently broad to permit indemnification of our directors and officers for
liabilities (including reimbursement of expenses incurred) arising under the
Securities Act.  Insofar as indemnification for liabilities arising
under the Securities Act may be permitted to directors, officers, or persons
controlling the registrant pursuant to the foregoing provisions, we have been
informed that in the opinion of the SEC such indemnification is against public
policy as expressed in the Securities Act and is therefore
unenforceable.





The indemnity provisions may discourage
stockholders from bringing a lawsuit against our directors for breach of their
fiduciary duty.  These provisions may also have the effect of reducing
the likelihood of derivative litigation against directors and officers, even
though such an action, if successful, might otherwise benefit us and our
stockholders.  Furthermore, a stockholder’s investment may be
adversely affected to the extent we pay the costs of settlement and damage
awards against directors and officers pursuant to these indemnification
provisions.  We believe that these provisions, the indemnification
agreements and the insurance are necessary to attract and retain talented and
experienced directors and officers.





At present, there is no pending
litigation or proceeding involving any of our directors or officers where
indemnification will be required or permitted.  We are not aware of
any threatened litigation or proceeding that might result in a claim for such
indemnification.





Anti-Takeover
Provisions





Provisions of Nevada law, our articles
of incorporation, or our bylaws could have the effect of delaying or preventing
a third party from acquiring us, even if the acquisition would benefit our
stockholders. The provisions of Nevada law and in our articles of incorporation
and bylaws are intended to enhance the likelihood of continuity and stability in
the composition of our Board of Directors and in the policies formulated by the
Board of Directors and to discourage certain types of transactions that may
involve an actual or threatened change of control of China Sky
One.  These provisions are designed to reduce our vulnerability to an
unsolicited proposal for a takeover that does not contemplate the acquisition of
all of our outstanding shares, or an unsolicited proposal for the restructuring
or sale of all or part of our company.  See the Subsection titled
“Anti-Takeover Provisions” in the “Description of Capital Stock” Section
below.





Director
Fiduciary Duty and Business Judgment Provisions





Nevada has enacted several statutes
governing the fiduciary duty and business judgment of our directors and officers
including a provision that our directors and officers must exercise their powers
in good faith and with a view to our interests. In the same section, the Nevada
Revised Statutes state that our directors and officers, in deciding upon matters
of business, are presumed to act in good faith, on an informed basis and with a
view to our interests. They may rely on information, opinions, reports,
financial statements and other financial data, that are prepared or presented by
our directors, officers or employees who are reasonably believed to be reliable
and competent.





Limitation
on Liability





Section 78.138(7) of the Nevada Revised
Statutes provides that our directors and officers will not be individually
liable to us or our stockholders or our creditors for any damages as a result of
any act or failure to act in their capacity as a director or officer unless it
is proven that the act or failure to act breached fiduciary duties as a director
or officer and such breach involved intentional misconduct, fraud or a knowing
violation of law. As a result, neither we nor our stockholders nor our creditors
have the right to recover damages against a director or officer for any act or
failure to act in his capacity as a director or officer, except in the
situations described above and except under very limited
circumstances.


- 54
-


Item
11.  Executive Compensation.





Summary
Compensation Table




The
following table sets forth the cash compensation paid by the Company to its
President and all other executive officers who earned annual compensation
exceeding $100,000 for services rendered during the 2008, 2007 and 2006 fiscal
years.





SUMMARY
COMPENSATION TABLE




Name and
                        Principal Position
                      
                      Year
                      
                      
                      Salary
                        ($)
                      
                      
                      Bonus
                        ($)
                      
                      
                      Stock
                        Awards
                        ($)(1)
                      
                      
                      Option
                        Awards
                        ($)(2)
                      
                      
                      Non-Equity
                        Incentive Plan
                        Compensation
                        ($)
                      
                      
                      Nonqualified
                        Deferred
                        Compensation
                        Earnings ($)
                      
                      
                      All Other
                        Compensation
                        ($)
                      
                      
                      Total
                        ($)Liu
      Yan-Qing
                        Chairman,
      Chief Executive Officer and President
                      
                      
                      2008
                        2007
                        2006
                      
                      
                      
                      34,320
                        68,512
                        19,500
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      51,380
                        -
                        -
                      
                      
                      
                      -
                        -
                        62,050
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      --
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      85,700
                        68,512
                        81,550Han
      Xiao-Yan
                        Vice
      Chairman and Director
                      
                      
                      2008
                        2007
                        2006
                      
                      
                      
                      25,68054,810
                        16,500
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      40,120
                        -
                        -
                      
                      
                      
                      -
                        -
                        43,800
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      65,80054,810
                        60,300Hao
      Yu-Bo
                        Chief
      Financial Officer and Secretary
                      
                      
                      2008
                        2007
                        2006
                      
                      
                      
                      17,241-
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      11,424
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      --
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      28,665
                        -
                        -Richard
      B. Stuart
                        former
      Chief
                        Executive
      Officer
                        and
      Director
                      
                      
                      2008
                        2007
                        2006
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        28,200
                      -
                        -
                        (3)
                        -
                      
                      
                      -
                        -
                        28,200Jack
      M. Gertino
                        former
      Chief
                        Financial
      Officer
                        and
      Director
                      
                      
                      2008
                        2007
                        2006
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        -
                      
                      
                      
                      -
                        -
                        56,325
                      -
                          -
                          (3)
                          -
                      
                      
                      -
                        -
                        56,325




(1)
            As
      of July 15, 2008, we issued
      an aggregate of 30,063 shares of restricted stock to certain employees,
      directors an advisors pursuant to our 2006 Stock Incentive
      Plan.





(2)
            Option
      Awards represent the aggregate grant date fair value of options to
      purchase 17,000 common shares for Mr. Liu and 12,000 common shares for Ms.
      Han, computed in accordance with FAS 123R.  The grant, vesting and
      forfeiture information and assumption made in valuation may be found in
      Note 6 to our financial statements for the year ended December 31, 2008,
      which are attached hereto, beginning on Page F-1, and in the notes
      following the table below.





(3)
            Mr.
      Stuart and Mr. Gertino were former officers and directors of ours through
      May 2006.  We recorded compensation expense for Richard B.
      Stuart and Jack M. Gertino, computed on an hourly basis, in the amounts
      indicated, for their efforts in reviewing specific business opportunities
      for a possible business combination during the fiscal year, participating
      in meetings and conference calls in connection with such opportunities,
      and undertaking related activities.




Summary
of Employment Agreements and Arrangements





We do not have formal employment
agreements with any members of management.


- 55
-


OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END





Name
                
                Number
      of
                  Securities
                  Underlying
                  Unexercised
                  Options
                  (#)
                  Exercisable
                
                
                Number
      of
                  Securities
                  Underlying
                  Unexercised
                  Options
                  (#)
                  Unexercisable
                
                
                Equity
                  Incentive
                  Plan
                  Awards:
                  Number
      of
                  Securities
                  Unexercised
                  Unearned
                  Options
                  (#)
                
                
                Option
                  Exercise
                  Price
                  ($)
                
                Option
                  Expiration
                  Date
                
                Number
                  of
                  Shares
      or Units
                  of
      Stock
                  That
      Have
                  Not
                  Vested
                  (#)
                
                
                Market
                  Value
                  of
                  Shares
                  or
                  Units
                  of
                  Stock
                  That
                  Have
                  Not
                  Vested
                  ($)
                
                
                Equity
                  Incentive
                  Plan
                  Awards:
                  Number
                  of
                  Unearned
                  Shares,
                  Units
      or
                  Other
                  Rights
                  That
                  Have
      Not
                  Vested
                  (#)
                
                
                Equity
                  Incentive
                  Plan
                  Awards:
                  Market
      or
                  Payout
                  Value
      of
                  Unearned
                  Shares,
                  Units
      or
                  Other
                  Rights
                  That
      Have
                  Not
                  Vested
                  ($)(a)
                
                (b)
                
                
                (c)
                
                
                (d)
                
                
                (e)
                
                (f)
                
                (g)
                
                
                (h)
                
                
                (i)
                
                
                (j)Liu
      Yan-Qing
                  Principal
      Executive Officer and Director
                
                
                17,000
                
                
                
                0
                
                
                
                0
                
                
                $
                3.65
                
                October
      26, 2011
                
                
                0
                
                
                
                0
                
                
                
                0
                
                
                
                0Han
      Xiao-Yan
                  former
      Principal Financial Officer and Director
                
                
                12,000
                
                
                
                0
                
                
                
                0
                
                
                $
                3.65
                
                October
      26, 2011
                
                
                0
                
                
                
                0
                
                
                
                0
                
                
                
                0Hao
      Yu-Bo
                  Principal
      Financial Officer
                
                
                0
                
                
                
                0
                
                
                
                0
                
                
                
                n/a
                
                n/a
                
                
                n/a
                
                
                
                n/a
                
                
                
                n/a
                
                
                
                n/a





(1) On October 26, 2006, we issued to
Liu Yan-Qing under our 2006 Incentive Stock Plan (the “Plan”), options to
purchase 17,000 shares of common stock, 6,000 options vesting June 30, 2007, and
the remaining 11,000 options vesting on June 30, 2008.  These options
are exercisable for a five-year period from the date of grant at an exercise
price of $3.65 per share.





(2) On October 26, 2006, we issued to
Han Xiao-Yan under our Plan, options to purchase 12,000 shares of common stock,
5,000 options vesting June 30, 2007, and the remaining 7,000 options vesting on
June 30, 2008.  These options are exercisable for a five-year period from
the date of grant at an exercise price of $3.65 per share.





Equity
Compensation Plan Information





Our Board of Directors adopted a 2006
Stock Incentive Plan (the “Plan”), to be effective on July 31,
2006.  The Plan was approved by our shareholders on July 31, 2006. The
Plan authorizes the granting of incentive stock options and nonqualified stock
options to purchase common stock, stock appreciation rights (“SARs”), restricted
stock, performance stock and bonus stock, to key executives and other key
employees and consultants of ours, including officers of our subsidiaries.
 The purpose of the Plan is to attract and retain key employees, to
motivate key employees to achieve long-range goals and to further identify the
interests of key employees with those of the other shareholders of ours.
 The Plan authorizes the award of 1,500,000 shares of common stock to be
used for stock, SARs, restricted stock and performance and bonus stock.  If
an award made under the Plan expires, terminates or is forfeited, canceled or
settled in cash, without issuance of shares covered by the award, those shares
will be available for future awards under the Plan.  The Plan will
terminate on July 31, 2017.  The Plan is intended to qualify for favorable
treatment under Section 16 of the Exchange Act, as amended, pursuant to Rule
16b-3 promulgated thereunder (“Rule 16b-3”).  The Plan provides for the
grant of “incentive stock options,” as defined in Section 422 of the Internal
Revenue Code (“Code”) and nonqualified stock options.


- 56
-





The Plan designates a Stock Option
Committee appointed by the Board of Directors (which may be the Compensation
Committee) and authorizes the Stock Option committee to grant or award to
eligible participants stock options, SARs, restricted stock performance stock
awards and bonus stock awards for up to 1,500,000 shares of our common stock.
The initial members of the Stock Option Committee are the Board of
Directors.





On October 26, 2006, we granted a total
of 113,500 non-qualified options under the Plan to key employees, including
certain of our officers.  These options are exercisable at a price of $3.65
per share, or 85% of the fair market value of the shares covered by the options
as of the date of grant.  The options begin to vest in June 2007, and
typically vest in increments over either a two-year or three year period, and
expire in October, 2011, unless earlier terminated by their terms.  The
outstanding options include a total of 29,000options held by current
officers and directors.


- 57
-


The following table provides certain
information with respect to our equity compensation plans in effect as of
December 31, 2008.





Plan Category
                      
                      (a) Number of securities
                        to
      be issued upon exercise
                        of
                        outstanding options,
                        warrants and rights
                      
                      
                      (b) Weighted-average
                        exercise price of
                        outstanding options,
                        warrants and rights
                      
                      
                      (c) Number of securities
                        remaining
                        available for future issuance
                        under
      equity compensation
                        plans
      (excluding
                        securities reflected
                        in
      column (a)Equity
      compensation plans approved by security holders
                      
                      
                      113,500
                      
                      
                      $
                      3.65
                      
                      
                      
                      1,386,500Equity
      compensation plans not approved by security holders
                      
                      NoneTotal
                      
                      
                      113,500
                      
                      
                      
                      
                      
                      
                      
                      1,386,500





Director
Compensation





We
do not currently pay any cash fees to our directors.





Limitation
on Liability and Indemnification of Directors and Officers





Chapter 78 of the Nevada General
Corporation Law ("NGCL") provides that a corporation may indemnify any person
who was or is a party or is threatened to be made a party to any threatened,
pending or completed action, suit or proceeding whether civil, criminal,
administrative or investigative (other than an action by or in the right of the
corporation) by reason of the fact that he is or was a director, officer,
employee or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action, suit or
proceeding if he is not liable pursuant to NGCL Section 78.138 or acted in good
faith and in a manner he reasonably believed to be in or not opposed to the best
interests of the corporation, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful. NGCL
Chapter 78 further provides that a corporation similarly may indemnify any such
person serving in any such capacity who was or is a party or is threatened to be
made a party to any threatened, pending or completed action or suit by or in the
right of the corporation to procure a judgment in its favor by reason of the
fact that he is or was a director, officer, employee or agent of the corporation
or is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, against expenses (including attorneys' fees) actually and
reasonably incurred in connection with the defense or settlement of such action
or suit if he is not liable pursuant to NGCL Section 78.138 or acted in good
faith and in a manner he reasonably believed to be in or not opposed to the best
interests of the corporation and except that no indemnification shall be made in
respect of any claim, issue or matter as to which such person shall have been
adjudged to be liable to the corporation unless and only to the extent that the
court or other court of competent jurisdiction in which such action or suit was
brought shall determine upon application that, despite the adjudication of
liability but in view of all of the circumstances of the case, such person is
fairly and reasonably entitled to indemnity for such expenses which the court or
other court of competent jurisdiction shall deem proper.





Our Articles of Incorporation and
By-laws provide that we may indemnify our officers, directors, agents and any
other persons to the fullest extent permitted by the NGCL.


- 58
-


Item
12.  Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.





Security
Ownership of Certain Beneficial Owners





The following table sets forth certain
information regarding the beneficial ownership of our common stock, by (i) each
person who, to our knowledge, owns more than 5% of our common stock, (ii) each
of our named executive officers and directors, and (iii) all of our named
executive officers and directors as a group.  Shares of our common
stock subject to options, warrants, or other rights currently exercisable, or
exercisable within 60 days of the date hereof, are deemed to be beneficially
owned and outstanding for computing the share ownership and percentage of the
person holding such options, warrants or other rights, but are not deemed
outstanding for computing the percentage of any other person. As of March 31,
2009, the Company had 16,446,467 shares of Common Stock issued and
outstanding.





Common Stock Beneficially OwnedName, Title and Address(1)
                                                  
                                                  Number(2)
                                                  
                                                  
                                                  Percent5%
      Stockholders:Pope
      Investments II LLC(3)
                                                    5100
      Poplar Avenue, Suite 805
                                                    Memphis,
      TN 38137
                                                  
                                                  
                                                  1,391,000
                                                  
                                                  
                                                  
                                                  8.3
                                                  %Named
      Executive Officers and Directors:Liu
      Yan Qing(4)
                                                    Chief
      Executive Officer, President and Chairman of the Board of
      Directors
                                                  
                                                  
                                                  4,677,595
                                                  
                                                  
                                                  
                                                  28.4
                                                  %Han
      Xiao Yan(5)
                                                    Vice
      Chairman of the Board of Directors
                                                  
                                                  
                                                  1,415,057
                                                  
                                                  
                                                  
                                                  8.6
                                                  %Hao
      Yu-Bo
                                                    Chief
      Financial Officer and Secretary
                                                  
                                                  
                                                  1,088
                                                  
                                                  
                                                  
                                                  *Song
      Chun Fang
                                                    Director
                                                  
                                                  
                                                  1,088
                                                  
                                                  
                                                  
                                                  *Jiang
      Qi Feng
                                                    Director
                                                  
                                                  
                                                  1,088
                                                  
                                                  
                                                  
                                                  *Zhao
      Jie
                                                    Director
                                                  
                                                  
                                                  1,088
                                                  
                                                  
                                                  
                                                  *Qian
      Xu Feng
                                                    Director
                                                  
                                                  
                                                  1,088
                                                  
                                                  
                                                  
                                                  *All Named Executive Officers and Directors as a
      Group (7 persons)(7)
                                                  
                                                  
                                                  6,098,092
                                                  
                                                  
                                                  
                                                  37.0
                                                  %*Less
      than
1%




(1)  Unless
otherwise indicated, each person named in the table has sole voting and
investment power and that person’s address is c/o the Company, at Room 1706, No.
30 Di Wang Building, Gan Shui Road, Nangang District, Harbin, People’s Republic
of China 150001.





(2)  All
shares are held of record and beneficially.


- 59
-


(3)  Includes
321,000 shares underlying currently exercisable warrants held by Pope
Investments II LLC.  William D. Wells is the Managing Member of Pope
Investments II LLC and has sole voting and investment power over the shares
owned by such entity.  Mr. Wells disclaims beneficial ownership of
these shares, except to the extent of his pecuniary interest
therein.





(4)  Includes
17,000 shares underlying currently exercisable stock options held by Mr.
Liu.  3,000,000 of Mr. Liu’s shares are held in escrow in connection
with a Make Good Agreement entered into with investors in a private offering the
Company closed in January 2008, pursuant to which such shares may be distributed
to such investors if the Company does not attain certain earnings per share
targets for fiscal 2007 and 2008, based on fully diluted shares outstanding at
the time of the offering excluding warrants issued in such offering. The Company
has satisfied the earnings per share targets for each of fiscal 2007 and 2008.
Therefore, the 3,000,000 shares shall be released to Mr. Liu in
2009.





(5)  Includes
12,000 shares underlying currently exercisable stock options held by Ms.
Han.





(7)  Includes
(i) 17,000 shares underlying currently exercisable stock options held by Mr.
Liu, and (ii) 12,000 shares underlying currently exercisable stock options held
by Ms. Han.





Item
13.  Certain Relationships and Related Transactions, and Director
Independence.





Since the beginning of our last fiscal
year, there have been no transactions between members of management, five
percent stockholders, “affiliates,” promoters and finders, except as set forth
below.  Each of the transactions listed below was negotiated on an
“arm’s length” basis.





Transactions
with Management and Others





Effective May 30, 2006, we acquired
100% of ACPG in a stock-for-stock exchange.  The transaction was
treated as a reverse merger and a recapitalization of ACPG for financial
reporting purposes.  As part of the exchange, Liu Yan-qing and Han
Xiao-yan, officers and directors of ACPG and TDR, received 4,660,595 and
1,402,907 shares, respectively, of our common stock in exchange for their
ownership interest in ACPG.  The other shareholders of ACPG received a
total of 4,129,875 shares of our common stock for their ownership interest in
ACPG, including American Eastern Group, Inc., American Eastern Securities, Inc.,
and its principal, Trang Chong (Charles) Hung, who received 87,685 shares,
54,803 shares, and 87,685 shares of our common stock, respectively, in
connection with the transaction.





In connection with the closing of the
stock exchange described above, we entered into a consulting agreement, as of
May 11, 2006, with Jack M. Gertino and Richard B. Stuart, officers and directors
who resigned at closing, providing for their services as
consultants.  For such services, we agreed to compensate Messrs.
Gertino and Stuart as follows: (a) the sum of $3,000 per month for a period of
two years; (b) the issuance of a total of 219,212 shares of our restricted
common stock (or 109,606 shares each). In addition, under this arrangement, we
granted to Mr. Gertino an option to purchase a total of 50,000 shares at a price
of $3.00 per share at any time before December 20, 2008.





We incurred fees to American Eastern
Group, Inc. (“AEG”), and Shenzhen DRB Investment Consultant Limited (“DRB”), in
the amount of $200,000 in cash for services rendered in connection with the
Exchange Agreement.  In addition, in October, 2006, we granted to AES
and DRB warrants to purchase an aggregate of 1,000,000 shares of common stock
(500,000 warrants each) exercisable at any time before July 31, 2009, at a price
of $2.00 per share.  One-half of such warrants were deemed to be
earned as of the completion of the Exchange Agreement, and the other one-half
was deemed earned after completion of our private offering in October,
2006.  The fair value of the above warrants was calculated as
$1,469,190 as of December 31, 2006, based on the Black-Scholes model of
accounting, and the total value of compensation to AES and DRB has been
determined to be $2,317,128.





American Eastern Securities, Inc.,
acted as placement agent for us in connection with our private offering
completed in October, 2006. We sold a total of 200 Units in the private
offering, at a price of $15,000 per Unit, for total gross proceeds of $3,000,000
and net cash proceeds of approximately $2,745,000. Each Unit in the private
offering consisted of a total of 5,000 shares of common stock and a warrant to
purchase an additional 2,500 shares of common stock at any time prior to October
10, 2008, at a price of $3.50 per share.  As a result, we sold a total
of 1,000,000 shares of common stock, and issued warrants to purchase an
additional 500,000 shares of common stock.  As placement agent,
American Eastern Securities earned a placement fee of $270,000 or 9% of the
total proceeds from the private offering, and was granted a warrant to purchase
Units equivalent to 10% of the Units sold in the offering in October 2006, or a
total of 100,000 shares at a price of $3.00 per share, and, subject to
exercising the foregoing $3.00 Warrants in full, a warrant for an additional
50,000 shares exercisable at $3.50 per share.  The $3.00 warrants were
exercised in full. All of the warrants described above have an expiration date
of October 10, 2008.


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Review,
Approval and Ratification of Related Party Transactions





Given our small size and limited
financial resources, we had not adopted prior to our Reverse Merger formal
policies and procedures for the review, approval or ratification of
transactions, such as those described above, with our executive officers,
directors and significant shareholders. However, we intend that such
transactions will, on a going-forward basis, be subject to the review, approval
or ratification of our board of directors, or an appropriate committee
thereof.





As of the date hereof, we have not
adopted a written conflict of interest policy that applies to our executive
officers and directors. We intend to adopt a written conflict of interest policy
in the near future.





Item
14.  Principal Accounting Fees and Services





Murrell, Hall, McIntosh & Co., PLLP
served as the principal accountant to audit our financial statements through
December 18, 2007, when they were replaced by the firm of Sherb & Co.,
LLP.  Effective as of May 21, 2008, we dismissed Sherb & Co., LLP
as our independent registered public accounting firm, and engaged the firm of
MSPC, Certified Public Accountants and Advisors LLP.





The following is a summary of the
combined fees billed to us by Murrell, Hall, McIntosh & Co., PLLP, Sherb
& Co., LLP and MSPC, Certified Public Accountants and Advisors LLP for
professional services rendered for the fiscal years ended December 31, 2008 and
2007:





Aggregate fees rendered for the fiscal
years ended December 2008 and 2007 were as follows:





2008
                  
                  
                  2007Audit
      Fees
                  
                  $
                  161,106
                  
                  
                  $
                  135,442Audit
      Related Fees
                  
                  $
                  29,600
                  
                  
                  $
                  21,500Tax
      Fees
                  
                  
                  -
                  
                  
                  
                  -Other
      Fees
                  
                  
                  -
                  
                  
                  
                  -Total
      Fees:
                  
                  $
                  190,706
                  
                  
                  $
                  156,942





Audit Fees. Consists of fees
billed for professional services rendered for the audit of our consolidated
financial statements and review of the interim consolidated financial statements
included in quarterly reports, services that are normally provided by our
independent registered public accounting firm in connection with statutory and
regulatory filings or engagements.





Audit-Related Fees. Consists
of fees billed for assurance and related services that are reasonably related to
the performance of the audit or review of our consolidated financial statements
and are not reported under "Audit Fees."





Tax Fees. Consists of fees
billed for professional services for our corporate tax returns and extensions,
tax compliance, tax advice and tax planning. No such fees were billed by our
independent registered public accounting firm in fiscal 2008 or
2007.





All Other Fees. No fees were
billed to us by our independent registered public accounting firm for products
and services other than the services reported above.  No such fees
were billed by our independent registered public accounting firm in fiscal 2008
or 2007.


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The board of directors has the sole
authority to review in advance and grant any pre-approvals of (i) all
auditing services to be provided by the independent auditor, (ii) all
significant non-audit services to be provided by the independent auditors as
permitted by Section 10A of the Securities Exchange Act of 1934, and
(iii) all fees and the terms of engagement with respect to such services.
All audit and non-audit services performed by Murrell, Hall, McIntosh & Co.,
PLLP, Sherb & Co., LLP and MSPC, Certified Public Accountants and Advisors
LLP during fiscal 2008 and 2007 were pre-approved pursuant to the
procedures outlined above.




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Item
15.  Exhibits, Financial Statement Schedules


3.1
                Articles
      of Incorporation, as amended (1)3.2
                Restated
      Articles of Incorporation, as filed with the Secretary of State of Nevada
      on July 11, 2008 (8)3.3
                Certificate
      of Amendment to Articles of Incorporation (9)3.4
                By-Laws
      of the Company (1)3.3
                Finance
      Committee Charter (2)3.4
                Audit
      Committee Charter (2)3.5
                Compensation
      Committee Charter (2)3.6
                Nominating
      and Governance Committee Charter (2)3.7
                Executive
      Committee Charter (2)4.1
                Form
      of Class A Warrant issued to investors in connection with January 2008
      private offering (3)10.1
                Form
      of Securities Purchase Agreement between Company and investors, dated as
      of January 31, 2008 (3)10.2
                Form
      of Registration Rights Agreement between Company and investors, dated as
      of January 31, 2008 (3)10.3
                Form
      of Make Good Agreement between Pope Asset Management LLC, as the
      authorized agent of the investors, the Company and Liu Yan-Qin, dated as
      of January 31, 2008 (3)10.4
                Form
      of Make Good Escrow Agreement between Pope Asset Management LLC, as the
      authorized agent of the investors, the Company, Liu Yan-Qing and Interwest
      Transfer, dated as of January 31, 2008 (3)10.5
                Form
      of Put Agreement between Company and investors, dated as of January 31,
      2008 (3)10.6
                Equity
      Transfer Agreement, dated as of February 22, 2008, relating to acquisition
      of Heilongjiang Tianlong Pharmaceutical, Inc. (4)10.7
                Equity
      Transfer Agreement, dated as of April 18, 2008, relating to acquisition of
      Heilongjiang Haina Pharmaceutical Inc. (5)10.8
                Acquisition
      Agreement, dated as of June 9, 2008, relating to acquisition of Peng Lai
      Jin Chuang Pharmaceutical Company (7)14.1
                Code
      of Ethics (2)16.1
                Letter
      from Sherb & Co., LLP dated as of June 6, 2008 (6)31.1
                Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (10)




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31.2
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (10)32.1
              Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002 (10)32.2
              Certification
      of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act
      of 2002 (10)(1)
              Incorporated
      by reference to the Registrant’s Registration Statement on Form 10-SB, as
      filed on May 13, 1999.(2)
              Incorporated
      by reference to the Registrant’s Annual Report on Form 10-KSB, for the
      fiscal year ended December 31, 2007.(3)
              Incorporated
      by reference from exhibits filed with Current Report on Form 8-K, Date of
      Event of January 31, 2008.(4)
              Incorporated
      by reference to the Registrant’s Form 8-K/A, filed on April 9,
      2008(5)
              Incorporated
      by reference to the Registrant’s Form 8-K, filed on April 24,
      2008(6)
              Incorporated
      by reference to the Registrant’s Form 8-K/A, filed on June 10,
      2008(7)
              Incorporated
      by reference to the Registrant’s Form 8-K, filed on June 11,
      2008(8)
              Incorporated
      by reference to the Registrant’s Quarterly Report on Form 10-Q, for the
      fiscal quarter ended June 30, 2008(9)
              Incorporated
      by reference to the Registrant’s Form 8-K, filed on November 21,
      2008(10)
              Filed
      herewith






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SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.




CHINA
      SKY ONE MEDICAL, INC.Dated:
      April 15, 2009
                        By:
                        /s/ Liu Yan-QingLiu
      Yan-QingChairman,
      Chief Executive Officer and
                          President
      (Authorized
Representative)




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.




Name
                    
                    Title
                    
                    Date/s/ Liu Yan-Qing
                    
                    President,
      Chief Executive Officer
                    
                    April
      15, 2009Liu
      Yan-Qing
                    
                    and
      Director (Principal Executive Officer)/s/ Hao Yu-Bo
                    
                    Chief
      Financial Officer and
                    
                    April
      15, 2009Hao
      Yu-Bo
                    
                    Secretary
      (Principal Financial and
                      Accounting
      Officer)/s/ Han Xiao-Yan
                    
                    Vice
      Chairman and Director
                    
                    April
      15, 2009Han
      Xiao-Yan/s/ Song Chun Fan
                    
                    Director
                    
                    April
      15, 2009Song
      Chun Fan/s/ Jiang Qi Feng
                    
                    Director
                    
                    April
      15, 2009Jiang
      Qi Feng/s/ Zhao Jie
                    
                    Director
                    
                    April
      15, 2009Zhao
      Jie/s/ Qian Xu Feng
                    
                    Director
                    
                    April
      15, 2009Qian
      Xu Feng




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