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
      1934





For the
fiscal year ended: December
31, 2009




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




For the
transition period from ____________ to ____________





Commission
file number: 001-34080





CHINA
SKY ONE MEDICAL, INC.


(Exact
name of registrant as specified in its charter)




Nevada
                    
                    87-0430322(State
      or other jurisdiction of
                    
                    (I.R.S.
      Employerincorporation
      or organization)
                    
                    Identification
      No.)




No.
      2158, North Xiang An Road, Song Bei District,
                              Harbin,People’s
      Republic of China
                          
                          150028(Address
      of principal executive offices)
                          
                          (Zip
      Code)
  Registrant’s
telephone number, including area code: 86-451-87032617
(China)
  Securities
registered pursuant to Section 12(b) of the Act:
  Title
      of each class
                              None
                            
                            Name
      of each exchange on which registered
                                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 o     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 o     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
o





Indicate by check mark whether the
registrant has submittedelectronically and postedon itscorporate Website, if any, every
Interactive Data File requiredto be submittedand postedpursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter)
during the preceding 12 months (or for such shorter
period that the registrant was requiredto submit and post such
files).


YesoNoo









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.                   
o





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





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





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


Yes o     No
x





As of
June 30, 2009, the aggregate market value of the voting and non-voting common
equity held by non-affiliates was approximately $135,214,631, based on the last
closing price of $13.48 per share, as quoted on the Nasdaq Global
Market.





As of
March 15, 2010, the registrant had 16,790,851 shares of common stock issued and
outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE





None









CHINA
SKY ONE MEDICAL, INC.




ANNUAL
REPORT ON FORM 10-K




TABLE
OF CONTENTS




PAGESpecial
      Note Regarding Forward-Looking Statements
                            
                            1PART
      I
                            
                            
                            
                            2Item
      1.
                            
                            Business
                            
                            2Item
      1A.
                            
                            Risk
      Factors
                            
                            16Item.
      1B.
                            
                            Unresolved
      Staff Comments
                            
                            30Item
      2.
                            
                            Properties
                            
                            30Item
      3.
                            
                            Legal
      Proceedings
                            
                            30Item
      4.
                            
                            Reserved
                            
                            30PART
      II
                            
                            
                            
                            31Item
      5.
                            
                            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                            
                            31Item
      6.
                            
                            Selected
      Financial Data
                            
                            33Item
      7.
                            
                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                            
                            34Item
      7A.
                            
                            Quantitative
      and Qualitative Disclosures About Market Risk
                            
                            49Item
      8.
                            
                            Financial
      Statements and Supplementary Data
                            
                            F-1Item
      9.
                            
                            Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
                            
                            50Item
      9A.
                            
                            Controls
      and Procedures
                            
                            50Item
      9B.
                            
                            Other
      Information
                            
                            51PART
      III
                            
                            
                            
                            52Item10.
                            
                            Directors,
      Executive Officers and Corporate Governance
                            
                            52Item
      11.
                            
                            Executive
      Compensation
                            
                            57Item
      12.
                            
                            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                            
                            62Item
      13.
                            
                            Certain
      Relationships and Related Transactions, and Director
      Independence
                            
                            64Item
      14.
                            
                            Principal
      Accounting Fees and Services
                            
                            64Item
      15.
                            
                            Exhibits,
      Financial Statement Schedules
                            
                            65Signatures
                            
                            
                            
                            67




- i
-




SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS




This Annual Report on Form 10-K,
together with other statementsand information we publicly
disseminate, contains certain forward-looking statementswithin the meaning of Section27Aof the Securities Act of 1933, as
amended, and Section 21E of the Securities
Exchange Act of 1934, as amended.  We intend such
forward-looking statementsto be coveredby the safe harbor provisions for
forward-looking statementscontainedin 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 statementssince 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
resultsto differ materially from current
expectations include, but are not limited to the “Risk Factors”discussed in Part 1, Item1Aof thisAnnual Report on Form
10-K.  Accordingly, there is no assurance that our expectations will
be realized.  Except as otherwise
requiredby the federal securities laws, we disclaim any
obligations or undertaking to publicly release any updates or revisions to any
forward-looking statement containedherein (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 supplementsandover-the-counter plant and herb-based pharmaceutical and medicinal
products. Our principal productsare external use Traditional Chinese
Herbal Remedies/Medicines,commonly referredto in the industry as “TCM.”We have evolvedinto an integratedmanufacturer, marketer and distributor of
external-useTCMproductssold primarily inthe People’s Republic ofChina(“China”or“PRC”)and through Chinese domestic pharmaceutical chains.Recently, wehave been expanding our worldwide sales
effort as well.Prior
to2009, we soldboth our own manufacturedproducts, as well as medicinal and pharmaceutical
productsmanufacturedby others(the sale of third partyproductsisreferredto herein as “Contract Sales”).Commencing in 2009, we
discontinuedallof ourContract Sales aspart of ourrevisedstrategic plan.




Corporate History




We are 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.”  We are a holding company doing business through
American California Pharmaceutical Group, Inc., a California corporation
(“ACPG”), our non-operating
UnitedStates(“U.S.”)holding company subsidiary, and ACPG’s direct and indirect
subsidiaries located in the People’s Republic of China (the “PRC”).




ACPG, was incorporatedon December 16, 2003,under the name “QQ Group, Inc.”QQ Groupchangeditsname to “American California Pharmaceutical
Group,Inc.”in anticipation of the stock exchange
transactions with our predecessor filer(then known as “Comet Technologies, Inc.”) andHarbin City Tian Di Ren
Medical Co., a company organized under the laws of the PRC (“TDR”), asfurtherdescribedbelow.On December 8, 2005, ACPG
completeda stockexchange transaction with
TDRand TDR’s subsidiaries, each of which was a
fully operating company in the PRC.In connection with this
transaction, ACPG
exchanged100% of itsissuedand outstanding common stock for 100% of the
capital stock of TDR and
itssubsidiaries.




Thereafter, on May 11, 2006, ACPG
entered into a Stock Exchange Agreement (the “Exchange Agreement”) with our shareholders.Thetransactionacquisitioncontemplatedunder the Exchange Agreement
wasconsummatedon May 30, 2006.As a result of thistransaction, we issueda 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.  As a result, ACPG becameour wholly-ownedsubsidiary.




TDR was originally formed in 1994 and
itsprincipal executive officeis locatedinHarbin City,HeilongjiangProvince,PRC.On December 29, 2000,TDR was reorganizedand incorporatedas a limitedliability company under the
“Corporation Laws and
Regulations”of the PRC.At the timeofTDR’s acquisition by ACPG,in December of 2005, TDR had two
wholly-ownedsubsidiaries, Harbin First
Bio-Engineering CompanyLimited(“First”)and Kangxi Medical Care Product Factory(“Kangxi”).  In July, 2006, First and
Kangximerged, with First asthe 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(“Tian Qing”), to conduct research and development in
the areas of tissue and stem cellbanks, which is describedin furtherdetail below.As of December 31, 2009,
Tiang Qing had no operating activities.




On April 3, 2008, TDR completed
itsacquisition of Heilongjiang Tianlong
Pharmaceutical, Inc.,a
company organizedunder the laws of the PRC
(“Tianlong”), that hasa variety ofmedicinesapprovedby the PRC’s State Food and Drug Administration
(the “SFDA”)and new medicine applications, andwhich is in the business of
manufacturing external-use
pharmaceuticals.TDR previously acquiredtheBeijingsales office of Tianlong in mid-2006.In connection with this
transaction,TDR
acquired100% of the issuedand outstanding capital stock of Tianlong fromitssole stockholder, in consideration for
an aggregate purchase price of approximately $8,300,000, consisting of$8,000,000 incash, and23,850 shares of our common
stock(valuedat $12.00per share).




2




On April 18, 2008, TDR consummated
itsacquisition of Heilongjiang Haina
Pharmaceutical Inc., a
companyorganizedunder the laws of the PRC
(“Haina”),licensedas a wholesaler of TCM, bio-products, medicinal devices, antibiotics and chemical
medicines.Haina did not have an
establishedsales network and was
acquiredfor itsprimary asset, a Good Supply Practice
(“GSP”) license (License No. A-HLJ03-010), issuedby theHeilongjiangProvinceoffice of theSFDAas of December 21, 2006.The SFDAonlyissuessuch licenses topharmaceuticalresellers that maintain certain quality
controlstandards.The GSP licensewillbe up for renewalon January 29, 2012.  In
connection with this transaction,TDR acquired100% of the issuedand outstanding capital stock of Haina from
itsthree stockholders in consideration for
payment of approximately $437,000.




On
September 5, 2008, TDR acquired Peng Lai Jin Chuang Pharmaceutical Company, a
company organized under the laws of the PRC (“Peng Lai ”), from its sole
stockholder.  Peng Lai, which has received Good Manufacturing Practice
(“GMP”) certification from the SFDA, was organized to develop, manufacture and
distribute pharmaceutical, medicinal and diagnostic products in the
PRC.  In connection with this transaction, TDR acquired all of Peng
Lai’s assets, including, without limitation, franchise, production and operating
rights to a portfolio of 20 medicines approved by the SFDA, for an aggregate
purchase price of approximately $7,000,000 million, consisting of approximately
$2,500,000 million in cash, and 381,606 shares of our common stock (valued at
$12.00 per share).




Principal
Products and Markets




We are engaged, through TDR,and itssubsidiaries in the PRC, in the
development, manufacture,marketing and sale of over-the-counter,
branded nutritional supplementsand over-the-counter plant and herb-based pharmaceutical and medicinal
products.We have evolvedinto an integratedmanufacturer, marketer and distributor
of external use Chinese
medicine productssold primarily to and
throughdomestic
pharmaceutical chainsin
the PRC.Historically, we handledsales of both ourown manufacturedproductsandContract Sales ofmedicinal and pharmaceutical productsmanufacturedby others.However, commencing in2009, we discontinuedall Contract Sales as part of ourrevisedsales strategy.




With the exception ofPeng Lai, which is located inShanDongProvince, PRC, all of our manufacturing
facilities are located inHeilongjiangProvince, PRC.In addition, we have sales offices
locatedin 24provinces acrossChina.




Our principal productsare external use TCMs. Using various formulas, we produce a
number of TCM productswith several forms of delivery
including ointments, sprays,medicatedskin patches,injections, capsules, suppositories,
tabletsandgranules.We also develop and sellbio-engineering productsin the form of diagnostic
kits, which are usedfor testingfordifferent diseases.Over the next few years,we intend to concentrate muchof our effortsonthedevelopment, production and sales of TCM
productsand testingkits,andantibiotic products.




Our principal operations are inthe PRC, where TDR and itssubsidiaries have manufacturing
facilities and sales
distributionchannelscovering most of theprovincesin the PRC.Part of our sales strategy is to
expandour worldwide sales by locating
qualifieddistributors and sales agentsoutside of the PRC.Our overall revenues wereapproximately$130,092,000in2009, of whichexportoverseassaleswere approximately $10,121,000,
accountingforapproximately7.8% ofourtotal revenue.Overseas sales were $7,570,000in 2008, accountingfor approximately 8.2%ofourtotal revenues.   Overseas sales were
$12,404,000 in 2007,
accountingfor
approximately 25.2% ofourtotal revenue in
2007.




3




All of oursignificantoperations and long livedassetsare locatedin the PRC.Below is a chart depicting our corporate
organizational
structure:









SFDA Licenses




The SFDAissues the licenses to manufacture and
market pharmaceutical productsin the PRC.Our licenses relateprimarily topharmaceuticalproductionlicenses,which are neededmainly for topical products, ointmentsand external test kits. TCM productsalso require a permit for sales, which
permitsare generally grantedon a non-exclusive basis for four to
five years depending on theproductand subject to periodicreview for renewal.For the year endedDecember31, 2009,wecommercialized91 productsthrough TDR and itssubsidiaries.We have the necessary licenses and
permitsfor all of our products.




4




Our TDR Subsidiary Owns the Following
Subsidiaries inChina




HarbinFirst
Bio-Engineering




On September 26, 2003, TDR formedFirst under the laws of the
PRCas itswholly owned subsidiary, with an
authorized capital ofapproximately$1,460,000(10,000,000
RMB).  Firstfocuses on research and development of the use of natural medicinal plantsand biological technology products, such asourdiagnostic kits.First, which officially commencedproduction on July 21, 2006, is one of
the first companies inHeilongjiangProvinceconducting research and development of
high technology
biological
products.  First has two
productlines:




·
            an enzymeimmunity reagent kit
      productline;
      and




·
            a colloid gold productline.




HarbinTian Qing Biotech
Application




On October 16, 2006, TDR
organizedTian Qing under the laws of the
PRCas itswhollyownedsubsidiary, to conduct research and
development in the areas of tissue and stem cell banks, which is
describedin more detail below. (See “Research and Development”below.)As of December 31, 2009, Tian Qing had
no significant operations.




HeilongjiangTianlong
Pharmaceutical




On April 3, 2008, TDR
completedthe acquisition of Tianlong, which is in the business of manufacturing
external-use pharmaceuticals.Tianlong’s assetsincluded, among other things, GMPcertifiedmanufacturing facilities,
state-of-the-art
manufacturing equipment, aresearch and developmentcenter,andproduction and operating
rightsto a portfolio of 69medicines approvedby the SFDA.




HeilongjiangHaina
Pharmaceutical




On April 18, 2008, TDR
consummateditsacquisition ofHaina,which is licensedas a wholesaler of TCM, bio-products, medicinal devices, antibiotics and chemical
medicines.At the time of the acquisition, Haina
did not have an establishedsales network and was
acquiredfor itsprimary asset, a GSPlicenseissuedby theHeilongjiangProvinceoffice of the SFDAas of December 21, 2006.The SFDAonlyissuessuch licenses to resellers of
medicines that maintain certain quality
controlstandards.The GSP licensewillbe up for renewalon January 29, 2012.Obtaining this license hasenabledus to expandoursales of medicinal productswithout having to go through a
lengthylicense application
process.




Peng Lai Jin Chuang
Pharmaceutical




On September 5, 2008, TDR acquired
Peng Lai,whichreceived GMPcertification from the SFDA,andwas organized to develop, manufacture
and distribute pharmaceuticalproductsin the PRC.In connection with the acquisition ofPeng Lai, TDR acquiredall ofPeng Lai’s assets, including, without limitation,
franchise, production and operating rightsto a portfolio of 20medicines approvedby the SFDA.




Product Line




In 2009, we manufacturedand marketed91products.Our manufacturing operations are
conductedin our indirect
subsidiaries’facilities locatedinHeilongjiangProvinceandShanDongProvincein the PRC.




For the year endedDecember 31, 2009, we soldour productsunder fivemain categories:




·
            Patches(7 products);




·
            Ointments(18 products);




·
            Sprays(15 products);




·
            Diagnostic Kit(3 products);




·
            Others (48 products)




5




Adescription of our principleproducts, whichgeneratedamajority of our sales revenue in
2009,is asfollows:




Patch Category:




Sumei Slim Patch




The Sumei Slim Patch is
marketedand sold within and outside the PRC as a more naturaltreatmentto loseweight.  The Sumei Slim Patch
uses Saponinas
itsmajor ingredient,andis effective inregulatingand restrainingthe excessive secretion of certain
hormones, while promoting othersto foster weight lossas well asprevent weight gain.




PainReliefPatch




A painreliefpatchisdesignedtoapplyto thearea ofneck, shoulder,and waist.The patch is usedfor a number of ailments, including fever, headache,heartdysentery, diarrhea,and stiffness and paincausedby hypertension.




Anti-Hypertension
Patch




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




OintmentCategory:




Hemorrhoids Ointment




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




Compound Camphor
Cream




This product ismadeforthe treatment of various pathogens on
the skin surface and subcutaneously, such as mycete, trichopytic, staphylococcal
bacteria aureus, bacillus coli, and candida albicans
(thrush).




Spray Category:




Stomatitis Spray




This spray isusedfor the treatment ofdental ulcers,pharyngitis,and faucitis.It is made withpure herbal medicinesand,thus,hasminimumside effectsto human bodies.




Diagnostic Kit Category:




Cardiac Arrest Early Examination
Kit




This product is usedfor early stage diagnosis of myocardial
infarction (heart attacks).




6




Kidney Disease Testing
Kit




The Urinate Micro Albumin Examination
Testing Kit is usedin connection with early stage diagnosis for primary kidney
disease, hypertension and diabetes.




Other ProductCategory:




We include 48of ourproductsunderthe “Other”product category,because thecategories of a pplicationsforthese productsdo not separately represent a material
amount of our revenues.The Other product categoryincludes suppositories, eye drops,
nasal drops, capsules,granules, injections, tabletsand wash fluids.




Naftopidil Dispersible
Tablet




This tablet isdesignedto treatbenign enlargement of the prostateamongmales in theirmiddle age.It is effective in itstreatment because itsingredientscan be easily digestedand absorbedby the human body.




Naphazoline Hydrochloride Eye Drop




Naphazoline is recommendedfor the temporary relief of eye
redness associatedwith minor irritations.This product can comfort the
eyesby lubricating them and relieving such
irritations.




Revenues
by Product Categories




Webelievethat the most meaningful presentation ofour productsis by categories of method
ofdelivery.Our total revenues during fiscal
2009,2008, and 2007wereapproximately$130,092,000,$91,816,000,and $49,318,000,respectively.The following table setsforth our principal product categories
basedon application type and the
approximate amount and
percentage of revenue from each ofsuch product categories forthe fiscal yearsendedDecember 31, 2009,2008, and 2007:




For the Years Ended December
      31
                                                      ($ in
      thousands)2009
                                                    2008
                                                    2007Product
      Category
                                                    Sales
                                                    %
      of  Sales
                                                    Sales
                                                    % of Sales
                                                    Sales
                                                    % of
  SalesPatches
                                                    $40,770
                                                    31.3%
                                                    $35,484
                                                    38.6%
                                                    $19,609
                                                    39.9%Ointments
                                                    28,862
                                                    22.2%
                                                    23,068
                                                    25.1%
                                                    3,270
                                                    12.6%Sprays
                                                    18,499
                                                    14.2%
                                                    10,613
                                                    11.6%
                                                    8,742
                                                    18.7%Diagnostic Kits
                                                    10,239
                                                    7.9%
                                                    8,781
                                                    9.6%
                                                    2,994
                                                    6.1%Contract
    Sales
                                                    0
                                                    0.0%
                                                    5,655
                                                    6.2%
                                                    12,998
                                                    16.6%Others
                                                    31,722
                                                    24.4%
                                                    8,215
                                                    8.9%
                                                    1,705
                                                    6.2%Total
                                                    $130,092
                                                    100.0%
                                                    $91,816
                                                    100.0%
                                                    $49,318
                                                    100.0%





For a
narrative description of the reasons for the changes in our revenue by product
category over the past three years, see “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” below.





Research and
Development





We conduct all of our research
anddevelopment
(“R&D”) activitieseither internally or through
collaborative arrangementswith universities and research
institutions in the PRC.We have our own research,
development and laboratory
facilities locatedin the facilities of First and
Tianlong.Our internal R&D team currently
consistsof38people.Many of our team members are professors
affiliatedwith universities in the
PRC.




7




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




·
            Establisheda gene medicine laboratoryfor Small RNAprojectwithHarbinMedicalUniversity;
  and




·
            Establisheda laboratoryforAntroquinonol fromAntrodia Camphorata
      withTaiwanGoldenBiotechnology Corporation.




Under our partnership arrangementswithuniversities and research institutions,
we will generally hold the intellectual property rightsto any developedtechnology.For example, as a result of our
collaborationwithHarbinMedicalUniversity, a product known as “Endostatin”is currently under development as a
cancer suppressing product.Although this technology still
bearsthe name ofHarbinMedicalUniversity,we ownthe intellectual property
rightspertaining to this
technology.Additional information relating to this
product and other productsbeing developedis set forth under “ProductsUnder Development”below and under the general product
descriptions throughout this report.




We investedapproximately $14,960,000,
$7,413,000, and $3,158,000 in R&Dfor the yearsendedDecember 31, 2009, 2008, and 2007,
respectively.Additional information about our R&D
investmentsis includedin the financial statementsin Item 8 of this report(and notes thereto) and our
“Management Discussion and
Analysis on Financial Condition and Resultsof Operations”section below.




ProductsUnder Development




The projectswhich accountedforamajority ofour2009 research and development expenses,
groupedby subsidiary,are as follows:




TDR




Breast Cancer
Technology




HyperplasieGlobulaireis the early stage ofHyperplasia of the Mammary Glands that has a high occurrence among
females between twenty-five and forty-five years of age.  Medicines
with Endocrine can have significant side effects to the
patient.  OurBreast
Cancer Technologyis
designedtoeffectively treatthe HyperplasieGlobulairewith Traditional Chinese Medicineandwith minimum side effects.We spent approximately$2,272,000, or 15.2% of total R&D
expenditure in 2009,for efficacy testing, acute and long term
toxicity testing.




Monoclonal Antibody Research




Monoclonal
antibody is a bioactive substance produced when human cells identify and resist
pathogenic intrusion from outside.  Monoclonal antibody technology
can produce large
amountsof pure antibodies with
desiredsubstance.Tumor cells that can replicate endlessly
are fusedwith mammalian cells that produce an
antibody.The result of this cell fusionwill continually produce antibodies.  These antibodies are
called monoclonal because they come from only one type of cell, the hybridoma
cell.We believeMonoclonal antibodies have tremendous
applications in the field of diagnostics, therapeutics, targeteddrug delivery systems, not only for
infectious disease causedby bacteria, viruses and
protozoa,but also for cancer, metabolic and
hormonal disorders.We spent approximately $965,000, or 6.5% of total R&D expenditure
in 2009,forapplication andperformance appraisal.As of December 31, 2009,wecompletedthis project andareable to manufacture and commercializetheseantibody materials.




Endostatin Research




Endostatinisa 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 nutrientsupon which the cancer cellssurvive.Wehave already completedteratogenicity testing, and have
establishedquality standards for this
drug.  Further
developmentsare underway to improve the product
quality of Endostatin.We spent approximately $439,000, or 2.9%
of total R&D expenditure in 2009,foracute and long term toxicity
testing.




8




Patch Products




We spentapproximately $1,820,000, or 12.2% of
total R&D expenditure in 2009,forthe optimization experimentsof several patch productsincludingslim patch,anti-hypertension patch,asthma patch, andpainrelief patch.The optimization experimentsare focusingon optimization of theextractedingredientsand
irritation  tests.




First




Diagnostic Kits




In 2009, we had6diagnostic kitsunder clinical trials.We spent approximately $2,727,000, or18.2% of total R&D expenditure in
2009, on clinical trials
for these 6 diagnostic kits.




Tianlong




Antroquinonol Extractedfrom Antrodia
Cinnamomea




Antrodia Cinnamomeais well known
in Taiwan as a traditional Chinese medicine.  For several decades, it
has been used in the treatment of food and drug intoxication, diarrhea,
abdominal pain, hypertension, rashes, and liver and lung cancer. We have
obtained an exclusive right to develop this technology with Taiwan Golden
Biotechnology Corporation, which has completed pre-clinical research on
Antroquinonol in the United Kingdom.  The compound has been approved
by the Food and Drug Administration in the U.S. to enter into first stage
clinical trial.  We spent approximately $387,000, or 2.6% of total R&D expenditureon this projectin 2009.




Injections





In 2009, we had 3injections under clinical trials.We spent approximately $1,944,000, or 13.1% of total R&D expenditurein clinical
trialsfor these
projectsin 2009.




Peng Lai




We spentan aggregate ofapproximately $879,000, or 5.9% of
total R&D expenditure
in 2009,in optimizing effectiveness test forNaftopidil
Dispersibletabletsfor prostate treatment, Sertraline Hydrochloridecapsulesfor the treatment of mental
depression,andRadix Isatidisgranulesand syrupto treatInfluenza (flu).




Set forth below is a table of
ourmajorresearch and developmentprojects, respective stageof developmentandapplicableexpenses for 2009:




Major Research and
      Development Expenses
      in Fiscal2009
                        ($ in thousands)Projects
                      Stage
                      Expenses
                      % of total
      R&DDiagnostic Kits- 6 products
                      Clinical
    trial
                      $2,727
                      18.2Injections - 6 projects
                      Clinical
    trial
                      1,944
                      13.0Breast Cancer
      Technology
                      Efficacy testing, Acute and Long Term
      Toxicity testing
                      2,272
                      15.2Patches - 4 products
                      Extraction optimization
      testing
                      1,820
                      12.2Monoclonal
      Antibody
                      Completed
                      965
                      6.5Endostatin
                      Efficacy testing, Acute and Long Term
      Toxicity testing
                      439
                      2.9Antroquinonol
                      Clinical
    trial
                      387
                      2.6Radix Isatidis granule and
      syrup
                      Production process
      optimization
                      282
                      1.9Naftopidil Dispersible
      tablets
                      Production process
      optimization
                      256
                      1.7Sertraline Hydrochloride
      capsules
                      Production process
      optimization
                      249
                      1.7Total
                      
                      $11,341
                      75.8




(a)
              In
      fiscal 2009, we spent approximately $2,272,000 on our breast cancer
      technology, which represented approximately 15.2% of our total R&D
      expenditures.  No other product represented 10% or more of our
      R&D expenses in fiscal 2009.


9




Totalresearch and development expenses in
fiscal 2009were$14,960,000.The abovelistedprojectscomprise 75.8% of our total research
and development expenses in fiscal 2009.The other projectsand miscellaneous materialsmake up the remaining24.2% of totalresearch and development expenses for the
year.




Set forth
below is a table of our research and development expenses for fiscal 2008,
classified by product category and stage of development:




Stage
      of Development by Number of Projects and U.S. Dollar Amount
                                                                                                                  ($
      in thousands)Category
                                                                                                                
                                                                                                                Application
                                                                                                                  and
      Efficacy
                                                                                                                Acute
      and Long Term Toxicity
                                                                                                                Long
      Term Stability
                                                                                                                Pending
      SFDA Approval
                                                                                                                Supplemental
      Documentation
                                                                                                                SFDA
                                                                                                                  Approval
                                                                                                                TOTALBio-Engineering(a)
                                                                                                                #
                                                                                                                1
      (b)
                                                                                                                1
      (c)
                                                                                                                13
                                                                                                                2
                                                                                                                -
                                                                                                                1
                                                                                                                18$
                                                                                                                $948
                                                                                                                $1,192
                                                                                                                $2,261
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $4,401Eye
      Drops
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                2
                                                                                                                2$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $103
                                                                                                                $103Nasal
      Drops
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                1
                                                                                                                1$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $61
                                                                                                                $61Injections
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                1
                                                                                                                -
                                                                                                                4
                                                                                                                5$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $104
                                                                                                                -
                                                                                                                $510
                                                                                                                $614Spray
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                1
                                                                                                                -
                                                                                                                -
                                                                                                                1$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $139
                                                                                                                -
                                                                                                                -
                                                                                                                $139Ointment
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                1
                                                                                                                1
                                                                                                                1
                                                                                                                3$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $112
                                                                                                                $90
                                                                                                                $115
                                                                                                                $317Suppository
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                3
                                                                                                                4
                                                                                                                2
                                                                                                                9$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $273
                                                                                                                $352
                                                                                                                $217
                                                                                                                $842Gel
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                2
                                                                                                                2
                                                                                                                4$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $293
                                                                                                                $136
                                                                                                                $429Liquid
                                                                                                                #
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                2
                                                                                                                2
                                                                                                                -
                                                                                                                4$
                                                                                                                -
                                                                                                                -
                                                                                                                -
                                                                                                                $209
                                                                                                                $210
                                                                                                                -
                                                                                                                $419TOTAL
                                                                                                                #
                                                                                                                1
                                                                                                                1
                                                                                                                13
                                                                                                                10
                                                                                                                9
                                                                                                                13
                                                                                                                47
(d)$
                                                                                                                $948
                                                                                                                $1,192
                                                                                                                $2,261
                                                                                                                $837
                                                                                                                $944
                                                                                                                $1,142
                                                                                                                $7,324(e)





(a)
            Bio-engineering
      projects include our Endostatin cancer treatment drug, breast cancer drug
      and diagnostic kits.  The diagnostic kits are designed for
      testing for different cancers and viruses, such as prostate cancer,
      stomach cancer, ovarian cancer, rectal cancer, liver cancer, Hepatitis B
      and C, human papilloma virus and mycoplasma virus.  Diagnostic
      kits accounted for approximately 30.5% of total R&D expenditures in
      2008.





(b)
            In
      fiscal 2008, we spent approximately $948,000 on research and development
      related to Monoclonal antibodies, which represented approximately 12.8% of
      our total R&D expenses. Monoclonal antibodies are a bioactive
      substance produced naturally when human cells identify and resist
      pathogenic intrusion from outside. Monoclonal antibody technology can produce
      large amountsof pure
      antibodies.Therefore,Monoclonal antibodies have
      tremendous applications in the field of diagnostics,
      therapeutics,andtargeteddrug delivery systems, not only
      for infectious disease causedby bacteria, viruses and protozoa
      but also for cancer, metabolic and hormonal
    disorders.





(c)
            In
      fiscal 2008, we spent approximately $1,192,000 on our Endostatin cancer
      treatment drug, which represented approximately 16.1% of our total R&D
      expenses.  Endostatin is 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 nutrientsupon which the cancer cells
      survive.




(d)
              Except
      as set forth in notes (b) and (c) above, no single project represented a
      material portion of our total R&D expenditures in fiscal
      2008.
 (e)
                Does
      not include costs for materials used in our R&D projects. Our total
      R&D expenditures for fiscal 2008 were approximately
      $7,413,000.
  10


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.On October 16, 2006, the Health
Department of Heilongjiang Province grantedus, through Tian Qing, the exclusive right and license to
become engaged in tissue and stem cell bank activities inHeilongjiangProvince,PRC, through December 2010.Since the development of this project
will require substantial managerial, technical and financial resources, and a
number of significant risks, managementis still evaluatingthe proper timing and strategy in launching this
project.




Sales Approach




Over the past several years, we have
continuously expandedour distribution channels for our
products.As a result, we have
establishedasales network covering 24 provinces of
mainlandChina,andhavepositionedsales managers and representatives in
each of these markets.




In fiscal 2007, our sales model was
focusedon the creation of our own distribution
channels.Therefore, we sold productsdirectly to many small distributors and
retail store locations.Commencing infiscal 2008, we changedour business model and
enteredinto distribution agreementswith larger regional sales
agents,who resell to smaller distributors and
retail store locations.In addition, we enteredinto contractswith nationwide chain pharmacies.These changes to our product
distribution channels resultedin our direct customer base
decreasingfrom 943
customers at December 31,
2007 to 212 customers at December 31, 2009.  Our change in sales
strategy is further describedin “Customers and Distribution”below.




Wealsomanagedtoestablisha marketing network through independent agentsto develop an international
marketfor our
products.At present,our primary initial growth focus remainsin thePRC.  However,part of our sales strategy is to expand
our sales outside of the PRC.Overseas sales accounted
for approximately 7.8%, 8.2% and 25.2% of sales revenue for the fiscal years
ended December 31, 2009, 2008 and 2007, respectively.




Materials and
Suppliers




We employ
purchasing staff with extensive knowledge of our products, who work with our
marketing, product development, and formulations and quality control personnel
to source raw materials for our products and other items.  Raw
materials are sourced principally in the PRC, and are generally available from a
variety of suppliers.  Harbin Zhong Jia Medicine Company and
Heilongjiang Kangda Medicine Company accounted for approximately 16% and 42% of
our total inventory purchases for the year ended December 31, 2009,
respectively.  Heilongjiang Kangda Medicine Company accounted for
approximately 33% of our total inventory purchases for the year ended December
31, 2008.  Harbin Yong Heng accounted for 23% of our total inventory
purchases for the year ended December 31, 2007.  No othersuppliers accountedfor 10% or more of our totalinventory purchasesin 2009, 2008, and
2007.




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 believe raw materials are available through alternative
suppliers in the market place, if necessary.  We manufacture bulk
branded products to allow more extensive vertical integration and to improve the
quality and consistency of raw materials.




Historically,
we have signed agreements with suppliers that allowed us to hold extra raw
materials at the cost of the suppliers.  As a result, we could
minimize our own inventory carrying costs, and improve our cash management, by
keeping the inventory at the minimum level required to support our short-term
sales.  However, due to price increases for raw materials, and the
related overhead costs for storing such raw materials, we started to increase
our inventory levels toward the second half of 2009.  In anticipation
of continued price increases, management may further increase our inventory
levels in fiscal 2010.




11




Customers and
Distribution




In fiscal
2007, our sales model was focused on the creation of our own distribution
channels. Therefore, we sold products directly to many small distributors and
retail store locations.  In fiscal 2008, we changed our business model
and entered into distribution agreements with larger regional sales agents, who
resell to smaller distributors and retail store locations.  In
addition, we entered into contracts with nationwide chain pharmacies. Through
the extensive sales networks, of these nationwide chains, we were able to reach
all major metropolitan areas throughout the PRC. These changes to our product
distribution channels resulted in our direct customer base decreasing from 943
customers at December 31, 2007 to 233 customers (not including branches of
retail and drug supply chains) at December 31, 2008.  As of December
31, 2009, we had 212 customers, not including branches of retail and drug supply
chains.




The
change in our sales strategy, which began in fiscal 2008, was initiated to
improve product channel efficiencies, and to give us access to an increased
number of ultimate purchasers.  We believe that these changes will
continue to lead to increased revenue by extending the reach of our distribution
network.  By reducing the number of customers we sell to directly, we
have streamlined our accounts receivable management and collection and reduced
channel distribution costs.  These favorable cost variances have been
partially offset by product price incentives we grant to the larger agents with
which we have contracted.




For the year endedDecember 31, 2009,sales toHarbin Shiji Baolong Medicine Company and Shanxi Xintai
Medicine Company accountedforapproximately16% and 11% of total
revenues,respectively.Harbin Bao Da Medicine Company and Harbin Shiji Baolong
Medicine Company accountedforapproximately16% and 14%of ouraccountsreceivablein 2009,respectively.For the year endedDecember 31, 2008,sales toShanxi Xintai and Harbin Shiji Baolong
accountedfor 15%and 12% ofourtotalrevenues,respectively.Harbin Shiji Baolongand Shanxi Xintai accountedforapproximately29% and 11%of ouraccountsreceivablein 2008,respectively.For the year endedDecember 31, 2007,sales toNing BoYue Hua Trading
Companyand Guang Zhou Xing
He Trading Company accountedforapproximately14% and 11% ofourtotalrevenues, respectively.Hua Li Jiu Zhou Company
accountedforapproximately11% of ouraccountsreceivablein 2007.No other customers accountedfor 10% or more of our total
revenuesor
accountsreceivablein 2009, 2008, and
2007.




In 2009, we implemented various initiatives
toward promoting and marketing our products.Our advertising costsforthefiscal years endedDecember 31, 2009, 2008, and 2007 were
approximately are $14,527,000, $7,299,000 and $4,385,000,
respectively.




We will
continue efforts to expand our markets into other provinces and larger cities in
the PRC, and to other markets worldwide.  Currently, our products are
sold primarily in the PRC.  In 2009, 2008 and 2007, approximately
92.2%, 91.8% and 74.8% of our revenues in were from the sale of products in
China, respectively.Part of our sales strategy is to expand
our worldwide sales.  As a means of accelerating our
distribution into other countries, we will seek to enter into strategic
marketing arrangements with qualified firms that have distribution channels,
brand name recognition, or other unique marketing strengths.




Competition




Competition in the TCM, pharmaceutical,
and over-the-counter nutraceutical business is intense inChina,and throughout the world.We compete with various firms, many of
which produce and market productssimilar 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.




Our direct competitors are other
domestic firms engagedin developing, manufacturing and
marketing TCMand
nutraceutical products.There are many of these companies in the
PRC, inHeilongjiangProvince, and even in the city ofHarbin.




We expect that the competition for
medicinal productsin the PRC andother world marketswill 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 establishedproducts, a strong proprietary pipelineand strong financial
resources.Our management believes that we have
certain competitive advantages in introducing new productsto market due to key focus areas for
development, our existing distribution channels, research and development
capabilities andour
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 inthe PRC can
be found in the “Risk
Factors”section
below.




12




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
productsin the PRC, and setspenalties 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 rightsand regulations, which relating to our
stem cell R&D license.Permitswe attain for TCM productsare grantedon a non-exclusive basis
andaresubject to periodical review for
renewal.




The governmental approval process in the
PRC for a newly developedhealth product can be lengthy and
difficult.  A product sample is first sent to a clinical testing agent
designatedby the Ministry of Health, which
conductsextensive clinical testing and
examinationof the product
to verify if it has the specifiedfunctions as statedby the company producing the
product.  A report will then be preparedand issuedby the clinical testingagent confirming or negating such
functions.After submittal
to the agency, it generally
takes six months to one year for a report to be issuedby the testing agent.The report must then be
submittedto a provincial Health
ManagementCommission for
approval.Following this submittal, a letter of
approval issuedby such commission will be
submittedto 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
betweeneighteen months and
two years.The approval process will depend to a
certain extent on whether a specifiedproduct is a plant basedpharmaceutical (“PBP”), or a plantbasednutraceutical (“PBN”).  PBPs are
productscomposedof herbs, rootsand plantsthat do not use synthetic chemicals,
with certain medicinal functions for treatment of one or
more illnesses.PBPs are generally
prescription-basedbut in some cases may be sold
over-the-counter.PBNs, also frequently known as
“dietary
supplements”or “nutritional supplements,”are also composedof herbs, rootsand plants, but are essentially prophylactic or
preventive innature.All PBNs are available over-the-counter
without a prescription.  In the PRC, PBPs require the approval of the SFDA,
whilePBNs only require the
approval of state and local governmentsprior to manufacturing and sale.Obtaining the approval from
the SFDA is generally more
complex and lengthy.




Because we and our subsidiaries are
wholly-ownedenterprises, we are subject to the law
of foreign investment enterprises in the PRC, and the foreign company provisions
of the CompanyLaw of
China, which governs the conduct of our wholly-ownedsubsidiaries and their officers and
directors, and also limitsour 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 effortsto ensure the environmental
sustainability of our operations.Because the manufacturing of herb and
plant-basedproductsdoes 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
withapplicable laws, we
may be subject to penalties.




Intellectual
Property




We own
certain SFDA licenses for drug batch numbers and other proprietary
technologies.   Historically, we included our proprietary
technologies and SFDA licenses for drug batch numbers within the category of
patents.  We now believe it is more accurate to categorize such
intellectual property as SFDA licenses for drug batch numbers and other
proprietary technologies.




13




As of
December 31, 2009, our intellectual property breakdown by SFDA licenses for drug
batch numbers and other proprietary technologies is as follows:





IPs
      (Intangible Assets)
                  Year
      Acquired
                  Acquisition
      Cost
                    $
      in thousands
                  Reflected
      under Intangible Assets
                  Proprietary
      Technologies
                  Drug
      Batch NumbersEndostatin
                  2006
                  $1,727
                  Yes
                  Yes
                  -SFDA
      licenses for drug batch numbers
                  2008
                  $6,848
                  Yes
                  -
                  YesMonoclonal
      Antibody
                  2008
                  $5,106
                  Yes
                  Yes
                  -Breast
      Cancer Technology
                  2008
                  $1,459
                  Yes
                  Yes
                  -Antroquinonol
                  2009
                  $5,119
                  Yes
                  Yes
                  -Small
      RNAs Technology
                  2009
                  $5,850
                  Yes
                  Yes
                  -





We
purchased the rights to the patents for Endostatin and Antroquinonol, which are
registered under the names of Harbin Medical University and Taiwan Golden
Biotechnology Corporation, respectively.





We have
acquired certain additional proprietary technologies from non-related third
parties.  The fair value of these proprietary technologies recorded in
our financial statements are appraised periodically and amortized during its
useful life.





As of the
date of this filing, we own two registered patents for product
packaging.  As of December 31, 2009, these patents have nominal
carrying values.





Under the
PRC’s State Protection Law, certain herbal medicine products, which have
received approval from the SFDA, have automatic protection.  SFDA
licenses for drug batch numbers we acquired in connection with our acquisitions
of Tianlong and Peng Lai in fiscal 2008 have been recorded as part of our
intangible assets.  We did not appraise or assign any value to the
SFDA licenses for drug batch numbers developed internally by TDR or
First.





We have
registered “Kang Xi” as our trademark, which is used for all of our TCM
products.   The “Kang Xi” trademark was developed internally and
registered by TDR before we became a public company.  Our cost basis
in the trademark is nominal.




Employees




The number of our employees has
increaseddue to growth, increasedresearch and developmentactivitiesand expandedmarketing and distributioneffortsfor ourproducts.Our employees generally fall into the
following categories:




By subsidiary
company:




Number of
      EmployeesCompany
                    
                    2009
                    
                    
                    2008TDR
                    
                    
                    1,315
                    
                    
                    
                    1,515Tian Qing
                    
                    
                    0
                    
                    
                    
                    0First
                    
                    
                    107
                    
                    
                    
                    97Tianlong
                    
                    
                    207
                    
                    
                    
                    97Haina
                    
                    
                    399
                    
                    
                    
                    24Peng Lai
                    
                    
                    126
                    
                    
                    
                    71TOTAL:
                    
                    
                    2,154
                    
                    
                    
                    1,804




14




By nature of job:




Number of
      EmployeesType of Job
                    
                    2009
                    
                    
                    2008Executives and managers
                    
                    
                    201
                    
                    
                    
                    146Production and clerical
                    
                    
                    424
                    
                    
                    
                    359Sales and marketing
                    
                    
                    1,491
                    
                    
                    
                    1,261Research and development, technology
                    
                    
                    38
                    
                    
                    
                    38TOTAL:
                    
                    
                    2,154
                    
                    
                    
                    1,804







As of December 31, 2008, we had 1,804
full-time employees.  Our 2,154 employees, as of December 31, 2009, includes both305fulltime employeesand1,849individuals hired on a contract basis
through agencies.  In 2009, we began hiring certain employees on a
contract basis, in order to take advantage of cost
efficiencies.




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




Available
Information




We file various reportswith the SEC, including Annual
Reportson Form 10-K, Quarterly
Reportson Form 10-Q and Current
Reportson 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
documentsare also available to be read or
copiedat the SEC’s Public Reference Room
locatedat100 FStreet, NE,Washington,D.C.,20549. Information on the Public Reference
Room may be obtainedby calling the SEC at
1-800-SEC-0330.




We also make available free of charge
through our website (www.cski.com.cn) our AnnualReport on Form 10-K, Quarterly
Reportson Form 10-Q, Current Reportson Form 8-K, and, if applicable,
amendmentsto those reportsfiledor furnishedpursuant to the Exchange Act as soon as
reasonably practicable after we electronicallyfile such material with, or furnishes it
to, the SEC.




15




Item1A.Risk Factors.




We are subject to certain risks and
uncertainties as
describedbelow.  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, resultsof operations and cash
flows.  Our business and operations may be adversely
affectedif any of such risks are
realized.  All investors should
consider the following risk factors before deciding to purchase or sell our
securities.




Risks Relatedto 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.





Liu Yan-qing andHan Xiao-yan, who are officers and
directors of ours, also
serve as officersand
directors of ACPG,TDRand itssubsidiaries.As of the date hereof,Dr.Liu and Ms. Hanown, in the aggregate, approximately36.5%ofthe issuedand 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 authorizednumber 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 lossof
their services could adversely affect our business.




We place substantial reliance upon the
effortsand abilities of our executive
officers, Liu Yan-qing, President, Chief Executive Officer and Chairman of the
Board, Han Xiao-yan, Vice Chairman, andStanleyHao, Chief Financial Officer and Secretary.We do not have employment
agreementswith 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 tocontinue ourgrowththrough increasing the distribution and
sales ofour
productsby penetrating existing
marketsin the PRC, and entering new geographic
marketsin the PRC as well as Asia, theUnitedStatesand other countries. However, many
obstacles to entering such new marketsexist, including, but not limitedto, international trade and tariff
barriers, regulatory constraints, product liability concerns, shipping
and delivery costs, costsassociatedwith marketing effortsabroad and maintaining attractive
foreign exchangeratios.Moreover, our expansion strategy may be
basedon incorrect assumptions and may be
flawed, and may even damage our performance,
competitive position in the market and,ultimately,even our abilityto survive in the
marketplace.We cannot, therefore, assure
shareholders that we will be able to successfully overcome such obstacles and
establish our productsin any additional markets.Our inability to implement this growth
strategy successfully may have a negative impact onourgrowth, future financial condition,
resultsof operations or cash
flows.




16




There are many safety risks
involvedin our productsand services that could expose us to
liability or inhibit our ability to secure insurance.




Our productsand services involve direct or indirect
impact on human health and life.The productswe manufacture and sell may be
flawedand cause dangerous side
effects,and even fatality in certain cases,leadingto major business losses
andlegal and other
liabilities and damages to our company.In the event that any of our
productsare allegedto have adverse side effects, we could be subject to product
liability claims.In addition to the threat of liability,
there may be insurance
costsif we enter into certain
marketsor may not be able to obtain insurance
for certain productsin some countries.  Some
distributors may refuse to sell our productsin certain countries if they perceive
such productsto have a high risk or to beuninsurable.




We do not maintain any insurance and are
exposedto all risks of loss, including
resulting form product liability, property loss or damages,or other harm that we may cause to
customers, vendors, suppliers and other third parties,
orsecurities law
claims.





We do not
maintain liability or property insurance coverage or director and officer
insurance coverage and, therefore, we are self-insured for all risks of
loss.  Although we seek to reduce potential liability through measures
such as contractual indemnification provisions with distributors and suppliers,
we cannot assure you that such measures will be enforced or
effective.  Our policy is to record losses associated with our lack of
insurance coverage at such time as realized loss is incurred. Historically, we
have not had any material losses in connection with our lack of insurance
coverage and are not party to any material pending legal proceedings as of the
date of this report.  Management’s intention is to use our working
capital to fund any such losses incurred due to our exposure to inadequate
insurance coverage.  Our operating results could be materially and
adversely affected if we were to pay significant damages or incur significant
defense costs in connection with a claim.





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 productsas well as similar productsdistributedby other companies.Thus, the mere publication of
reportsasserting that such productsmay be harmful could have a material
adverse effect on our business, regardless of whether these reportsare scientifically supported.




The PRC governmenthas recently taken anti-corruption
measures to correct corrupt practices.In the pharmaceutical industry, suchpractices include, among
other things, acceptance of
kickbacks, bribery or other
illegal gains orbenefitsby 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
conductedthrough 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
productsmay be seizedand 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
investmentsin research, to be attentive to consumer needs, or fail to focus on the most
advancedtechnologies, our current and future
productscould be surpassedby more effective or advancedproductsof other companies.




We currently rely on third parties to supply
the key raw materials we use to produce our products.




Our business depends upon the
availability of key raw materials.We rely on only external suppliers for
these rawmaterials.In fiscal year 2009,Harbin Zhong Jia Medicine Company and Heilongjiang Kangda
Medicine Company accountedfor approximately 16% and42% of ourtotal inventory purchases, respectively.Heilongjiang Kangda Medicine Company accountedfor approximately 33% of ourtotal inventory purchases for the year
endedDecember 31, 2008.Forthe 2010 fiscal year,we expect that our raw material
suppliers will be
substantially similar to last yearand the amount of raw materials will
increase commensurate with the increase in the demand of our products.If any of ourmajorsuppliers were to default or become
unable to deliver the raw materials in sufficient quantities, we may be
unable to purchase these raw materials from alternative sources on the same or
similar terms, which could result in a significant decrease in our operating
costs.In addition, any disruption in the
supply of our raw materials
could cause delay in the delivery of our productswhich would be harmful to our sales
reputation and business.If supply is disruptedthe increasedamount we have to pay for raw materials
could negatively impact our margins, cause us to cease production if an
alternate supplier cannot be found.If we are unable to procure replacement
supplies, our ability to meet the production demands of our customers could
cause the loss of costumers and/or market share.Our financial resultscould be negatively impactedby the lost sales or
decreasedmargins.




17




We
are dependent on a limited number of customers for a significant portion of our
revenues and accounts receivable and this dependence is likely to
continue.




We have
been dependent on a limited number of customers for a significant portion of our
revenue.  For the year
ended December 31, 2009, sales to Harbin Shiji Baolong Medicine Company and
Shanxi Xintai Medicine Company accounted forapproximately16% and 11% of total revenues,respectively.  For the year
endedDecember 31, 2008, sales to Shanxi
Xintai and Harbin Shiji Baolong accountedfor 15%and 12% ofourtotalrevenues,respectively.For the year endedDecember 31, 2007,salestoNing BoYue Hua Trading Company and Guang
Zhou Xing He Trading Company accountedforapproximately14% and 11% ofourtotalrevenues, respectively.Dependence on a few
customers could make it difficult to negotiate attractive prices for our
products and could expose us to the risk of substantial losses if any such
customer stops purchasing our products.  We expect that a limited
number of customers will continue to contribute to a significant portion of our
sales in the near future. Our ability to maintain close relationships with these
top customers is essential to the growth and profitability of our
business.  If we fail to sell our products to one or more of these top
customers in any particular period, or if a large customer purchases fewer of
our products, defers orders or fails to place additional orders with us, or if
we fail to develop additional major customers, our revenue would likely decline
and our results of operations would be adversely affected.




In
addition, our accounts receivable are concentrated among a small number of our
customers.  Harbin Bao Da Medicine Company and Harbin Shiji Baolong
Medicine Company accounted for approximately 16% and 14% of our
accounts receivable in 2009, respectively.  Harbin Shiji Baolong and
Shanxi Xintai accounted for approximately 29% and 11% of our
accounts receivable in 2008, respectively.  Hua Li Jiu Zhou Company
accounted for approximately
11% of our accounts receivable in 2007. If any our customers fail to pay us on a
timely basis, or do not pay us at all, our business, cash flow, financial
condition and results of operations may be materially and adversely
affected.




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




We compete with other companies, many of
which aredevelopingand/oroffering, or can be expectedto develop and offer, productssimilar to ours.Our market is a large market with many
competitors.Many of our competitors are more
establishedthan we are, and have significantly
greater financial, technical, marketing andother resources than us.  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
requirementsand 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.




We are subject to market and channel
risks.




In fiscalyear2009, over92% of our sales were made in the PRC, where we primarily
sell our productsthrough drug chain stores.Because of this,we are dependent to a large
degree upon the success of
our PRC-baseddistribution channel,as well as the success of specific
retailers in the distribution channel.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 willbe able to grow or prosper as
theyfaces 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.




18




We may have difficulty in defending
intellectual property rightsfrom infringement.




Our TCM productsare generally not protectedby patentsbut by trade secrets.Certain TCMlicense agreementsare made on a non-exclusive basis.Our success depends, in large part, on
our ability to protect current and future technologies and productsand to defend our intellectual property
rights.If we fail to protect our intellectual
property adequately,
competitors may manufacture and market similarproducts.We havefiledpatent applications seeking to protect
newly developedand/ortechnologies.Some patent applications in the PRC are
maintainedin 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 itsdiscoveries.Patentsmay not be issuedwith respect to any of our patent
applications and existing or future patentsissuedto or licensedby us may not provide competitive
advantages for itsproducts.Patentsthat are issuedmay be challenged, invalidatedor circumventedby competitors.Furthermore, our patent rightsmay not prevent our competitors from
developing, using or commercializing productsthat are similar or functionally
equivalent to our products.




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




We also rely on trade secrets, non-patentedproprietary expertise and continuing technological innovation that
we seek to protect, in part, by entering into confidentiality
agreementswith licensees, suppliers, employees
and consultants.These agreementsmay be breachedand 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 secretsand proprietary
technologiesmay otherwise
become known or be independently developed by competitors.  If
patentsare not issuedwith respect to productsarising 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 rightsand may prevent us from manufacturing
and selling certain of our products.




There has been substantial litigation in
the pharmaceutical and nutraceutical industrieswith respect to the manufacturing, use
and sale of new products.These lawsuitsrelate to the validity and infringement
of patentsor proprietary rightsof third parties.We may be requiredto commence or defend against charges
relating to theinfringement 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 rightsto develop or make certain
      products;
  and




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




Although patent and intellectual
property disputes within these industries have often been settledthrough licensing or similar
arrangements, costsassociatedwith these arrangementsmay be substantial and could include
the long-term payment of royalties.These arrangementsmay be investigatedby regulatory agencies and, if
improper, may be invalidated.Also, the requiredlicenses may notbe made available to uson 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 productsor increase coststo market these products.




In addition, when seeking regulatory
approval for some of our products, we are requiredto certify to regulatory authorities,
including the SFDA that such productsdo 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 us.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.




19




The launch of a product prior to a final
court decision or the expiration of a patent held by a third party may
result insubstantial damages to us.  Depending upon the
circumstances, a court may award the patent holder damages equal to three times
their loss of income.If we
arefound 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 resultsof operations and financial
condition.




Our failure to comply with accounting
policies and regulations in making reasonable estimates and judgmentscould negatively impact our financial position and
resultsof operation.




We aresubject to critical accounting policies
and actual resultsmay vary from estimates.We have followed, and will continue to follow, generally
acceptedaccounting principles for theUnitedStatesin preparing financial statements.As part of this work, we must make many
estimates and judgmentsconcerning future events.These affect the value of the
assetsand liabilities, contingent assetsand liabilities, and revenue and
expenses reportedin such financial statements.We believe that these estimates and
judgmentsare reasonable, and we have made them
in accordance with accounting policies basedon information available at the
time.However, actual resultscould differ from estimates, and this
could require us to record adjustmentsto expenses or revenues that could be
material to our financial position and resultsof operations in the
future.




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




Our business must be conductedin compliance with various government
regulations and in particular, theSFDA’sregulations.Government regulations may have material impact on our
operations, increase costsand could prevent or delay the
manufacturing and selling
of our products.Research, development, testing,
manufacturing and marketing activities are subject to various governmental
regulations inChina, 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
ourproductswithout a proper approval from
government agencies and in
particular the SFDA.This approval process is lengthy, with
approvals for TCM productstypically occurring 18-24 months after
the application is initially filed.There is no assurance that we will
obtain such approvalson a
timely basis, or at all.Delays in
obtainingapprovals will
delay our ability to market productsand denial of approval for a specific
product will result in our inability to market the product and recoup the
expenses incurredin that productsdevelopment and
testing.




In addition, delays or rejections may be
encounteredbasedupon additional government regulation
from future legislation, administrative action or changes in governmental policy
and interpretation during the period of product development andproduct assessment.Although we have, so far,
obtainedthe rightsto sell our productsin the PRC, we may not continue to
receive and maintain regulatory approvals for the sales of these products.Our marketing activities are also
subject togovernment
regulations with respect to the prices that it intends to charge or any other
marketing and promotional
relatedactivities.Government regulations may substantially
increase the costsfor developing, licensing,
manufacturing and selling
products, impacting negatively our operations,revenue, income and cash
flow.




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 productsin the PRC is heavily
regulatedby many state, provincial and local authorities.These regulations significantly
increasedthe difficulty and costsinvolvedin 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 hasimplementednew guidelines for licensing of
pharmaceutical products.All existing manufacturers with
licenses, which are currently valid under the previous guidelines, were
requiredto apply for the GMPcertifications by June 30, 2004, and to
receive approvals by December 31, 2004.We receivedcertifications 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.




20




We needto manage growth in operations to
maximize our potential growth and achieve our expectedrevenues.




Our success depends on our ability to
achieve continuedgrowth.In order to maximize
potentialgrowth 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 needto continue to improve financial
controls, operating procedures, and management
information systems if and
as we grow.We will also needto 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 ofU.S.and international regulations.




We are requiredto comply with a number of
international regulations in countries outside of theUnitedStates.  In addition, we must comply
with the Foreign Corrupt Practices Act, orFCPA, which prohibitsU.S. companies or their
agentsand 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
agentscomply 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
targetedforeign countries, entities and
individuals basedonU.S.foreign policy and national security
goals.As a result, we are restrictedfrom entering into transactions
with certain
targetedforeign countries, entities and
individuals except as permittedby OFAC which may reduce our future
growth.




We may incur significant coststo ensure compliance withU.S.corporate governance and accounting
requirements.




We are a public reporting company, and,
as such, we will incur significant costsassociatedwith public company reporting
requirements, costsassociatedwith newly applicable corporate governancerequirements, including requirementsunder the Sarbanes-Oxley Act of 2002
and other rules implementedby the U.S. Securities and Exchange
Commission(“SEC”).All of these applicable rules and
regulations can be expectedto increase legal and financial
compliance costsand to make some activities
more time consuming and
costly.Management also expectsthat these applicable rules and
regulations may make it more difficult and more expensive to obtain director
andofficer liability
insurance and we may be requiredto accept reducedpolicy limitsand coverage or incur substantially
higher coststo obtainthe same or similar coverage.As a result, it may be more difficult for usto attract and retain qualifiedindividuals 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 commonstock.




In recent years, thesecurities marketsin the U.S.have experienceda high level of price and volume
volatility, and the market price of securities of many companies have
experiencedwide fluctuations that have
not necessarily been
relatedto the operations, performances,
underlying asset valuesor
prospectsof such companies.For these reasons, our shares of common
stock can also be expectedto be subject to volatility resulting
from purely market forces
over which we will have nocontrol.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.




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




To the fullest extent
permittedby Chapter 78 of the Nevada
RevisedStatues, we may, if and to the extent
authorizedby 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 requiredto 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.




21




Risks Relatedto Doing Business inChina




Our business will be affectedby the government regulation and
Chinese economic environment because most of our sales will be in theChinamarket.




In 2009, 2008, and 2007,approximately92%, 92%and 75% of our total revenues,respectively, were from sales in the
PRC.The
manufacture and sale of pharmaceutical productsinChinais heavily regulatedby many state, provincial and local
authorities.The SFDArequires pharmaceutical manufacturers
to obtain GMPcertifications.We currently have the certifications
neededfor 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 inChina, and our businesses would be materially
and adversely affected.These regulations significantly increase the difficulty and
costsinvolvedin obtaining and maintaining regulatory
approvals for marketing new
and existing products.Our future growth and profitability
depend to a large extent on our abilityto obtain regulatory approvals.Additionally, the law could change so as
to prohibit the use of certain pharmaceuticals.If one of our productsbecomes prohibited, this change would cease
theproductivity of that
product.The China National Development and Reform Commission (“CNDRC”), has recently implemented price
adjustmentson 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 startedexporting productsto other countries, most of our sales
are in thePRC.  It is anticipatedthat our productsin the PRC will continue to represent a
significant portion of sales in the near future.As a result ofour reliance on the PRC markets, our operating resultsand financial performance could be
affectedby 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 regulatedwill continue toevolve.As a pharmaceutical company, we are
subject to the Pharmaceutical Administrative Law, which governs the licensing,
manufacture, marketing and distribution of pharmaceutical
productsin the PRC, and setspenalty provisions for violations of
provisions of the Pharmaceutical Administrative
Law.In addition as
a  “Foreign
OwnedEnterprise,”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 requirementsshould be proposedand adopted, such new legislation or regulatory
requirementsmay have a material adverse effect on
our financial condition, resultsof operations or cash flows.In addition, we are subject to varying
degrees of regulation and licensing by governmental agencies inChina.At this time, we are unaware of anyChinalegislative 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-compliancewith 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 toChinacould adversely affect us.




Chinais transitioning from a
plannedeconomy to a market economy.While the PRC government has
pursuedeconomic reforms since itsadoption of the open-door policy in
1978, alarge portion of
the Chinese economy is still operating under five-yearplans 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 domesticmarket of various industries, the PRC
government exertsconsiderable direct and indirect
influence on the economy.Many of the economic reforms
carriedout by the PRC government are
unprecedentedor experimental, and are
expectedto be refinedand improved.Other political, economic and social
factors can also lead to furtherreadjustment of such reforms.This refining and readjustment process
may not necessarily have a positive effect on our operations or future business development.Our operating resultsmay 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.




Accordingly, government actions in the
future, including any
decision not to continue to support recent economic reforms and to return to a
more centrally plannedeconomy 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.




22




There are risks i nherent in doing business inChina.




The PRC is a developing country with a
young market economic system overshadowedby the state underheavy regulation and
scrutiny.Itspolitical and economic systems are very
different fromthe more
developedcountries.Chinaalso faces many social, economic and
political challenges that may produce major shocks and instabilities and even
crises, in both itsdomestic arena and in itsrelationship with other countries,
including but notlimitedto theUnitedStates.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.  However, there are substantial uncertainties regarding the
interpretation and application of PRC laws and regulations, including, but not
limited to, the laws and regulations governing our business. In addition, the
effectiveness of newly-enacted laws, regulations or amendments may be delayed,
resulting in detrimental reliance by investors.  New laws and
regulations that affect existing and proposed future businesses may also be
applied retroactively. 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.




Our business may be affectedby unexpectedchanges in regulatory
requirementsin the jurisdictions in which we
operate.




Our company, and itssubsidiaries, are subject to many
general regulations governing business entities and their behavior inChinaandin 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 supplementsand pharmaceutical products.   Such regulations
typically deal with licensing, approvals and
permits.  Any change in product
licensing may make our productsmore or less available on the
market.  Such changes may have a positive or negative impact on the
sale of our productsand may directly impact the
associatedcostsin 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 productsto certain countries and regions, such
asHong Kong, which would limit itsinternational
expansion.




A
slowdown or other adverse developments in the PRC economy may materially and
adversely affect our customers, demand for our services and our
business.




All of
our operations are conducted in the PRC and almost all of our revenues are
generated from sales in the PRC. Although the PRC economy has grown
significantly in recent years, we cannot assure you that such growth will
continue.  According to the PRC National Bureau of Statistics, the
PRC’s economy expended 6.8% from a year earlier in the fourth quarter of 2008,
which means that a full-year growth for 2008 was 9.0%.  It is the
first time since 2002 that the PRC has expanded by less than 10%
annually.  A number of factors have contributed to this slow-down,
including appreciation of the RMB, which has adversely affected the PRC’s
exports. In addition, the slow-down has been exacerbated by the recent global
crisis in the financial services and credit markets, which has resulted in
significant volatility and dislocation in the global capital markets. It is
uncertain how long the global crisis in the financial services and credit
markets will continue and how much adverse impact it will have on the global
economy in general or the PRC economy in particular.  We do not know
how sensitive we are to a slowdown in economic growth or other adverse changes
in the PRC economy which may affect demand for our products.  A
slowdown in overall economic growth, an economic downturn or recession or other
adverse economic developments in the PRC may materially reduce the demand for
our products and materially and adversely affect our business.




23




Inflation
in the PRC could negatively affect our profitability and growth.




While the
PRC economy has experienced rapid growth, it has been uneven among various
sectors of the economy and in different geographical areas of the country. Rapid
economic growth can lead to growth in the money supply and rising inflation. If
prices for our products do not rise at a rate that is sufficient to fully
absorb inflation-driven increases in our costs of supplies, our profitability
can be adversely affected.




During
the past ten years, the rate of inflation in the PRC has been as high as 20.7%
and as low as 2.2%. These factors have led to the adoption by the Chinese
government, from time to time, of various corrective measures designed to
restrict the availability of credit or regulate growth and contain inflation. In
order to control inflation in the past, the PRC government has imposed controls
on bank credits, limits on loans for fixed assets and restrictions on state bank
lending. The implementation of these and other similar
policies can impede economic growth and thereby harm the market for
our products.




Substantially
all of our assets are located in the PRC and all of our revenues are derived
from our operations in the PRC.  Accordingly, our results of
operations and prospects are subject, to a significant extent, to the economic,
political and legal developments in the PRC.




Substantially
all of our assets are located in the PRC and all of our revenues are derived
from our operations in the PRC.  Accordingly, our results of
operations and prospects are subject, to a significant extent, on the economic,
political and legal developments in the PRC.  The PRC economy differs
from the economies of most developed countries in many respects.




Since
1978, the PRC has been one of the world’s fastest-growing economies in terms of
gross domestic product, or GDP growth. We cannot assure you, however, that such
growth will be sustained in the future. If, in the future, the PRC’s economy
experiences a downturn or grows at a slower rate than expected, there may be
less demand for spending in certain industries.




Our
ability to implement our business plan is based on the assumption that the
Chinese economy will continue to grow. The PRC’s economic growth has been
uneven, both geographically and among various sectors of the economy. The PRC
government has implemented various measures to encourage economic growth and
guide the allocation of resources. Some of these measures benefit the overall
PRC economy, but may also have a negative effect on us.




The PRC
economy has been transitioning from a planned economy to a more market-oriented
economy. Although in recent years the PRC government has implemented measures
emphasizing the use of market forces for economic reform, the reduction of state
ownership of productive assets and the establishment of sound corporate
governance in business enterprises, a substantial portion of productive assets
in the PRC is still owned by the PRC government. In addition, the PRC government
continues to play a significant role in regulating industry development by
imposing industrial policies. It also exercises significant control over PRC
economic growth through the allocation of resources, controlling payment of
foreign currency-denominated obligations, setting monetary policy and providing
preferential treatment to particular industries or companies. We cannot assure
you that changes in the PRC’s economic, political or legal systems will not
detrimentally affect our business, prospects, financial conditions and results
of operations.




We may have difficulty attracting talent
in foreign countries.




Currently, over92% of our sales are inthe PRC.We are in the process of attempting to
establish marketingand sales presence in theU.S.and other countries.We expect to establish an office in theU.S.for investor relations.In the future, we may explore expanding
itsoperations in other countries throughout the world.Upon effecting any such expansion, we
may not be able to identify and retain qualifiedpersonnel due to itslack 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 inChinaor of Chinese productsmore expensive.




The PRC governmentimposes control over the conversion ofRenminbi (“RMB”), the currency ofChina,into foreign currencies.Under the current unifiedfloating exchange rate system, the
People’s Bank of China publishes an exchange
rate, referredto as the PBOC exchange rate,
basedon the previous day’s dealings in the inter-bank foreign
exchange market.Financial institutions
authorizedto deal in foreign currency may enter
into foreign exchange transactions at exchange rates within an authorizedrange above or below the PBOC exchange
rate according to market conditions.




24




Pursuant to the Foreign Exchange Control
Regulations of the PRC issuedby 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 (“FIEs”), for use on current account items,
including the distribution of dividends and profitsto foreign investors, is
permissible.  FIEs are permittedto convert their after-tax dividends
and profitsto foreign exchange and remit such foreign exchange to their
foreign exchange bank accountsin 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
amendedthe 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
paymentsand 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
(“SAFE”)effect payment from their foreign
exchange account or convert and pay at the designatedforeign exchange banks by providing
valid receiptsand 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 itsrelevant 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 requirementsin the future.




Since 1994, the exchangerate for RMB against the U.S.
dollarhas
remainedrelatively stable, most of the time in
the region of approximately
RMB8.00 to U.S.$1.00.However, in 2005, the Chinese government
announcedthat 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 RMB6.84to U.S.$1.00 resulting in the increase in price
of Chinese productstoU.S.purchasers.As our operations are primarily inChina, 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
needto convertUnitedStatesdollars into Chinese RMB for
operations, appreciation ofthis currency against the
U.S.dollar could have a
material adverse effect on our business, financial condition and resultsof operations.Conversely, if we decide toconvert Chinese RMB into
U.S.dollars for other
business purposes and the
U.S.dollar appreciates
against this currency, the
U.S.dollar equivalent of
the Chinese RMB that we convert would be reduced.




Restrictions
on currency exchange may limit our ability to utilize our revenues effectively
and the ability of the PRC entities to obtain financing.




Substantially
all of our revenues and operating expenses are denominated in Renminbi.
Restrictions on currency exchange imposed by the PRC government may limit our
ability to utilize revenues generated in Renminbi to fund our business
activities outside the PRC, if any, or expenditures denominated in foreign
currencies. Under current PRC regulations, Renminbi may be freely converted into
foreign currency for payments relating to “current account transactions,” which
include among other things dividend payments and payments for the import of
goods and services, by complying with certain procedural requirements. The PRC
entities may also retain foreign exchange in their respective current account
bank accounts, subject to a cap set by the State Administration for Foreign
Exchange, or SAFE, or its local counterpart, for use in payment of international
current account transactions. However, conversion of Renminbi into foreign
currencies, and of foreign currencies into Renminbi, for payments relating to
“capital account transactions,” which principally includes investments and
loans, generally requires the approval of SAFE and other relevant PRC
governmental authorities. Restrictions on the convertibility of the Renminbi for
capital account transactions could affect the ability of the PRC entities to
make investments overseas or to obtain foreign exchange through debt or equity
financing, including by means of loans or capital contributions from the parent
entity.




25




Any
existing and future restrictions on currency exchange may affect the ability of
the PRC entities or an affiliated entity to obtain foreign currencies, limit our
ability to utilize revenues generated in Renminbi to fund any business
activities outside the PRC that are denominated in foreign currencies, or
otherwise materially and adversely affect our business.




We are requiredto be in compliance with the
registeredcapital requirementsof the PRC.




Under the
Company Law of the PRC, we are 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 our and our 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.




Dividends
we receive from our subsidiaries located in the PRC may be subject to PRC
withholding tax.




The PRC’s
Enterprise Income Tax Law (“EIT Law”) provides that an income tax rate of 10%
may be applicable to dividends payable to non-PRC investors that are
“non-resident enterprises.” Non-resident enterprises refer to enterprises which
do not have an establishment or place of business in the PRC, or which have such
establishment or place of business in the PRC but the relevant income is not
effectively connected with the establishment or place of business, to the extent
such dividends are derived from sources within the PRC. The income tax for the
non-resident enterprises shall be subject to withholding at income source with
the payer acting as the obligatory withholder under the EIT Law, and therefore,
such income tax is generally called “withholding tax” in practice.  It
is currently unclear in what circumstances a source will be considered as
located within the PRC.  As a U.S. holding company and substantially
all of our income will be derived from dividends we receive from our PRC
operating subsidiaries. Thus, if we are considered as a “non-resident
enterprise” under the EIT Law and the dividends paid to us by our PRC operating
subsidiaries are considered income sourced within the PRC, such dividends may be
subject to a 10% withholding tax.  No dividends were paid to us by our
PRC operating subsidiaries in 2007, 2008 or 2009.




Deterioration
of the PRC’s political relations with the U.S., Europe, or other nations could
make Chinese businesses less attractive to Western investors.




The
relationship between the U.S. and the PRC is subject to sudden fluctuation and
periodic tension. Changes in political conditions in the PRC and changes in the
state of Sino-foreign relations are difficult to predict and could materially
adversely affect our operations or cause potential target businesses or services
to become less attractive. This could lead to a decline in our profitability.
Any weakening of relations between the U.S., Europe, or other nations and the
PRC could have a material adverse effect on our operations or our ability to
raise additional capital.




The
discontinuation of any of the preferential tax treatments currently available to
the PRC entities could materially increase our tax liabilities.




The rate
of income tax on companies in China may vary depending on the availability of
preferential tax treatment or subsidies based on their industry or location. The
current maximum corporate income tax rate is 33%. The new Enterprise Income Tax
Law became effective as of January 1, 2008, pursuant to which, an enterprise
income tax of 25% applies to any enterprise. Although we were approved by the
local tax authority to be exempted from the enterprise income tax for a
five-year period commencing in 2007 and ending in 2012, we do not know whether
such new law will change the preferential treatment that was granted to us. Any
loss or substantial reduction of the tax benefits enjoyed by us would reduce our
net profit.




Because
PRC law governs almost all of our operating subsidiaries’ material agreements,
we may not be able to enforce our rights within the PRC or elsewhere, which
could result in a significant loss of business, business opportunities or
capital.




PRC law
governs almost all of the material agreements of our subsidiaries. We cannot
assure you that we will be able to enforce any of our material agreements or
that remedies will be available outside of the PRC.  The Chinese legal
system is similar to a civil law system based on written statutes. Unlike common
law systems, it is a system in which decided legal cases have little
precedential value.  In 1979, the PRC government began to promulgate a
comprehensive system of laws and regulations governing economic matters in
general.  The overall effect of legislation since then has been to
significantly enhance the protections afforded to various forms of foreign
investment in the PRC.  Certain of our subsidiaries are wholly
foreign-owned enterprises, and are subject to laws and regulations applicable to
foreign investment in the PRC in general and laws and regulations applicable to
wholly foreign-owned enterprises in particular.  Relevant PRC laws,
regulations and legal requirements may change frequently, and their
interpretation and enforcement involve uncertainties.  For example, we
may have to resort to administrative and court proceedings to enforce the legal
protection that we enjoy either by law or contract. However, since PRC
administrative and court authorities have significant discretion in interpreting
and implementing statutory and contractual terms, it may be more difficult to
evaluate the outcome of administrative and court proceedings and the level of
legal protection we enjoy than under more developed legal
systems.  Such uncertainties, including the inability to enforce our
contracts, could materially and adversely affect our business and
operations.  In addition, confidentiality protections in the PRC may
not be as effective as in the U.S. or other countries.  Accordingly,
we cannot predict the effect of future developments in the PRC legal system,
particularly with respect to financing sectors, including the promulgation of
new laws, changes to existing laws or the interpretation or enforcement thereof,
or the preemption of local regulations by national laws.  These
uncertainties could limit the legal protections available to us and other
foreign investors.




26




Our
PRC subsidiaries are obligated to withhold and pay PRC individual income tax on
behalf of our employees who are subject to PRC individual income tax. If we fail
to withhold or pay such individual income tax in accordance with applicable PRC
regulations, we may be subject to certain sanctions and other penalties and may
become subject to liability under PRC laws.




Under PRC
laws, our PRC subsidiaries are obligated to withhold and pay individual income
tax on behalf of our employees who are subject to PRC individual income tax. If
we fail to withhold and/or pay such individual income tax in accordance with PRC
laws, we may be subject to certain sanctions and other penalties and may become
subject to liability under PRC laws.




In
addition, the State Administration of Taxation has issued several circulars
concerning employee stock options. Under these circulars, our employees working
in the PRC (which could include both PRC employees and expatriate employees
subject to PRC individual income tax) who exercise stock options will be subject
to PRC individual income tax. Our PRC subsidiaries have obligations to file
documents related to employee stock options with relevant tax authorities and
withhold and pay individual income taxes for those employees who exercise their
stock options. While tax authorities may advise us that our policy is compliant,
they may change their policy, and we could be subject to sanctions.




Failure
to comply with the U.S. Foreign Corrupt Practices Act could subject us to
penalties and other adverse consequences.




We are
required to comply with the U.S. Foreign Corrupt Practices Act, which generally
prohibits U.S. companies from engaging in bribery or other prohibited payments
to foreign officials for the purpose of obtaining or retaining business. Foreign
companies, including some that may compete with us, are not subject to these
prohibitions, and therefore may have a competitive advantage over us.
Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices
may occur in the PRC.  If our competitors engage in these practices
they may receive preferential treatment, giving our competitors an advantage in
securing business, which would put us at a disadvantage. We can make no
assurance that our employees or other agents will not engage in such conduct for
which we might be held responsible. If our employees or other agents are found
to have engaged in such practices, we could suffer severe penalties and other
consequences that may have a material adverse effect on our business, financial
condition and results of operations.




We
face risks related to health epidemics and outbreak of contagious
disease.




Our
business could be materially and adversely affected by the effects of H1N1 Flu,
Avian Flu, Severe Acute Respiratory Syndrome (“SARS”) or other epidemics or
outbreaks.  In April 2009, an outbreak of H1N1 Flu first occurred in
Mexico and quickly spread to other countries, including the U.S. and the
PRC.  In the last decade, the PRC has suffered health epidemics
related to the outbreak of Avian Flu and SARS.  Any prolonged
occurrence or recurrence of H1N1 Flu , Avian Flu, SARS or other adverse public
health developments in the PRC may have a material adverse effect on our
business and operations.  These health epidemics could result in
severe travel restrictions and closures that would restrict our ability to ship
our products.  Potential outbreaks could also lead to temporary
closure of our manufacturing facilities, our suppliers’ facilities and/or our
end-user customers’ facilities, leading to reduced production, delayed or
cancelled orders, and decrease in demand for our products. Any future health
epidemic or outbreaks that could disrupt our operations and/or restrict our
shipping abilities may have a material adverse effect on our business and
results of operations.




27




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 resultscould cause our stock price to decline.Moreover, factors that are not
relatedto our operating performance could
cause our stock price to decline.The stock market has recently
experiencedsignificant price and volume
fluctuations that have affectedthe market prices for securities of
technology and communications companies.Consequently, you may experience a
decrease in themarket
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 needregulatory approval to do
so.




We have not declaredany 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 resultsof 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
futuredividends 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" preferredstock, 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 preferredstock 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 authorizedto fix the dividend rightsand terms, conversion rights, voting rights, redemption rights, liquidation preferences and other
rightsand restrictions relating to any series
of our preferredstock. Issuances of shares of
preferredstock 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 issuedcould have rights, preferences and designations superior to our common
stock.




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 warrantsthat are exercisable at prices that are
below current market prices
which will be dilutive to the common stock.




AsofMarch15,2010, we had 16,790,851shares 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, as of March15,2010, we hadissuedand outstanding warrantsto purchase an aggregate of593,800shares of our common stock, which are
exercisableat a price of
$12.50 per share.Our issuance of additional shares of
common stock upon exercise of our outstanding warrantswill 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 receivedupon such exercise, could cause a sharp
decline in the market price
of our common stock.




FORWARD-LOOKING
STATEMENTS




Some of the statementscontainedin this reportare not statementsof historical or current fact.As such, they are "forward-looking
statements" basedon our current expectations, which are subject to known and
unknown risks, uncertainties and assumptions.Theyinclude statementsrelating to:




·
            future sales and
      financings;




28




·
            the future development of our
      business;




·
            our ability toexecute our business
      strategy;




·
            projectedexpenditures;
      and




·
            the market for our
      products.




You can identify forward-looking
statementsby 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 statementsare not predictions.  Actual
eventsor resultsmay differ materially from those
suggestedby these forward-looking
statements.In evaluating these
statementsand our prospectsgenerally, you should carefully
consider the factors set forth below.  All forward-looking
statementsattributable to us or persons acting on
our behalf are expressly qualifiedin their entirety by these cautionary factors and to others
containedthroughout this
prospectus.  We are under no duty to update any of the forward-looking
statementsafter the date of this prospectus or to
conform these statementsto actual results.




Although it is not possible to create a comprehensive
list of all factors that may cause actual resultsto differ from the resultsexpressedor impliedby our forward-looking
statementsor that may affect our future
results, some of these factors are set forth under "Risk Factors" in
this
report.




29




Item.
1B.  UnresolvedStaff Comments.




None.




Item
2.  Properties.




Under Chinese law, the government owns
all of the land in the PRC and companies and individuals are
authorizedto use the land only through land use rightsgrantedby the PRC government.




Ourmanufacturingfacilities are locatedin the citiesofHarbinand Peng Laiin thePRC.Thesefacilities are operatedin accordance withGMP.We own thesefacilitiesand are not subject to costsassociatedunder rental or lease
obligations.




In
January 2010, we completed the construction of two office buildings and TDR and
Haina moved into these new facilities, located in Song Bei District of Harbin
City, Heilongjiang Province, PRC.  It is anticipated that residual
work, including road construction,  fire control equipment, amenity
improvement, and final acceptance, will be completed on these facilities in the
third quarter of 2010, at an additional cost of approximately $3.0 million. We
own these facilities and are not subject to costs associated under rental or
lease obligations.





A breakdown of our facilities by
subsidiary is as follows:




Subsidiaries
      Facilities as of March 15, 2010, in Square MetersTDR
                      First
                      Tianlong
                      Peng
      LaiLand
      Area
                      35,000
                      40,000
                      15,000
                      40,000Expiration
      Year
                      2058
                      2054
                      2051
                      2056Production,
      Warehouse, and Office
                      14,000
                      10,000
                      9,000
                      12,000






At this time, oursubsidiaries Haina andTian Qing use an insignificant portion
of our facilities.




Item 3.  Legal
Proceedings.




We are not a party to any
material pending legal
proceedings.




Item 4.Reserved.




30




PART II




Item 5.  Market for Common
Equity, RelatedStockholder 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.”  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.”  Effective as of January 4, 2010, we
qualifiedto be listedon Nasdaq Global Select
Market.The high
and lowsalesprices for our common stock inthe fiscal yearsof 2009and 2008areas follows:




Year EndedDecember 31, 2009
                
                
                Year EndedDecember 31, 2008High
                
                
                Low
                
                
                High
                
                
                Low1st Quarter
                
                $
                19.11
                
                
                $
                10.03
                
                
                $
                14.00
                
                
                $
                9.402nd Quarter
                
                $
                17.80
                
                
                $
                10.21
                
                
                $
                17.10
                
                
                $
                9.503rd Quarter
                
                $
                16.80
                
                
                $
                12.00
                
                
                $
                14.99
                
                
                $
                9.004th Quarter
                
                $
                25.45
                
                
                $
                11.02
                
                
                $
                16.28
                
                
                $
                6.29






OnMarch15, 2010,the closingprice for our common stock was
$17.24.




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 expectedthat any dividends on the common stock
will be declaredand 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




AtMarch15, 2010, there were 381holders of record of our common stock,
with 16,790,851shares issuedand outstanding.Such number of record owners was
determinedfrom our shareholder records and
doesnot includebeneficial owners whose shares are held in
nominee accountswith brokers, dealers, banks and
clearing agencies.




Securities AuthorizedFor Issuance Under Equity Compensation
Plan




As of
December 31, 2009, we had only one stock option, bonus, profit sharing, pension
or similar plan in place, which is our 2006 Stock Incentive Plan (the
“Plan”).  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.  The
following table provides information as of December 31, 2009 with respect to the
shares of our common stock that may be issuable under our existing equity
compensation plans:




31




Equity Compensation Plan
Information




(a)
                
                
                (b)
                
                
                (c)Plan
      Category
                
                Number
      of securities
                  to
      be issued upon
                  exercise
      of
                  outstanding
      options,
                  warrants
      and rights
                
                
                Weighted-
                  average
      exercise
                  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)
                
                
                0
                
                
                $
                -
                
                
                
                1,273,593
                (3)Equity
      compensation plans not approved by security holders (2)
                
                
                0
                
                
                
                N/A
                
                
                
                0Total
                
                
                0
                
                
                $
                -
                
                
                
                1,273,593





(1)
            Our
      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.  We have
      issued the following securities under the
Plan:




(a)  In
October 2006, we granted stock options to purchase an aggregate of 113,500
shares of common stock to a total of 36 participants under the
Plan.  In May 2009, an aggregate of 101,000 of these stock options
were exercised on a “cashless” basis by 36 participants, resulting in our
issuance of an aggregate of 75,888 shares.  In August 2009, the
remaining 12,500 of these stock options were exercised  on a
“cashless” basis by 9 participants, resulting in our issuance of an aggregate of
9,407 shares.




(b)  In
April 2007, we issued an aggregate of 30,000 shares of restricted stock to a
total of 200 individuals under the Plan.




(c)  In
July 2008, we issued an aggregate of 30,063 shares of restricted stock to a
total of 27 individuals under the Plan.




(d)  In
December 2009, we issued an aggregate of 52,844 shares of restricted stock to a
total of 11 individuals under the Plan.




Recent
Sales of Unregistered Securities




The following is a list of certain
securities we sold or issuedduring fiscal 2008.There were no underwriting
discountsor commissions paid in connection with
the sale of these securities, except as otherwise noted.Certain information previously includedin prior Exchange Act reportswe filedhas not been furnishedin this report.





As of December 26, 2009, we
issued52,844 “restricted”shares of our common stock to certain
employees,executive
officers and directors of ours as consideration for services pursuant to our
2006 Stock Incentive Plan.





We
believe the issuance of these shares was exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2) and/or Regulation D
promulgated thereunder, as a transaction by an issuer not involving a public
offering.




32




Item
6.  Selected Financial Data.




Key financial data from the fiscal
yearsendedDecember 2005 to 2009 is set
forthin the following
table.




For
      the Years Ended December 31,
                        ($
      in thousands, except per share data)2009
                      2008
                      2007
                      2006
                        (as restated)
                      2005Operating
      Data:Revenues
                      $130,092
                      $91,816
                      $49,318
                      $19,882
                      $7,712Cost
      of Goods Sold
                      31,671
                      22,403
                      10,940
                      5,063
                      2,214Gross
      Profit
                      98,421
                      69,413
                      38,379
                      14,819
                      5,498Selling
      expense
                      30,763
                      22,968
                      14,784
                      9,894
                      2,540General
      and administrative expense
                      4,191
                      2,514
                      1,380
                      844
                      735Research
      and development
                      14,960
                      7,413
                      3,158
                      2,027
                      64Income
      from Operations
                      46,251
                      35,659
                      18,614
                      1,932
                      2,462Other
      Income (Expense)
                      (1,291)
                      814
                      38
                      (228)
                      (18)Provision
      for income taxes
                      10,503
                      7,616
                      3,319
                      1,080
                      356Net
      Income
                      $34,457
                      $28,857
                      $15,333
                      $624
                      $2,089Basic
      Earnings Per Share
                      $2.08
                      $1.91
                      $1.27
                      $0.05
                      $0.19Diluted
      Earnings Per Share
                      $2.07
                      $1.87
                      $1.15
                      $0.05
                      $0.19Balance
      Sheet Data:Total
      Assets
                      $140,363
                      $101,259
                      $37,285
                      $16,681
                      $8,992Total
      current liabilities
                      9,389
                      6,326
                      5,040
                      2,370
                      1,641Working
      Capital
                      67,000
                      49,509
                      15,447
                      7,798
                      2,858Stockholder's
      Equity
                      $130,974
                      $94,933
                      $32,245
                      $14,311
                      7,351Other
      Data:Net
      cash provided by operating activities
                      $33,449
                      $27,538
                      $11,601
                      $5,183
                      1,090Net
      Cash used in investing activities
                      ($21,154)
                      ($23,115)
                      ($10,261)
                      ($4,597)
                      (776)Net
      Cash provided by (used in) financing activities
                      $29
                      $25,355
                      ($33)
                      ($2,931)
                      591





33




Item
7.  Management’s Discussion and Analysis of Financial
Condition and Resultsof 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
resultsof operations. The following discussion
should be read in conjunction with our consolidatedfinancial statementsand relatednotes includedin Part II, Item 8 of this
Report.




FORWARD LOOKING
STATEMENTS




The following discussion should be read
in conjunction with the information containedin our consolidatedfinancial statementsand 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
affordedthe safe harbor provisions of Section27Aof the Securities Act and Section 21E
of the Securities Exchange Act of 1934, as amended. Readers should carefully review the
risk factors
disclosedin this Annual Report and other
documentsfiledby us with the SEC.




DISCUSSION




We are engaged, through our China-basedindirect subsidiaries
describedbelow,in the development, manufacture,
marketing and sale of over-the-counter, brandednutritional supplementsand over-the-counter plant and
herb-basedpharmaceutical and medicinal products.  Our principal
productsare external useTCMs.  We have
evolvedinto an integratedmanufacturer, marketer and distributor
of external-use TCM productssold primarily in the PRC and through
Chinese domestic pharmaceutical chains.  Recently, we have been
expanding our worldwidesales effort as well.  Prior to2009, we sold both our own
manufacturedproducts, as well as medicinal and pharmaceutical
productsmanufacturedby otherson a contract basis,
categorizedby us as Contract Sales.Commencing in 2009, we
discontinuedallof ourContract Sales aspart of our revisedstrategic plan.




In 2009, we achievedcontinuedgrowth on the sale of our ownproduct line through our
sustainedeffortsto expand our distribution channels and
promote our products.For the year endedDecember 31, 2009, total
revenues were$130,092,000, comparedto $91,816,000 and $49,318,000 fortheyearsendedDecember 31,2008 and 2007, respectively.Net income was $34,457,000, or $2.07 per
share,in 2009, comparedto net income of $28,857,000,or $1.87 per
share,in the2008, and net income of$15,333,000, or $1.15 per share,in2007, as calculatedon a dilutedbasisfor all periods presented.




All of our business is
conductedthrough our wholly-ownedsubsidiary, ACPG which, in turn, wholly owns Harbin
TDR, and TDR’s subsidiaries.




Recent
Developments




On April 3, 2008, TDR
completeditsacquisition of Tianlong,a company that hada variety of medicinesapprovedby theSFDAand new medicine applications, and which
wasin the business of manufacturing
external-use pharmaceuticals.  TDR previously acquiredtheBeijingsales office of Tianlong in
mid-2006.  In connection with this transaction, TDR acquired100% of the issuedand outstanding capital stock of Tianlong from
itssole stockholder, in consideration for
an aggregate purchase price of approximately $8,300,000, consisting of
$8,000,000 incash, and 23,850 shares of our common stock
(valuedat $12.00 per
share).




On April 18, 2008, TDR
consummateditsacquisition of Haina,
licensedas a wholesaler of TCM,
bio-products, medicinal devices, antibiotics and chemical
medicines.  Haina did not have an
establishedsales network and was
acquiredfor itsprimary asset, a GSP license
issuedby theHeilongjiangProvinceoffice of the SFDA.  The SFDA
only issues such licenses
to pharmaceutical resellers that maintain certain quality control
standards.  The GSP license was issuedas of December 21, 2006 and will expire
on January 29, 2012.  This GSP licensehas enabledus to expand our sales of medicinal productswithout having to go through a lengthy
license application process.  In connection with this transaction, TDR
acquired100% of the issuedand outstanding capital stock of Haina from
itsthree stockholders in consideration for payment of
approximately $437,000.




On
September 5, 2008, TDR acquired Peng Lai, from Peng Lai Jin Chuang Group
Corporation.  Peng Lai, which has received Good Manufacturing Practice
(“GMP”) certification from the SFDA, was organized to develop, manufacture and
distribute pharmaceutical, medicinal and diagnostic products in the
PRC.  In connection with this transaction, TDR acquired all of Peng
Lai’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 $7,000,000 million, consisting of
approximately $2,500,000 million in cash, and 381,606 shares of our common stock
(valued at $12.00 per share).




34




Trends
and Uncertainties




In 2008, general worldwide economic
conditions declineddue to sequential effectsof the sub prime lending crisis,
general credit market crisis, collateral
effectson the finance and banking industries,
concerns about inflation, slower economic activity, decreasedconsumer confidence, reducedcorporate profitsand capital spending, adverse business
conditions and liquidity concerns.However, since all of our business
operations, and most of our sales, are currently conductedin the PRC, we have not been greatly
affectedbythe economic
downtown.





We havebenefitedfrom the overall economic development
in the PRC in recent years and the increase in the number of elderly people inChina, which together have resultedin increasedexpenditures on medicine in the PRC, including
TCMs.





In fiscal 2007, our sales model was
focusedon the creation of our own distribution
channels.Therefore, we sold productsdirectly to many smaller distributors
and retail store locations.In fiscal 2008, we changedour business model and
enteredinto distribution agreementswith larger regional sales
agents, who resell to smaller distributors and
retail store locations.In addition, we enteredinto contractswith nationwide chain
pharmacies, such as
Nepstar, Tong Ren Tang, Jin Xiang, and Ren Min Tong Tai.Through the extensive sales networks of
these nationwide chains, we are able to reach all major metropolitan areas
throughout the PRC.These changes to our product
distribution channels resultedin our direct customer basedecreasing from 943 customers at December 31, 2007 to 212 customers at
December 31, 2009.





Our change of sales strategy in fiscal
2008 was initiatedto improve product channel
efficiencies, and to give us accessto an increasednumber of ultimate purchasers.We believe that these changes will lead
to further increasedrevenue by extending the reach of
itsdistribution network.We also believe that, by reducing the number of customers we sell to
directly, we will be able
to streamline our accountsreceivable management and collection,
and reduce channel distribution costs.These favorable cost variances are
expectedto be partially offset by product price
incentives we grant to the larger agentswith which we have contracted.





In fiscal
2007, 26.4% of our total revenues, or $12,998,000, was attributable to sales of
other manufacturers’ products through Contract Sales.  One of the main
manufacturers for which we resold products was Tianlong.  On April 3,
2008, we acquired Tianlong and were able to fully integrated Tianlong’s
products, which we had been previously selling on a contract basis, into our
marketing and distribution channels.  Following the acquisition of
Tianlong we continued to phase out our Contract Sales and, as of the end of
fiscal 2008, we no longer sell other company’s products on a contract
basis.





Historically,
we signed agreements with suppliers that allowed us to hold extra raw materials
at the cost of the suppliers.  As a result, we were able to minimize
our own inventory carrying costs, and improve our cash management, by keeping
the inventory at the minimum level required to support the short-term
sales.  However, due to the forecasts for certain cost increases of
raw materials in fiscal 2010, we began to increase our inventory levels toward
the second half of 2009.




35




ResultsofOperations




For
the years ended December 31, 2009, 2008 and 2007




Revenue,Cost of Goods Sold Gross
Profit and Gross Profit Margin




The following table setsforthour revenues, cost of goods sold,gross profit and gross profit marginduring the fiscal
yearsendedDecember 31, 2009, 2008, and
2007:




For the Years Ended December
      31,
                                                    ($ in
      thousands)2009
                                                  Variance
                                                  2008
                                                  Variance
                                                  2007RevenuesProduct Sales (net of sales
      allowance)
                                                  $130,092
                                                  51%
                                                  $86,161
                                                  137%
                                                  $36,320Contract
    Sales
                                                  0
                                                  -
                                                  5,655
                                                  (57%)
                                                  12,998TotalRevenues
                                                  $130,092
                                                  42%
                                                  $91,816
                                                  86%
                                                  $49,318Cost of Goods
      SoldCost of goods
      sold
                                                  31,671
                                                  41%
                                                  22,403
                                                  105%
                                                  10,940Gross
Profit
                                                  $98,422
                                                  42%
                                                  $69,413
                                                  81%
                                                  $38,378Gross Profit
      Margin
                                                  75.7%
                                                  
                                                  75.6%
                                                  
                                                  77.8%







Year over year–2009 to 2008




Total
revenues increased by approximately $38,276,000, or 42%, from approximately
$91,816,000 in the fiscal year ended December 31, 2008, to approximately
$130,092,000 for the fiscal year ended December 31, 2008.  The increase inourrevenuesisprimarilyattributable toincrease in our product sales
relatedto:




·
            strong performances from
      our sales
      distribution channels, obtainedbyourhiringofadditional direct territory
      managersand sales
      agents;




·
            our effortsto locateandcooperate with more
      reputabledistributors for certain of our products;




·
            the increase inmarketing and
      advertisingexpendituresof approximately $7,228,000, or
      99%, from approximately $7,299,000 in fiscal 2008 to approximately
      $14,527,000 in fiscal 2009;
  and




·
            the full-year effect of sales of
      productsof Tianlong, which generatedapproximately$43,138,000 andapproximately$13,803,000 in 2009 and 2008,
      respectively, and Peng Lai,which generated approximately$11,188,000 andapproximately$2,164,000 in 2009
      and 2008, respectively, two of the businesses we acquired in fiscal
      2008.




The increase in our product sales
were partially offset by
our discontinuance of all Contract Sales in fiscal 2009, which we began to phase out in fiscal
2008.




Cost of goods sold increasedby approximately $9,268,000, or 41%,
toapproximately$31,671,000 in fiscal 2009 compared to
the prior year.This increase
was directly related to an increase in sales.




Gross profit increased by
42%,fromapproximately$69,413,000 in2008 toapproximately$98,422,000 in2009.  Our gross margin remained constant at approximately
76%.




36




Year over year–2008 to 2007




Total revenues increased by
approximately $42,498,000, or 86%, from approximately $49,318,000 in the fiscal
year ended December 31, 2007, to approximately $91,816,000 for the fiscal year
ended December 31, 2008.  Theincrease in revenue is
primarily attributable to strong performances from our sales distribution
channels, and our sales of
productsof Tianlong and Peng Lai, which we
acquired in fiscal 2008.




Product
sales increased by 137% in the year ended December 31, 2008, to approximately
$86,161,000 from approximately $36,320,000 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, and our sales of productsof Tianlong and Peng Lai, which we
acquired in fiscal 2008.




Contract
sales of non-manufactured products amounted to approximately $5,655,000 in the
year ended December 31, 2008, or a significant decrease of approximately
$7,343,000 from sales of approximately $12,998,000 in 2007.




In 2007,
our sales model was focused on the creation of our own distribution
channels.  Therefore, we sold products directly to many smaller
distributors and retail store locations.  In 2008, we changed our
business model and entered into distribution agreements with larger regional
sales agents, which resell to smaller distributors and retail store
locations.  In addition, we began entering into contracts with
nationwide chain pharmacies.  In 2008, TDR began to discontinue
contract sales as part of its strategic goals.




Our
change of sales strategy in fiscal 2008 was initiated to improve product channel
efficiencies, and to give us access to an increased number of ultimate
purchasers.  We believe that these changes will lead to further
increased revenue by extending the reach of our distribution
network.  We also believe that, by reducing the number of customers we
sell to directly, we will be able to streamline our accounts receivable
management and collection, and reduce channel distribution
costs.  These favorable cost variances are expected be partially
offset by product price incentives we grant to the larger agents with which we
have contracted.




Cost of
goods sold increased by approximately $11,464,000, or 105%, from approximately
$10,940,000 in the year ended December 31, 2007, to approximately $22,403,000
for the year ended December 31, 2008, as a direct result of increased sales
activities, partially offset by a higher gross margin on our sales of Tianlong
products following the acquisition in April 2008. Overall, our product gross
margins decreased slightly to 76% for the year ended December 31, 2008 from 78%
for the year ended December 31, 2007. From January 1, 2008 thought April 2,
2008, revenues from Tianlong contract sales were approximately $1,477,000, and
gross profit from these sales were approximately $1,173,000. The gross margin
from these sales were approximately 79.4%, After our acquisition of Tianlong,
revenues from sales of Tianlong products were approximately $13,803,000, and
gross profit from these sales were approximately $12,298,000. The gross margin
from these sales was approximately 89.1%. This increase in gross margin from
sales of Tianlong’s products following the acquisition was offset by the
decrease in gross margins related to sales of certain TDR’s products due to our
reduction in the sales prices of certain of our products to be competitive in
the PRC market.




37


Sales
by Product Line




We believe that themost meaningful presentation of our
productsis by categories of method of
delivery. The following
table setsforth our principal product categories
based on application type,and the approximate amount and
percentage of revenue from each of such productcategories, duringeach ofthe fiscal yearsended December 31, 2009, 2008, and
2007:




For the Years Ended December
      31,
                                                                        ($ in
      thousands)2009
                                                                      2008
                                                                      2007ProductCategory
                                                                      Sales
                                                                      % ofSales
                                                                      Sales
                                                                      % of Sales
                                                                      Sales
                                                                      % ofSalesPatches
                                                                      $40,770
                                                                      31.3%
                                                                      $35,484
                                                                      38.6%
                                                                      $19,609
                                                                      39.9%Ointments
                                                                      28,862
                                                                      22.2%
                                                                      23,068
                                                                      25.1%
                                                                      3,270
                                                                      12.6%Sprays
                                                                      $18,499
                                                                      14.2%
                                                                      10,613
                                                                      11.6%
                                                                      8,742
                                                                      18.7%Diagnostic Kits
                                                                      10,239
                                                                      7.9%
                                                                      8,781
                                                                      9.6%
                                                                      2,994
                                                                      6.1%Contract
    Sales
                                                                      $0
                                                                      0.0%
                                                                      5,655
                                                                      6.2%
                                                                      12,998
                                                                      16.6%Others
                                                                      31,722
                                                                      24.4%
                                                                      8,215
                                                                      8.9%
                                                                      1,705
                                                                      6.2%Total
                                                                      $130,092
                                                                      100.0%
                                                                      $91,816
                                                                      100.0%
                                                                      $49,318
                                                                      100.0%





Year over year–2009 to 2008




During the fiscal year endedDecember 31, 2008, we
acquiredTianlong  (April 2008), Haina
(April 2008) and Peng Lai (September 2008).Our revenues
increased in 2009 compared to 2008, primarily due to our cooperation with more reputable
sales agentsand distributors, which have been able
to put our productsin more extensive sales
networks,and the full-year effect of sales of
productsof Tianlong and Peng Lai, two of the
businesses we acquired in fiscal 2008.  As a result ofsigning agreementswith these distributors, the sales
revenues for
productsin thepatches, sprays, and diagnostic
kitscategoriesincreased14.9%, 74.3%, and 16.6% year over year.The revenue increase ofapproximately$5,794,000 inthe ointment category,and the revenue  increase ofapproximately$23,507,000 inother productscategory,are primarily due to our increased
spending in marketing and
advertisingfor certainproductsin these categories.Tianlong’s productsgenerated approximately $43,138,000and $13,803,000in 2009 and 2008,
respectively.  Revenue generated by Tianlong’s productsare included in the ointment, spray and
other product categories.Peng Lai’s productsgenerated approximately $11,188,000and $2,164,000in 2009 and 2008,
respectively.Revenue generated by Peng Lai’s productsare includedin the other product category. 
These
increases were partially offset by a decrease in our contract sales of
approximately $5,655,000, due to our discontinuance of all contract sales as of
January 1, 2009.




Out of the 91productswe commercializedin fiscal year 2009, 10productsaccountedfor approximately 68% of the total
revenue.Out of the 97 productswe commercializedin fiscal year 2008, 10
productsaccountedfor approximately 72% of total revenue.




Year over year–2008 to 2007




Ourincrease inrevenuesin 2008ascompared to 2007 was due to a combination of our sale of
productsof Tianlong and Peng Lai, two of the
businesses we acquired in fiscal 2008,as well as our internal growthdriven by increases in the revenues of
TDR and First.




Our
internal growth was driven by increases in the revenues of TDR, which increased
from $33,326,000 in 2007 to $60,078,000 in 2008 and First, which increased from
approximately $2,994,000 in 2007 to approximately $8,781,000 in
2008.  These increases were partially offset by a decrease in our
contract sales of approximately $7,358,000, or 57% from approximately
$12,998,000 in fiscal 2007 to approximately $5,640,000 in fiscal 2008, due
primarily to our discontinuance of contract sales of Tianlong products following
the acquisition of Tianlong as of April 3, 2008.




38




In 2008,
before TDR acquired Tianlong, the majority of our contracts sales consisted of
products purchased from Tianlong. In 2008, TDR began to discontinue contract
sales, and in 2009, TDR discontinued contract sales as part of its strategic
goals and, in 2009 TDR discontinued contact sales. Revenues derived from the
sale of a Tianlong product of approximately $4,805,000 and approximately
$1,477,000 for 2007 and 2008 respectively, have been reallocated to each of the
appropriate product categories to present a more appropriate measure of our
revenues by product line.




Following
the Tianlong acquisition, we were able to fully integrate Tianlong’s products
into our marketing and distribution channels and increase overall
sales.  As a result, we derived an aggregate of approximately
$13,803,000 from the sale of Tianlong’s products for the remainder of 2008, in
addition to approximately $1,447,000 of contract sales of Tianlong’s products
from January 1, 2008 through the Tianlong acquisition.




Prior to
our acquisition of Peng Lai, as of September 5, 2008, Peng Lai had nominal
production and operations.  Following the acquisition, Peng Lai
contributed revenue of approximately $2,164,000 to our total revenue in
2008.




Haina did not have an establishedsales network and was
acquiredonly for itsGSP license.




Operating Expenses




The following table summarizes the changes in our operating
expensesfor theyearsendedDecember 31, 2009, 2008and 2007:




For the Yearsended December
      31,
                                          ($in
      thousands)2009
                                        Variance
                                        2008
                                        Variance
                                        2007Operating
      ExpensesSellingexpense
                                        $30,763
                                        34%
                                        $22,969
                                        55%
                                        $14,784General andadministrativeexpense
                                        4,191
                                        67%
                                        2,514
                                        82%
                                        1,380Depreciation and
      amortization
                                        2,255
                                        163%
                                        858
                                        94%
                                        443Research and
      development
                                        14,960
                                        102%
                                        7,413
                                        135%
                                        3,158Total operating
      expenses
                                        $52,170
                                        55%
                                        $33,754
                                        71%
                                        $19,765Percentage of operating expenses
      to revenue
                                        40.1%
                                        
                                        36.8%
                                        
                                        40.1%




Year over year–2009 to 2008




Total
operating expenses increased by approximately $18,416,000, or 55%, from
approximately $33,754,000 in the fiscal year ended December 31, 2008, to
approximately $52,170,000 for the fiscal year ended December 31,
2009.




Selling expenses increasedbyapproximately$7,794,000 in2009 comparedwith2008.This increase wasprimarilyrelated toincreased costsofadvertisingfromapproximately$7,299,000 in2008 toapproximately$14,527,000 in2009, resulting from our increased marketing
and sales efforts.




General and administrative expensesfor the year
endedDecember 31, 2009 increasedapproximately $1,677,000,or 67%,comparedwith2008.This increase wasprimarily due toan expense forshare based compensation,ofapproximately$1,242,000,for shares we issued in December
2009.




Depreciation and amortization expensesin 2009increasedbyapproximately $1,397,000,or 163%, comparedwith 2008.  This increase
was primarily due
to:




·
            the amortization of certain
      proprietary technologies we acquired in the fourth quarter
      of fiscal 2008,in
      the amount of approximately $6.6 million,which are amortizedover a period of 10 years;
      and




·
            the full year effect of
      depreciation and amortization oftangible and intangibleassetswe acquired in the business
      acquisitions we consummated in fiscal 2008, in the amount of approximately
      $15.7 million.




39




Research
and development expenses were approximately $14,960,000 in the year ended
December 31, 2009, compared to approximately $7,413,000 for 2008.  The
increased R&D expenses in 2009 were primarily due to our research and
development of certain proprietary technologies.  Set forth below is a
table of our major research and development projects, respective stage of
development and applicable expenses for 2009:




Major Research and
      Development Expenses
      in Fiscal 2009
                    ($ in thousands)Projects
                  Stage
                  Expenses
                  % of total
      R&DDiagnostic Kits- 6 products
                  Clinical
    trial
                  $2,727
                  18.2Injections - 6 projects
                  Clinical
    trial
                  1,944
                  13Breast Cancer
      Technology
                  Efficacy testing, Acute and Long Term
      Toxicity testing
                  2,272
                  15.2Patches - 4 products
                  Extraction optimization
      testing
                  1,820
                  12.2Monoclonal
      Antibody
                  Completed
                  965
                  6.5Endostatin
                  Efficacy testing, Acute and Long Term
      Toxicity testing
                  439
                  2.9Antroquinonol
                  Clinical
    trial
                  387
                  2.6Radix Isatidis granule and
      syrup
                  Production process
      optimization
                  282
                  1.9Naftopidil Dispersible
      tablets
                  Production process
      optimization
                  256
                  1.7Sertraline Hydrochloride
      capsules
                  Production process
      optimization
                  $249
                  1.7Total
                  
                  $11,341
                  75.8






Year over year–2008to 2007




Total
operating expenses increased by approximately $13,989,000, or 71%, from
approximately $19,765,000 in the fiscal year ended
December 31, 2007, to approximately $33,754,000 for the fiscal year ended
December 31, 2008.




Selling expenses increasedbyapproximately$8,185,000 in2008compared with2007.The higher selling expensesareprimarilyrelatedto




·
            increased costsofadvertising,fromapproximately$4,385,000 in2007,toapproximately$7,299,000 in2008;
  and




·
            increasedsales commissions resulting from
      ourincreasedrevenues.




General and administrative expensesfor the year
endedDecember 31, 2008increasedapproximately $1,134,000,or82%, over the2007.The higher general and administrative
expensesare primarily due to theincreasesin salaries and other administrative
expenses resultingfrom the business acquisitions we made infiscal2008.In 2008, we recorded share-based
compensation expense of $316,000, as compared to $235,000 in
2007





Depreciation and
amortizationin
2008increasedbyapproximately $415,000 compared2008. The higher depreciation and amortizationexpenses areprimarily due to theincreasedtangible and intangible
assetswe acquiredthroughthebusiness acquisitionswe consummatedin2008.




We
conduct our research and development activities both internally and through
collaborative arrangements with universities and research
institutions.  Our research and development expenses were
approximately $7,413,000 in the year ended December 31, 2008, compared to
approximately $3,158,000 in the year ended December 31, 2007.The increasedR&D expenses in 2008were primarily due toour taking over of the ongoing research
anddevelopmentprojectsin Tianlong and Peng Lai because of
these two acquisitions.




40




Historically,
our internal research and development activities have been conducted at our
research, development and laboratory facilities located at the principal
business offices of its wholly-owned subsidiary, TDR.  In 2007, our
research and development projects consisted of a total of eight diagnostic kits.
These bio-engineering projects were conducted by TDR’s wholly-owned subsidiary,
First.  In 2008, we spent an immaterial amount on research and
development for these eight products, of which:




·
            we
      received approval by the SFDA of our Ovulation Diagnostic
    Kit;




·
            our
      Prostate Cancer Diagnostic Kit and Urine Micro-Albumin Colloid Gold
      Diagnostic Kit were submitted to the SFDA for approval;
  and




·
            the
      remaining five products were undergoing long-term stability testing while
      we provided supplemental documentation to the SFDA for these
      projects.




As
previously discussed, in fiscal 2008 we acquired Tianlong and Peng
Lai.  As a result, we had 47 projects in development in fiscal
2008.  Set forth below is a table of our research and development
expenses for 2008, classified by product category and stage of
development:





Stage
      of Development by Number of Projects and U.S. Dollar Amount
                                                ($
      in thousands)Category
                                              
                                              Application
                                                and
      Efficacy
                                              Acute
      and Long Term Toxicity
                                              Long
      Term Stability
                                              Pending
      SFDA Approval
                                              Supplemental
      Documentation
                                              SFDA
                                                Approval
                                              TOTALBio-Engineering(a)
                                              #
                                              1
      (b)
                                              1
      (c)
                                              13
                                              2
                                              -
                                              1
                                              18$
                                              $948
                                              $1,192
                                              $2,261
                                              -
                                              -
                                              -
                                              $4,401Eye
      Drops
                                              #
                                              -
                                              -
                                              -
                                              -
                                              -
                                              2
                                              2$
                                              -
                                              -
                                              -
                                              -
                                              -
                                              $103
                                              $103Nasal
      Drops
                                              #
                                              -
                                              -
                                              -
                                              -
                                              -
                                              1
                                              1$
                                              -
                                              -
                                              -
                                              -
                                              -
                                              $61
                                              $61Injections
                                              #
                                              -
                                              -
                                              -
                                              1
                                              -
                                              4
                                              5$
                                              -
                                              -
                                              -
                                              $104
                                              -
                                              $510
                                              $614Spray
                                              #
                                              -
                                              -
                                              -
                                              1
                                              -
                                              -
                                              1$
                                              -
                                              -
                                              -
                                              $139
                                              -
                                              -
                                              $139Ointment
                                              #
                                              -
                                              -
                                              -
                                              1
                                              1
                                              1
                                              3$
                                              -
                                              -
                                              -
                                              $112
                                              $90
                                              $115
                                              $317Suppository
                                              #
                                              -
                                              -
                                              -
                                              3
                                              4
                                              2
                                              9$
                                              -
                                              -
                                              -
                                              $273
                                              $352
                                              $217
                                              $841Gel
                                              #
                                              -
                                              -
                                              -
                                              -
                                              2
                                              2
                                              4$
                                              -
                                              -
                                              -
                                              -
                                              $293
                                              $136
                                              $429Liquid
                                              #
                                              -
                                              -
                                              -
                                              2
                                              2
                                              -
                                              4$
                                              -
                                              -
                                              -
                                              $209
                                              $210
                                              -
                                              $419TOTAL
                                              #
                                              1
                                              1
                                              13
                                              10
                                              9
                                              13
                                              47
(d)$
                                              $948
                                              $1,192
                                              $2,261
                                              $837
                                              $944
                                              $1,142
                                              $7,324(e)





(a)  Bio-engineering
projects include our Endostatin cancer treatment drug, breast cancer drug and
diagnostic kits.  The diagnostic kits are designed for testing for
different cancers and viruses, such as prostate cancer, stomach cancer, ovarian
cancer, rectal cancer, liver cancer, Hepatitis B and C, human papilloma virus
and mycoplasma virus.  Diagnostic kits accounted for approximately
30.5% of total R&D expenditures in 2008.





(b)  In
fiscal 2008, we spent approximately $948,000 on research and development related
to Monoclonal antibodies, which represented approximately 12.8% of our total
R&D expenses.  Monoclonal antibodies are a bioactive substance
produced naturally when human cells identify and resist pathogenic intrusion
from outside.  Monoclonal antibody technology can produce large
amountsof pure
antibodies.Therefore,Monoclonal antibodies have tremendous
applications in the field of diagnostics, therapeutics,andtargeteddrug delivery systems, not only for
infectious disease causedby bacteria, viruses and protozoa but
also for cancer, metabolic and hormonal disorders.




41




(c)  In
fiscal 2008, we spent approximately $1,192,000 on our Endostatin cancer
treatment drug, which represented approximately 16.1% of our total R&D
expenses.  Endostatin is 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 nutrientsupon which the cancer cells
survive.





(d)  Except
as set forth in notes (b) and (c) above, no single project represented a
material amount of our total R&D expenditures in fiscal 2008.





(e)  Does
not include costs for materials used in our R&D projects.  Our
total R&D expenditures for fiscal 2008 were approximately
$7,413,000.




Liquidity and Capital
Resources




The following table summarizes our cash
and cash equivalentsposition, our working capital, and our
cash flowactivity as of
December 31, 2009 and 2008and for each of the years then ended:




As of December
      31,
                ($ in thousands, except ratio and
      days)2009
              
              
              2008Cash and cash
      equivalents
              
              $
              52,756
              
              
              $
              40,288Current
    ratio
              
              
              8.1
              
              
              
              8.8Quick ratio
              
              
              7.9
              
              
              
              8.8Average accounts receivable
      collection days
              
              
              51.6
              
              
              
              45.5Average inventory turnover
      days
              
              
              21.6
              
              
              
              18.2Working
    capital
              
              $
              67,000
              
              
              $
              49,509Inventories
              
              $
              2,413
              
              
              $
              462Cash provided by (used
      in):Operating
      activities
              
              $
              33,449
              
              
              $
              27,538Investing
      activities
              
              $
              (21,154
              )
              
              $
              (23,115
              )Financing
      activities
              
              $
              29
              
              
              $
              25,355




As of
December 31, 2008, cash and cash equivalents were approximately $52,756,000 as
compared to $40,288,000 at December 31, 2008.We had working capital at December 31,
2008 ofapproximately
$67,000,000, compared to $49,509,000 at December 31, 2008.  Our
increase in working capital in 2009 was principally due to increased cash and
cash equivalentsfunded by the increased cash flows
generated from our operating activities of $33,449,000.  We consider current
working capital and borrowing capabilities adequate to cover our current
operating and capital requirementsfor the full year
2010.




Cash flows provided by operating
activities was approximately $33,449,000 for the year ended December 31,
2009 compared to$27,538,000in 2008.  Cash
flows provided by operating activities were primarily attributable to net income
of approximately $34,457,000 and non-cash depreciation and amortization of
approximately $2,747,000, partially offset by accounts receivable of
approximately $6,204,000 and inventories of approximately
$1,948,000.


42




Cash flowsused in investingactivities was approximately
$21,154,000for the year ended December 31, 2009
compared toapproximately$23,115,000in 2008.Cash flowsused in investingactivitiesin 2008 was primarily related to our
purchase of properties and equipment in connection with the business
acquisitions we consummated
in 2008.Cash
flowsused in investingactivitiesin 2009 was primarily related to our
expenditures in construction in progress of approximately $9.9million, in connection with our construction of
our new corporate headquarters, as well as the purchase of proprietary technologies forAntroquinonol, a
drug used for treatment of lung and liver cancers in the amount of approximately
$5.1 million, and Small RNA diagnosing technology, used for detecting heart
diseases in its early stage, in the amount of approximately $5.8
million.




Cash flowsprovided from financingactivities was approximately
$29,000for the year ended December 31, 2009
compared toapproximately$25,355,000 for the same period in
2008.Our higher
cash flowsprovided from financingactivitiesin 2008 were primarily due to the
private offering we completed in January 31, 2008, as well as cash generated
from the exercise of warrantsby certain warrant holders of
ours.




In
January 2010, we completed the construction of two office buildings and moved
into these new facilities.  It is anticipated that residual work,
including road construction,  fire control equipment, amenity
improvement, and final acceptance, will be completed on these facilities in the
third quarter of 2010, at an additional cost of approximately $3.0
million.




Our current ratio was8.1at December 31, 2009 comparedto 8.8at December 31, 2008and the quick ratio was7.9at December 31, 2009 comparedto8.8at December 31,2008.Weendeavor to ensure that funds
areavailable to take
advantage of new investment opportunities and that funds are sufficient to meet
future liquidity and capital needs.




We calculate accountsreceivable turnover by averaging the
opening and closing balances of out accountsreceivable during that period and
dividing that amount by our average daily sales during that period.Since accountsreceivables fluctuate over the course
of each quarter, in order to determine a more representative accountant
receivables collection
days, management calculates the turnover rate on a quarter-by-quarter basis.




In fiscal
2008, we implemented our new sales strategy to contract with regional sales
agents and large pharmacy chains rather than directly with smaller distributors
and individual retail stores.  As a result, the number of customers we
sell to directly has dramatically decreased from 943 in 2007 to 212 in
2009.  This lower number of customers has helped us to better manage
our accounts receivable.  In addition, we are now selling directly to
more reputable local pharmacy chains, which pay earlier and more
consistently.  Our average daily sales and turnover for each quarter
during 2008 and 2009 were as follows:




Quarter
      Ended
                    Average Daily
      Sales
                      ($ in
      thousands)
                    Average A/R
                      ($ in
      thousands)
                    Turnover
    DaysMarch 31, 2008
                    $136
                    $10,157
                    74.5June 30, 2008
                    $261
                    $9,377
                    35.9September 30, 2008
                    $326
                    $9,298
                    28.5December 31, 2008
                    $282
                    $12,134
                    43.02008
      Annual Average
                    
                    
                    45.5March 31, 2009
                    $276
                    $14,528
                    52.7June 30, 2009
                    $354
                    $15,125
                    42.8September 30, 2009
                    $475
                    $19,921
                    41.9December 31, 2009
                    $324
                    $22,403
                    69.02009
      Annual Average
                    
                    
                    51.6





Accounts
receivable turnover days fluctuate from quarter to quarter due to the
following:





·
            Sales
      revenue varies, which results in changing average daily
    sales;





·
            Accounts
      receivable collections are slower during the fourth fiscal quarter and the
      first fiscal quarter, partly due to the Chinese public holidays within
      that period (about three weeks in
total).





·
            During
      the second and third quarter of each year, due to stronger sales volume,
      the product turnover rate at the Company’s distributors and agents is
      higher, resulting in their shorter accounts payable
    periods.




43




During
2008 and 2009, our average inventory turnover was approximately 18 and 22 days,
respectively.  Since sales and costs of goods sold fluctuate over the
course of each quarter, in order to determine a more representative inventory
rate, management calculates inventory rate on a quarter-by-quarter basis, and
then takes the average of the resulting numbers. Management calculates our
inventory turnover rate using total inventory rather than just finished goods,
because our production cycle is of an extremely short duration.





Our inventory turnover days for the
years endedDecember 31, 2009 and2008 calculatedby using average daily costsof goods sold and average inventory for
each quarter were as the following:




Quarter
    Ended
                      Average Daily
      COGS
                        ($ in
      thousands)
                      Average
      Inventory
                        ($ in
      thousands)
                      Turnover
    DaysMarch 31, 2008
                      $31
                      $583
                      18.6June 30, 2008
                      $61
                      $1,109
                      18.3September 30, 2008
                      $80
                      $1,614
                      20.2December 31, 2008
                      $72
                      $1,133
                      15.72008
      Annual Average
                      
                      
                      18.2March 31, 2009
                      $67
                      $891
                      13.3June 30, 2009
                      $85
                      $1,446
                      17.0September 30, 2009
                      $118
                      $2,335
                      19.7December 31, 2009
                      $76
                      $2,755
                      36.32009
      Annual Average
                      
                      
                      21.6







One
reason for the quarterly fluctuations in our number of inventory turnover days
is that, historically, our inventory is at its lowest levels at the end of each
calendar year and in the first fiscal quarter.  We draw down our
inventory levels in December of each year for two main
reasons.  First, our customers want to receive goods prior to the
holiday season.  In addition, the first calendar quarter is
traditionally our slowest sales period.  Since a lower volume of sales
activity normally occurs during the first quarter of each calendar year, we
believe it is prudent to avoid incurring unnecessary inventory carrying
costs.  At the appropriate time toward the end of the first calendar
quarter of each fiscal year, we begin to ramp up our inventory levels to prepare
for increased demand during the coming stronger selling periods.





Second,
the number of inventory turnover days in each fiscal quarter of 2009 was lower
than in the comparable quarter of 2008, due to an increase in our revenues for
each quarter in 2009 compared to the same quarter in the prior year. Inventory
did not increase at the same level as revenues, which resulted in varying
amounts of cost of goods sold, and a corresponding lower number of inventory
turnover days.





Historically,
we signed agreements with suppliers that allowed us to hold extra raw materials
at the cost of the suppliers.  As a result, we could minimize our own
inventory carrying costs, and improve our cash management, by keeping the
inventory at the minimum level required to support the short-term
sales.  However, due to the forecast of certain cost increases of raw
materials in 2010, management began to increase the inventory levels toward the
second half of 2009.




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”).




44




In
connection with the Offering, 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 SEC, 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 (the “Registration
Requirements”). We have not yet satisfied the Registration
Requirements.  We engaged an independent third-party consultant to
calculate the derivative liability resulting from our failure to register the
Registrable Securities for resale.  The calculation was made using the
Black-Scholes model.  The liability was deemed to be immaterial as of
December 31, 2009.





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 interpretations by the SEC of Rule
415 of the Securities Act of 1933, as amended.





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”); provided, however, 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.





·
            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.





·
            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.




45




As of
March 15, 2010, we have 593,800 Class A Warrants outstanding. If all of these
Class A Warrants were exercised for cash pursuant to their terms, we would
receive $7,422,500 in proceeds, although there can be no assurance that any of
these Class A Warrants or placement agent warrants will be exercised for
cash.





Significant
Accounting Policies





We have
established various accounting policies that govern the application of
accounting principles generally accepted in the U.S., which were utilized in the
preparation of our financial statements.  Certain accounting policies
involve significant judgments and assumptions by management that have a material
impact on the carrying value of certain assets and
liabilities.  Management considers such accounting policies to be
critical accounting policies.  The judgments and assumptions used by
management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances.  Because of the
nature of the judgments and assumptions made by management, actual results could
differ from these judgments and estimates, which could have a material impact on
the carrying values of assets and liabilities and the results of
operations.





While our
significant accounting policies are more fully described in Note 3 to our
financial statements included in this Annual Report on Form 10-K for the year
ended December 31, 2009, we believe that the following accounting policies are
the most critical to aid you in fully understanding and evaluating our reported
financial results and affect the more significant judgments and estimates that
we use in the preparation of our financial statements.





Use
of estimates





The
preparation of the financial statements included in Item 8 of this Annual Report
on Form 10-K in conformity with U.S. GAAP, 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 assigned lives to acquired tangible and intangible
assets, uncollectible accounts receivable, impairment testing of goodwill and
other long-lived assets.   Actual results may differ from these
estimates.





Accounts
receivable





Accounts
receivable are stated at net realizable value, net of an allowance for doubtful
accounts.  The allowance for estimated bad debts is based upon
the periodic analysis of individual customer balances including an
evaluation of days of sales outstanding, payment history, recent payment trends,
and perceived credit worthiness.As ofDecember31, 2009 ourallowance for doubtful
accountswas $56,000and$50,000, respectively.





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 upon the periodic analysis of individual inventory items
including an evaluation of historical usage and/or movement, age, expiration
date, and general conditions.  There are no inventory reserve
provision recorded at December
31, 2009 and 2008.





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.  We use an estimated residual value of 5% of cost, or
valuation for both financial and income tax reporting purposes.  The
estimated lengths of the useful lives of our property and equipment 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




46




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 be obtained 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 statements 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, wewill measure the impairment loss as the
amount by which the carrying value of the asset exceeds itsfair value.  Wedid not record any impairment charges in
the years ended December 31, 2009,2008and 2007.





Intangible
assets





Intangible
assets are accounted for in accordance with ASC topic 350, “Intangibles – Goodwill and
Other.”  Intangible assets with finite useful lives are
amortized while intangible assets with indefinite useful lives are not
amortized.  We review our long-lived assets, including property and
equipment and finite-lived intangible assets for impairment on at least an
annual basis or 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, we evaluate 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.  We
recognize an impairment loss based on the excess of the carrying amount of the
assets over their respective fair values.  Fair value is determined by
the use of undiscounted future cash flows, independent appraisals or other
approximate methods.  Wedid not record any impairment chargesforthe years endedDecember 31, 2009,2008and 2007.





Intangible
assets consists of proprietary technologies, SFDA licenses for drug batch
numbers, and goodwill. We acquired proprietary technologies from a non-related
third party.  The fair value of proprietary technologies recorded in
our financial statements is appraised periodically and amortized during its
estimated useful life.  SFDA licenses for drug batch numbers were
acquired through business acquisitions of Tianlong and Peng
Lai.  Goodwill consists the payments we made when we acquired
Tianlong’s Beijing sales office and Haina.  We have registered “Kang
Xi” as our trademark, which is used for all of our TCM products.  The
“Kang Xi” trademark was developed internally and registered by TDR before we
became a public company.  Our cost basis in the trademark is
nominal.  Therefore, we did
not have our “Kang Xi” trademark appraised, or record an intangible asset for
it.  Additionally, none of the costs associated with the trademark
have been capitalized.





As of
December 31, 2009, the remaining weighted average life of our intangible assets
is approximately 8 years.





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.  We believe that all of these criteria are
satisfied upon shipment from its facilities.  Historically, we
estimated returns, allowances and claims have been deemed
immaterial.  Our sale agreements only allow a return if the product
has quality related issues.  In such event, we accept the return for
equivalent product exchange from inventory only.





We
occasionally apply to various government agencies for research
grants.  Revenue from such research grants is recognized when
earned.  In situations where we receive 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.




47




Research
and Development





Research
and development expenses include the costs associated with our 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 consolidated
statement of operations.





We
recognize in-process research and development in accordance with ASC topic 730,
“Research and
Development.” 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 other technologies
acquired that has foreseeable future cash flows are capitalized as intangible
assets.  Such intangible assets are amortized starting from the year
revenue is generated and amortized over an estimated period of 10 years. Should
these capitalized intangible assets have no future benefit, we will record an
immediate write-off for the remaining net carrying value within the consolidated
statement of operations.





Weincurredresearch and development
expensesofapproximately $14,960,000,
$7,413,000, and $3,158,000, for the years
endedDecember 31, 2009, 2008, and 2007,
respectivelyin research and development
costs.





Recent
Accounting Pronouncements





Refer to
Note 3 to the Financial Statements included in Item 8 of this Annual Report on
Form 10-K, which discusses new accounting pronouncements we adopted during 2009,
as well as accounting pronouncements recently issued or proposed but not yet
required to be adopted.





Contractual
Obligations and Commercial Commitments





As of
December 31, 2009, we have commitments and contractual obligations as
follows:





In
January 2010, we completed the construction of two office buildings and moved
into the new facilities located in Song Bei District of Harbin city,
PRC.  We spent approximately $9.9 million, $730,000, and $2.1 million
in the year of 2009, 2008, and 2007 respectively for this construction in
progress.  It is
anticipated that residual work, includingroad
construction,  fire control equipment, amenity improvement, and final
acceptance,will be completed on
these facilities in the third quarter of 2010, at an additional cost of approximately $3.0
million.





The
continuing development of 8 research and development projects, which commenced
in the second half of fiscal 2009, have been carried over to the year of 2010
according to our contracts signed with various research institutions. The
expenditures for these 8 research and development projects in the year of 2010
is expected to be approximately $2.4 million.





Other
than the above contracts and commitments, we do not have any long-term debt
obligations, capital lease obligations, operating lease obligations, purchase
obligations, and other long term liabilities reflected on our balance sheet
under GAAP.





Currency Exchange
Fluctuations




All of our revenues and majority of the
expenses during the year endedDecember 31, 2008 were
denominatedprimarily in RMB, the currency of China, and wereconvertedinto U.S.dollars at the exchange rate of 6.96225
RMB to 1 U.S. Dollar.  In the third quarter of 2005, the RMBbegan to rise against the U.S.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 resultsof operations. We do not engage in
currency hedging.




Off-Balance Sheet Arrangements




We do not have any off-balance sheet
arrangementsthat are currently material or
reasonably likely to be material to our financial position or
resultsof operations.




48




Item7A.  Quantitative and
Qualitative Disclosures About Market Risk




As of
December 31, 2009, we do not invest or trade market risk sensitive instrument or
have any debt subject to interest rate fluctuations.




Substantially
all of our revenues and expenses are denominated in RMB.  Since 1994,
the exchange rate for the RMB against the U.S. dollar has remained relatively
stable, most of the time in the region of approximately RMB8.00 to U.S.$1.00.
However, in 2005, the Chinese government announced that would begin pegging the
exchange rate of the RMB against a number of currencies, rather than just the
U.S. dollar. Currently, exchange rates are approximately RMB6.8 to U.S.$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.  If we decide to convert RMB into
U.S. dollars and the U.S. dollar appreciates against the RMB, the U.S. dollar
equivalent of the RMB that we convert would be reduced.





Inflation
in China has not materially impacted our results of operations in recent years,
but we can provide no assurance that we will not be affected in the
future.  According to the PRC National Bureau of Statistics, the
inflation rate in the consumer price indexinChinawas5.9%, 4.8%, and1.9%in 2009,2008,and 2007,respectively.





A
significant amount of our cash and cash equivalents are held in commercial bank
checking accounts in the PRC and earned an annual interest income yield of
approximately 0.36% for the year ended December 31, 2009.  For all the
bank accounts in the PRC, we earned interest incomeof approximately $71,000,
$112,000and $10,000for the years ended December 31,
2009,2008and 2007, respectively.




49




Item 8.  Financial
Statementsand Supplementary
Data.






Index
to the Consolidated Financial Statements of China Sky One Medical,
Inc.




PAGEReports
      of Independent Registered Public Accounting Firms
                                                                
                                                                F-2Financial
      StatementsConsolidated
      Statements of Operations and Comprehensive Income for the YearsEnded
      December 31, 2009, 2008 and 2007
                                                                
                                                                F-4Consolidated
      Balance Sheets at December 31, 2009 and 2008
                                                                
                                                                F-5Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31, 2009,2008
      and 2007
                                                                
                                                                F-6Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2009, 2008and
      2007
                                                                
                                                                F-7Notes
      to Consolidated Financial Statements
                                                                
                                                                F-8
      – F-27





F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders


China Sky
One Medical Inc. and Subsidiaries




We have
audited the accompanying consolidated balance sheets of China Sky One Medical
Inc. and subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the
related consolidated statements of operations, stockholders’ equity, and cash
flows for each of the years in the two-year period ended December 31,
2009.  We also have audited the Company’s internal control over financial
reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission .  The Company’s management is responsible for these
consolidated financial statements, for maintaining effective internal control
over financial reporting, and for its assessment of the effectiveness of
internal control over financial reporting, included in the accompanying Management’s Report on Internal
Control over Financial Reporting. Our responsibility is to express
an opinion on these consolidated financial statements and an opinion on the
Company’s internal control over financial reporting based on our
audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the consolidated financial statements included
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
consolidated financial statement presentation. Our audit of internal
control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also included
performing such other procedures as we considered necessary in the
circumstances.  We believe that our audits provide a reasonable basis for
our opinions.




A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control
over financial reporting includes those policies and procedures that (a)pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (b)provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the
company; and (c)provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the company’s assets that could have a material effect on
the financial statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, 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.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company as
of December 31, 2009 and 2008, and the consolidated results of their operations
and their cash flows for each of the years in the two-year period ended December
31, 2009, in conformity with accounting principles generally accepted in the
United States of America. Also in our opinion, the Company maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.






/s/
MSPC


MSPC


Certified
Public Accountants and Advisors,


A
Professional Corporation






New York,
New York


March 15, 2010





F-2




REPORT OF INDEPENDENT
REGISTEREDPUBLIC
ACCOUNTING FIRM




[Letterhead of Sherb & Co.,
LLP]




To the Board of Directors and
Stockholders of


China Sky One Medical, Inc.




We have auditedthe accompanying consolidatedbalance sheetsof China Sky One Medical, Inc. and itsSubsidiaries as of December 31, 2007
and the relatedconsolidatedstatementsof operations, stockholders’equity and cash flows for the year
endedDecember 31, 2007.China Sky One Medical, Inc. management is responsible for
these financial statements. Our responsibility is to express an
opinion on these consolidatedfinancial statementsbasedon our audit.




We conductedour audit in accordance with standards
ofthe Public Company
Accounting Oversight Board (UnitedStates). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statementsare free of material misstatement. The
Company is not
requiredto have, nor were we engagedto perform, and audit of itsinternal control over financial
reporting. Our audit includedconsideration 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
amountsand disclosures in the financial
statements, assessing the accounting principles
usedand 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
consolidatedfinancial statementsreferredto above present fairly, in all
material respects, the financial position of China Sky
One Medical, Inc. as ofDecember 31, 2007 and the
resultsof itsoperations and itscash flows for the year endedDecember 31,2007 inconformity with accounting principles
generally acceptedin the UnitedStates.









/s/ Sherb
& Co.,
LLP


CertifiedPublic Accountants








Boca Raton,Florida


March25, 2008




F-3




China Sky One Medical, Inc. and
Subsidiaries


ConsolidatedStatementsof Operations and Comprehensive
Income


$ in thousands,
except share and per share data




Years Ended December
      31,2009
                                          
                                          
                                          2008
                                          
                                          
                                          2007Revenues
                                          
                                          $
                                          130,092
                                          
                                          
                                          $
                                          91,816
                                          
                                          
                                          $
                                          49,318Cost of Goods
      Sold
                                          
                                          
                                          31,671
                                          
                                          
                                          
                                          22,403
                                          
                                          
                                          
                                          10,940Gross
Profit
                                          
                                          
                                          98,421
                                          
                                          
                                          
                                          69,413
                                          
                                          
                                          
                                          38,379Operating
      ExpensesSelling
    expense
                                          
                                          
                                          30,763
                                          
                                          
                                          
                                          22,968
                                          
                                          
                                          
                                          14,784General and administrative
      expense
                                          
                                          
                                          4,191
                                          
                                          
                                          
                                          2,514
                                          
                                          
                                          
                                          1,380Depreciation and
      amortization
                                          
                                          
                                          2,255
                                          
                                          
                                          
                                          858
                                          
                                          
                                          
                                          443Research and
      development
                                          
                                          
                                          14,960
                                          
                                          
                                          
                                          7,413
                                          
                                          
                                          
                                          3,158Total Operating
      Expenses
                                          
                                          
                                          52,170
                                          
                                          
                                          
                                          33,753
                                          
                                          
                                          
                                          19,765Income from
      Operations
                                          
                                          
                                          46,251
                                          
                                          
                                          
                                          35,659
                                          
                                          
                                          
                                          18,614Other Income
      (Expenses)Interest
    Income
                                          
                                          
                                          71
                                          
                                          
                                          
                                          112
                                          
                                          
                                          
                                          10Miscellaneous income
      (Expenses)
                                          
                                          
                                          (32
                                          )
                                          
                                          
                                          702
                                          
                                          
                                          
                                          28Change in fair value of derivative
      liability
                                          
                                          
                                          (1,330
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Total Other Income
      (Expenses)
                                          
                                          
                                          (1,291
                                          )
                                          
                                          
                                          814
                                          
                                          
                                          
                                          38Income Before Provision for Income
      Tax
                                          
                                          
                                          44,960
                                          
                                          
                                          
                                          36,473
                                          
                                          
                                          
                                          18,652Provision for income
      taxes
                                          
                                          
                                          10,503
                                          
                                          
                                          
                                          7,616
                                          
                                          
                                          
                                          3,319Net Income
                                          
                                          $
                                          34,457
                                          
                                          
                                          $
                                          28,857
                                          
                                          
                                          $
                                          15,333Basic Earnings Per
      Share
                                          
                                          $
                                          2.08
                                          
                                          
                                          $
                                          1.91
                                          
                                          
                                          $
                                          1.27Basic Weighted Average Shares
      Outstanding
                                          
                                          
                                          16,575,885
                                          
                                          
                                          
                                          15,101,833
                                          
                                          
                                          
                                          12,094,949Diluted Earnings Per
      Share
                                          
                                          $
                                          2.07
                                          
                                          
                                          $
                                          1.87
                                          
                                          
                                          $
                                          1.15Diluted Weighted Average Shares
      Outstanding
                                          
                                          
                                          16,668,452
                                          
                                          
                                          
                                          15,429,136
                                          
                                          
                                          
                                          13,370,528Other Comprehensive
      IncomeForeign currency translation
      adjustment
                                          
                                          
                                          312
                                          
                                          
                                          
                                          3,295
                                          
                                          
                                          
                                          1,850Net income
                                          
                                          $
                                          34,457
                                          
                                          
                                          $
                                          28,857
                                          
                                          
                                          $
                                          15,333Comprehensive
      Income
                                          
                                          $
                                          34,769
                                          
                                          
                                          $
                                          32,152
                                          
                                          
                                          $
                                          17,183


See accompanying notes to the
consolidated financial statements.
  F-4




China
Sky One Medical, Inc. and Subsidiaries


Consolidated
Balance Sheets


$ in thousands,
except share data




Year Ended December
      31,2009
                                            
                                            
                                            2008ASSETSCurrent
    AssetsCash and cash
      equivalents
                                            
                                            $
                                            52,756
                                            
                                            
                                            $
                                            40,288Accounts receivable,
      net
                                            
                                            
                                            21,146
                                            
                                            
                                            
                                            14,979Inventories
                                            
                                            
                                            2,413
                                            
                                            
                                            
                                            462Prepaid and other current
      assets
                                            
                                            
                                            74
                                            
                                            
                                            
                                            106Total current
      assets
                                            
                                            
                                            76,389
                                            
                                            
                                            
                                            55,835Property and equipment,
      net
                                            
                                            
                                            15,491
                                            
                                            
                                            
                                            14,797Intangible assets,
      net
                                            
                                            
                                            25,114
                                            
                                            
                                            
                                            15,852Construction in
      progress
                                            
                                            
                                            12,932
                                            
                                            
                                            
                                            4,317Land use rights,
      net
                                            
                                            
                                            4,586
                                            
                                            
                                            
                                            1,945Construction
      deposit
                                            
                                            
                                            5,851
                                            
                                            
                                            
                                            8,513Total
Assets
                                            
                                            $
                                            140,363
                                            
                                            
                                            $
                                            101,259LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      LiabilitiesAccounts payable and accrued
      expenses
                                            
                                            $
                                            4,186
                                            
                                            
                                            $
                                            2,937Taxes
    payable
                                            
                                            
                                            3,873
                                            
                                            
                                            
                                            3,363Deferred
      revenue
                                            
                                            
                                            -
                                            
                                            
                                            
                                            26Derivative
      liability
                                            
                                            
                                            1,330
                                            
                                            
                                            
                                            -Total current
      liabilities
                                            
                                            
                                            9,389
                                            
                                            
                                            
                                            6,326Commitments
      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,16,714,267 and 16,306,184 issued and
      outstanding at December 31, 2009 and 2008,
      respectively)
                                            
                                            
                                            17
                                            
                                            
                                            
                                            16Additional paid-in
      capital
                                            
                                            
                                            41,376
                                            
                                            
                                            
                                            40,105Retained
      earnings
                                            
                                            
                                            5,879
                                            
                                            
                                            
                                            5,567Accumulated other comprehensive
      income
                                            
                                            
                                            130,974
                                            
                                            
                                            
                                            94,933Total stockholders'
      equity
                                            
                                            
                                            83,702
                                            
                                            
                                            
                                            49,245$
                                            140,363
                                            
                                            
                                            $
                                            101,259






See accompanying notes to the
consolidated financial statements.




F-5




China Sky One Medical, Inc. and
Subsidiaries


ConsolidatedStatementsof Stockholders'
Equity


$ in thousands,
except share data




AccumulatedAdditional
                            
                            
                            
                            
                            
                            Other
                            
                            
                            TotalCommon
      Stock
                            
                            
                            Paid-in
                            
                            
                            Retained
                            
                            
                            Comprehensive
                            
                            
                            Stockholders'Shares
                            
                            
                            Amount
                            
                            
                            Capital
                            
                            
                            Earnings
                            
                            
                            Income
                            
                            
                            EquityBalance at December 31,
      2006
                            
                            
                            12,031,536
                            
                            
                            $
                            12
                            
                            
                            $
                            8,822
                            
                            
                            $
                            5,055
                            
                            
                            $
                            422
                            
                            
                            $
                            14,311Issuance of common stock for
      service
                            
                            
                            30,000
                            
                            
                            
                            -
                            
                            
                            
                            195
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            195Warrants
      exercised
                            
                            
                            166,827
                            
                            
                            
                            -
                            
                            
                            
                            516
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            516Employee stock
      options
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            40
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            40Foreign currency translation
      adjustment
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,850
                            
                            
                            
                            1,850Net income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            15,333
                            
                            
                            
                            
                            
                            
                            
                            15,333Balance at December 31,
      2007
                            
                            
                            12,228,363
                            
                            
                            
                            12
                            
                            
                            
                            9,573
                            
                            
                            
                            20,388
                            
                            
                            
                            2,272
                            
                            
                            
                            32,245Issuance of common stock through
      private placement, net
                            
                            
                            2,500,000
                            
                            
                            
                            3
                            
                            
                            
                            23,485
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            23,488Warrants and options exercised
      under cash and cashless
                            
                            
                            1,142,302
                            
                            
                            
                            1
                            
                            
                            
                            1,866
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,867Issuance of common stock under
      business acquistions
                            
                            
                            405,456
                            
                            
                            
                            -
                            
                            
                            
                            4,865
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            4,865Share-based
      compensation
                            
                            
                            30,063
                            
                            
                            
                            -
                            
                            
                            
                            316
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            316Foreign currency translation
      adjustment
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            3,295
                            
                            
                            
                            3,295Net income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            28,857
                            
                            
                            
                            
                            
                            
                            
                            28,857Balance at December 31,
      2008
                            
                            
                            16,306,184
                            
                            
                            
                            16
                            
                            
                            
                            40,105
                            
                            
                            
                            49,245
                            
                            
                            
                            5,567
                            
                            
                            
                            94,933Warrants and options exercised
      under cash and cashless
                            
                            
                            355,239
                            
                            
                            
                            -
                            
                            
                            
                            29
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            29Share-based
      compensation
                            
                            
                            52,844
                            
                            
                            
                            -
                            
                            
                            
                            1,242
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,242Foreign currency translation
      adjustment
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            312
                            
                            
                            
                            312Net income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            34,457
                            
                            
                            
                            
                            
                            
                            
                            34,457Balance at December 31,
      2009
                            
                            
                            16,714,267
                            
                            
                            $
                            17
                            
                            
                            $
                            41,376
                            
                            
                            $
                            83,702
                            
                            
                            $
                            5,879
                            
                            
                            $
                            130,974




See accompanying notes to the
consolidated financial statements.




F-6




China Sky One Medical, Inc. and
Subsidiaries


ConsolidatedStatementsof Cash Flows


$ in
thousands




Years Ended December
      31,2009
                                                                                                      
                                                                                                      
                                                                                                      2008
                                                                                                      
                                                                                                      
                                                                                                      2007Cash Flows From Operating
      ActivitiesNet income
                                                                                                      
                                                                                                      $
                                                                                                      34,457
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      28,857
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      15,333Adjustments to reconcile net
      income to net cash provided (used) by operating
      activities:Allowance for bad
      debt
                                                                                                      
                                                                                                      
                                                                                                      17
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      38
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -Depreciation and
      amortization
                                                                                                      
                                                                                                      
                                                                                                      2,747
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      858
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      443Share-based
      compensation
                                                                                                      
                                                                                                      
                                                                                                      1,242
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      316
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      235Change in fair value of derivative
      liability
                                                                                                      
                                                                                                      
                                                                                                      1,330
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -Decrease (increase) in operating
      assets:Accounts receivable and other
      receivables
                                                                                                      
                                                                                                      
                                                                                                      (6,204
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (3,398
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (7,479
                                                                                                      )Inventories
                                                                                                      
                                                                                                      
                                                                                                      (1,948
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (66
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (73
                                                                                                      )Prepaid expenses and
      others
                                                                                                      
                                                                                                      
                                                                                                      92
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (24
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      93Increase (decrease) in operating
      liabilities:Accounts payable and accrued
      liabilities
                                                                                                      
                                                                                                      
                                                                                                      1,215
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (678
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      2,136Tax payable
                                                                                                      
                                                                                                      
                                                                                                      501
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,660
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      960Deferred
      revenue
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (26
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (48
                                                                                                      )Net cash provided by operating
      activities
                                                                                                      
                                                                                                      
                                                                                                      33,449
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      27,538
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      11,601Cash Flows From Investing
      ActivitiesPurchase of property and
      equipment
                                                                                                      
                                                                                                      
                                                                                                      (254
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (11,167
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (2,222
                                                                                                      )Land and construction
      deposit
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (8,003
                                                                                                      )Construction in
      progress
                                                                                                      
                                                                                                      
                                                                                                      (9,932
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      4
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -Purchase of intangible
      assets
                                                                                                      
                                                                                                      
                                                                                                      (10,968
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (11,951
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (35
                                                                                                      )Net cash used in investing
      activities
                                                                                                      
                                                                                                      
                                                                                                      (21,154
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (23,115
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      (10,261
                                                                                                      )Cash Flows From Financing
      ActivitiesSale of common stock for cash, net
      of offering costs
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      23,488
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -Proceeds from warrants
      conversion
                                                                                                      
                                                                                                      
                                                                                                      29
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,868
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      516Repayment of short-term
      loan
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (548
                                                                                                      )Net cash provided by (used in)
      financing activities
                                                                                                      
                                                                                                      
                                                                                                      29
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      25,355
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (33
                                                                                                      )Effect of exchange rate changes on
      cash
                                                                                                      
                                                                                                      
                                                                                                      272
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,318
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,296Net Increase in Cash and Cash
      Equivalents
                                                                                                      
                                                                                                      $
                                                                                                      12,468
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      31,097
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      2,604Cash and Cash Equivalents at
      Beginning of Year
                                                                                                      
                                                                                                      
                                                                                                      40,288
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      9,191
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      6,587Cash and Cash Equivalents at End
      of Year
                                                                                                      
                                                                                                      $
                                                                                                      52,756
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      40,288
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      9,191Supplemental disclosure of cash
      flow informationInterest
    paid
                                                                                                      
                                                                                                      $
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      135
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      10Taxes paid
                                                                                                      
                                                                                                      $
                                                                                                      10,164
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      6,630
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      2,359






See accompanying notes to the
consolidated financial statements.




F-7




China Sky One Medical, Inc. and
Subsidiaries


Notes to ConsolidatedFinancial Statements




1.
              Description of
      Business




China Sky One Medical Inc.("China Sky One" or the “Company”), aNevadacorporation, was formedon February 7, 1986, and formerly known
as Comet Technologies, Inc. (“Comet”).On July 26, 2006, the Company
changedthe name of the reporting company from
"Comet Technologies, Inc." to "China Sky One Medical, Inc."




China Sky One is a holding company whose
principal operations are through itswholly-owned subsidiaries; it has no
revenues separate from itssubsidiaries, and hasexpenses related to itsstatus as a public reporting company
and to itsownership interest inAmerican California Pharmaceutical
Group, Inc. (“ACPG”)andHarbin City Tian Di Ren Medical Co. (“TDR”).




ACPG, our non operatingUnitedStatesholding company subsidiary, was
incorporatedon December 16, 2003, in the State ofCalifornia, under the name “QQ Group, Inc.”QQ Group, Inc. changeditsname 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, describedherein. On December 8, 2005, ACPG
completeda stock exchange transaction with TDR a
People’s Republic of China (“China”or“PRC”) basedoperating 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 exchanged100% of itsissuedand outstanding common stock for 100% of the
capital stock of TDR and itssubsidiaries, describedbelow.




Thereafter, on May 11, 2006, ACPG
enteredinto a Stock Exchange Agreement (the
“Exchange
Agreement”) with the
shareholders of China Sky One. The terms of the Exchange Agreement were
consummatedand the acquisition was
completedon May 30,2006. As a result of the transaction,
the Company issueda total of 10,193,377 shares of
itscommon voting stock to the stockholders
of ACPG, in exchange for 100% of the capital stock of ACPG resulting in ACPG
becoming our wholly-ownedsubsidiary.The transaction is treatedas a reverse merger for accounting
purposes.




TDR, formerly known as “Harbin City Tian Di Ren Medical Co.,”was originally formedin 1994 and maintaineditsprincipal executive office inHarbinCityofHeilongjiangProvince, in the PRC.TDR was reorganizedand incorporatedas a limitedliability company on December 29, 2000,
under the “Corporation Laws
and Regulations”of the
PRC. At the time of the TDR Acquisitionby ACPG in December of 2005, TDR had
two wholly-ownedsubsidiaries, Harbin First
Bio-Engineering Company Limitedand Kangxi Medical Care Product Factory, until July,
2006, when the two were merged, with Harbin First Bio-Engineering
CompanyLimited(“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 commenceditsbusiness in the sale of
brandednutritional supplementsand over-the-counter pharmaceutical
productsin theHeilongjiangProvince. TDR has subsequently evolvedinto an integratedmanufacturer, marketer, and distributor
of external use natural Chinese medicineproductssold primarily to and throughChina’s various domestic pharmaceutical chain
stores.




As of October 16, 2006, the Company
organized Harbin Tian Qing Biotech Application Company as a wholly-owned PRC
subsidiary of TDR (“Tian
Qing”), to
conduct research and
development in the areas of tissue and stem cell banks.  As of
December 31, 2010, Tian Qing had insignificant operation.




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
completedan acquisition pursuant to an Equity
Transfer Agreement datedFebruary 22, 2008, between TDR and
Heilongjiang Tianlong Pharmaceutical, Inc., a corporation with a multitude ofmedicinesapproved by the PRC’s State Food and Drug Administration
(“SFDA”)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
acquiredtheBeijingsales office of Tianlong in mid 2006.
Pursuant to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stockof Tianlong from Tianlong’ssole stockholder, in consideration for an aggregate purchase
price of approximately $8,300,000, consisting of (i) $8,000,000 incash, and (ii) 23,850 shares of China
Sky One (at $12 per
share). The acquisition
receivedregulatory approval and
closedon April 3, 2008.




F-8




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




2.
            Acquisition of Businesses
      (Continued)




The following table summarizes the
approximate estimatedfair values of the assetsacquiredin the Tianlong
acquisition.




$ in
    thousandsFixed assets
                
                $
                6,315Intangible assets–SFDA licenses for
      drug batch numbers
                
                
                1,787Other
                
                
                170Net assetsacquired
                
                $
                8,272





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 Heilongjiang office of the State Food and Drug
Administration (“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.




$ in
    thousandsCash
                
                $
                84Intangible assets- Goodwill
                
                
                353Net assetsacquired
                
                $
                437




Pursuant to the Equity Transfer
Agreement, TDR acquired 100% of the issued and outstanding capital stock of Haina from
itsthree stockholders in consideration for
payment of3,000,000RMB (approximately $437,000). TDR has been overseeing the
operations of Haina since January of 2008 as part of itsdue diligence prior to closing of this
acquisition.




On June 9, 2008, TDR enteredinto a Merger and Acquisition Agreement (the
“Acquisition
Agreement”) with Peng Lai
Jin Chuang Company, a corporation organizedunder the laws of the
People’s Republic of China(“Peng Lai”), which wasorganizedto develop, manufacture and distribute
pharmaceutical,
medicinal and diagnostic productsin the PRC. Pursuant to the Acquisition
Agreement, TDR acquiredall of the assetsof Peng Lai in consideration for an
aggregate of approximately (i) U.S.$2.5 million in cash, and (ii) 381,606
shares of theCompany’s common stock with a fair value of
approximately $4.6 million (at $12 per share). The acquisition of Peng Lai
closedon September 5,
2008.




The following table summarizes the
approximate estimatedfair values of the assetsacquiredin the Peng Lai
acquisition.




$ in thousandsFixed assets
                
                $
                4,177Intangible assets-SFDA licenses for drug
      batch numbers
                
                
                2,917Net assetsacquired
                
                $
                7,094





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




Years Ended
      December 31,2008
                                      
                                      
                                      2007($
      in thousands)Revenue
                                      
                                      $
                                      92,378
                                      
                                      
                                      $
                                      51,334Operating
      income
                                      
                                      $
                                      35,747
                                      
                                      
                                      $
                                      17,143Net
      income
                                      
                                      $
                                      28,934
                                      
                                      
                                      $
                                      13,822Basic
      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 ConsolidatedFinancial Statements
  3.
                                      Summary ofSignificant AccountingPolicies




We have
established various accounting policies that govern the application of
accounting principles generally accepted in the United States of America
(“U.S.”), which were utilized in the preparation of our financial statements.
Certain accounting policies involve significant judgments and assumptions by
management that have a material impact on the carrying value of certain assets
and liabilities.  The judgments and assumptions used by management are
based on historical experience and other factors, which are believed to be
reasonable under the circumstances. Because of the nature of the judgments and
assumptions made by management, actual results could differ from these judgments
and estimates, which could have a material impact on the carrying values of
assets and liabilities and the results of operations.





Principles of
Consolidation–The accompanying consolidated financial
statementsinclude the accountsof the Company and itswholly-owned subsidiaries, ACPG, TDR,
First,Tian Qing,Tianlong,Hainaand Peng Lai. All significant
inter-company transactions and balances were eliminated.The





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





Certain
items in the 2008 and 2007 financial statements have been reclassified to
conform to the 2009 financial statements presentation.





Use of estimates– The
preparation of these financial statements in conformity with U.S. GAAP, 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 assigned lives to acquired tangible and intangible
assets, uncollectible accounts receivable, impairment testing of goodwill and
other long-lived assets. 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
such 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 instruments purchased with a maturity period of
three 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.





A
significant amount of our cash and cash equivalents are held in commercial bank
checking accounts in the PRC and earn   interest income
(annual yield of approximately 0.36% for the year ended December 31, 2009). For
all the bank accounts in the PRC, the Company earned interest incomeof approximately$71,000, $112,000 and$10,000for the years ended December
31, 2009, 2008 and 2007, respectively.





Accounts receivable
–Accounts receivable are stated at net realizable value, net of an
allowance for doubtful accounts. The allowance for estimated bad debts is based
upon the periodic analysis of individual customer balances including an
evaluation of days of sales outstanding, payment history, recent payment trends,
and perceived credit worthiness.
As ofDecember 31, 2009 and 2008,
theCompany’s allowance for doubtful
accountswas $56,000and $50,000, respectively.





F-10




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




3.
            Summary ofSignificant AccountingPolicies (Continued)





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
upon the periodic analysis of individual inventory items including an evaluation
of historical usage and/or movement, age, expiration date, and general
conditions. The Company recorded no inventory reserve position as of December
31, 2009 and 2008.





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 the useful lives of
our property and equipment 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 charged to the consolidated 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 be obtained 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 statements 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 value exceeds 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 itsfair value. The Company did not record
any impairment chargesof
property and equipmentin
theyears ended December
31, 2009,2008and 2007.





Construction-in-progress– Properties
currently under development are accounted for as construction-in-progress.
Construction-in-progress includes the acquisition and land right cost,
development expenditures, professional fees, and capitalized interest costs
during the period of construction.





Upon
completion and readiness for use of the project, the cost of
construction-in-progress is transferred as part of property and equipment. 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 are accounted for in accordance with ASC topic 350, “Intangibles –
Goodwill and Other.” Intangible assets with finite useful lives are amortized
while intangible assets with indefinite useful lives are not amortized. The
Company reviews its long-lived assets and finite-lived intangible assets for
impairment on at least an annual basis or 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 the
use of undiscounted future cash flows, independent appraisals or other
approximate methods. The Company
did not record any impairment chargesforthe years endedDecember 31, 2009,2008and 2007.




F-11




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




3.
            Summary ofSignificant AccountingPolicies (Continued)





Our
intangible assets consists of proprietary technologies, SFDA licenses for drug
batch numbers, and goodwill. Proprietary technologies are technologies that we
own.  The SFDA licenses for drug batch numbers and goodwill were
acquired in the business acquisitions of Tianlong and Peng Lai.  We
have registered “Kang Xi” as our trademark, which is used for all of the
Company’s Tradition Chinese Medicine (“TCM”) products. The “Kang Xi” trademark
was developed internally and registered by TDR before the Company became a
public company. The Company’s cost basis in the trademark is nominal. Therefore, the Company did
not have its “Kang Xi” trademark appraised, or recorded an intangible asset for
it. Additionally, none of the costs associated with the trademark have been
capitalized.





Derivative Instruments – The
fair value of the Company’s derivative warrants liability was provided by an
independent third party valuation expert.  Certain derivatives with
limited activity are valued using externally developed models that consider
unobservable market parameters.





Foreign Currency - The
Company’s principal country of operations is in the PRC. The financial position
and results of operations of the Company are recorded in Renminbi (“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.  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 U.S. 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 all of these criteria are
satisfied upon shipment from its facilities. Historically, the Company’s
estimated returns, allowances and claims have been deemed immaterial. The
Company’s sale agreements only allow a return if the product has quality related
issues. In such event, the Company accepts the return for equivalent product
exchange from inventory only.





The
Company occasionally applies to various government agencies for research grants.
Revenue from such research grants is recognized when earned. In situations where
the Company 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 consolidated
statement of operations.





The
Company recognizes in-process research and development in accordance with ASC
topic 730, “Research and Development.” 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 other
technologies acquired that has foreseeable future cash flows are capitalized as
intangible assets. Such intangible assets are amortized starting from the year
revenue is generated and amortized over an estimated period of 10 years. Should
under any circumstances these capitalized intangible assets have no future
benefit; the Company will record an immediate write-off for the remaining net
carrying value within the consolidated statement of operations.





The Company incurredresearch and development
expensesofapproximately $14,960,000,
$7,413,000, and $3,158,000, for the years
endedDecember 31, 2009, 2008, and 2007,
respectively.




F-12




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




3.
            Summary ofSignificant AccountingPolicies (Continued)





Advertising–TheCompany signs contractswith agentswho then place itsadvertising in the mediums of television, radio and internet.Advertising expense is
incurredin the period the
advertisementstake place.Thus, costsof advertising are expensedas incurred.Advertising costsfor the years endedDecember 31, 2009, 2008, and 2007wereapproximately$14,527,000,$7,299,000and $4,385,000, respectively.An immaterialamountof the Company’sadvertisement expenses in 2009, 2008 and 2007
were related toadvertisingproductioncosts.Advertising costsare reportedas part of selling expenses in the
statementsof operations.





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 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





According to “Enterprise Income Tax and Certain
Preferential Policies Notice”publishedby the Ministry of Finance and the
National Tax Affairs Bureau, if the enterprise is authorizedby the State Council as a special
entity, the enterprise income tax rate is reducedto 15%. The following table setsforth the Company’sincometax rate for TDR and itssubsidiaries for the year
endedDecember 31, 2009,2008and 2007:




Income
      Tax Rate
                  2009
                  2008
                  2007TDR
                  15%
                  15%
                  15%First
                  15%
                  25%
                  25%Tianlong
                  15%
                  12%
                  -Haina
                  25%
                  25%
                  -Peng
      Lai
                  2%
      of Revenue
                  25%
                  -




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.




F-13




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




3.
            Summary ofSignificant AccountingPolicies (Continued)





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.





We may
from time-to-time be assessed interest or penalties by major tax jurisdictions,
although such assessments historically have been minimal and immaterial to our
financial results. Our policy is to recognize interest and penalties accrued on
any unrecognized tax benefits as a component of income tax expense.





The
Company files corporate income tax returns in the United States (“U.S.”) for
China Sky One and ACPG. ACPG wholly owns 100% of TDR and subsidiaries in the
PRC. China Sky One and ACPG are holding companies and do not generate business
revenues and management’s intent is not to distribute dividend income from TDR
and subsidiaries to either China Sky One or ACPG. As such, management has
established a full valuation allowance for the net operating losses incurred by
China Sky One and ACPG. The Company files income tax returns in the PRC for TDR
and its subsidiaries.





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.





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 is registered and all qualified employees as
defined by statutory regulations are eligible to participate in the
plan.





Contributions
to the pension or retirement plan are calculated at 22% 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. The Company incurredcostsof $209,000, $89,000, and
$22,000 forthe
years endedDecember 31, 2009,2008,and 2007,respectively.





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, 2009 and 2008 because of the relatively short-term maturity
of these instruments.  The fair
value of derivative instruments is provided by the use of an independent third
party valuation expert.  Certain derivatives with limited market
activity are valued using externally developed models that consider unobservable
market parameters.


Subsequent
Events




The Company evaluated subsequent eventsthrough the date of filing of
this Form 10-K in accordance with the Subsequent Events Topic of the FASB
Accounting Standards Codification under ASC topic 855.





Recent
accounting pronouncements





The
Financial Accounting Standards Board (“FASB”) has codified a single source of
authoritative nongovernmental U.S. GAAP, the “Accounting Standards
Codification”   (the “Codification” or “ASC”). While the Codification does
not change U.S. GAAP, it introduces a new structure that is organized in an
easily accessible, user-friendly on-line research system. The Codification
supersedes all existing accounting standards documents. All other accounting
literature not included in the Codification will be considered nonauthoritative.
Unless needed to clarify a point to readers, we will refrain from citing
specific section references when discussing application of accounting principles
or addressing new or pending accounting rule changes.





In December 2007, the FASB
issuednew accounting guidance on business
combinations. The new guidance establishes principles and requirementsfor how an acquirer recognizes and
measures in itsfinancial statementsthe identifiable assetsacquired, the liabilities assumed, any noncontrolling interest in the acquiree and
the goodwill acquired. The new accounting guidance also
establishes disclosure requirementsto enable the evaluation of the nature
and financial effectsof the business combination. The new
guidance is effective as of
the beginning of an entity’s fiscal year that begins
after December 15,
2008, and wasadoptedby the Companyin the first quarter of Fiscal
2009.




F-14




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




3.
            Summary ofSignificant AccountingPolicies (Continued)





In April 2009, the FASB issued newaccounting guidance
addressing the interim disclosures about the fair value of financial
instruments, which amended the previous disclosures
regarding the fair value of financial instruments, and interim financial reporting. This
new guidance requires disclosures about the fair value of
financial instrumentsin interim financial
statements, in addition to the annual financial
statementsas already required. This new accounting guidance became
effective for interim periods ending after June 15, 2009, andwas adoptedby us in the third quarter of Fiscal
2009. The adoption of this new guidance had no material impact on our
consolidated financial statements.




In April 2009, the FASB issuednew accounting guidance regarding the
determination of fairvalue
when the volume and level of activity for assetsor liabilities have significantly
decreased, and identifying transactions that are
not orderly. This guidance requires an evaluation of whether there has been a
significant decrease in the volume and level of activity for the asset or
liability in relation to normal market activity for the asset or liability. If
there has, transactions or quotedprices may not be indicative of fair
value and a significant adjustment may needto be made to those prices to estimate fair value.
Additionally, an entity must consider whether the observedtransaction was orderly (that is, not
distressedor forced). If the transaction was orderly, the
obtainedprice can be considereda relevant observable input for determining fair
value. If the transaction is not orderly, other valuation techniques must be
usedwhen estimating fair value. This new
accounting guidance must be applied prospectively for interim periods ending
after June 15, 2009,
and was adopted by us effective June 30, 2009,buthadnomaterialimpact on ourconsolidatedfinancial statements.





In May 2009, the FASB issuednew accounting guidance, “Subsequent Events”, which establishedgeneral standards of accounting for and
disclosure of eventsthat occur after the balance sheet date
but before the financial statementsare issuedor available to be issued. The guidance requires new disclosure
in financial statementsof the datethrough which reporting entities have
evaluatedeventsor transactions that occur after the
balance sheet date but before the financial statementsare issuedor available to be issued. The guidance requires public entities,
including the Company, to
evaluate subsequent eventsthrough the date that the financial
statementsare issued. Financial statementsare consideredissuedwhen they are widely
distributedto stockholders and other financial
statement users for general use andreliance in a form and format that
complies with U.S. GAAP. The guidance is effective for interim and annual
financial periods ending after June 15, 2009 and shall be appliedon a prospective
basis.





In April 2008, the FASB issuednew accountingguidance regarding the determination of
useful lives of intangible assetsthat amends the factors that should be
consideredin developing renewal or extension
assumptions usedfor purposes of determining the useful
life of a recognizedintangible asset. This guidance is
intendedto improve the consistency between the
useful life of a recognizedintangible asset under accounting
guidance relatedto goodwill and other intangible
assetsand the period of expectedcash flows usedto measure the fair value of the asset
under accounting guidance relatedto business combinations and other
U.S. GAAP. This guidance is effective for fiscal years beginning after
December 15, 2008, andwasadoptedby us in the first quarter of
Fiscal 2009.Theadoption of this guidancedid nothave a material effect on the
Company’sresultsof operations and financial
condition.





Standards Not Yet Adopted





In April
2009, the FASB issued new accounting guidance regarding the accounting for
assets acquired and liabilities assumed in a business combination due to
contingencies. This new guidance clarifies the initial and subsequent
recognition, subsequent accounting and disclosure of assets and liabilities
arising from contingencies in a business combination. This new guidance requires
that assets acquired and liabilities assumed in a business combination that
arise from contingencies be recognized at fair value, if the acquisition date
fair value can be reasonably estimated. If the acquisition-date fair value of an
asset or liability cannot be reasonably estimated, the asset or liability would
be measured at the amount that would be recognized using the accounting guidance
related to accounting for contingencies or the guidance for reasonably
estimating losses. This new accounting guidance becomes effective for us on
November 1, 2010; however, as the provision of the guidance will be applied
prospectively to business combinations with an acquisition date on or after the
guidance becomes effective, the impact to us cannot be determined until a
transaction occurs.




F-15




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




4.           Revenue
By Product Category and Geographic Region




In 2009, 2008 and 2007, overseas sales
were approximately $10,121,000, $7,570,000 and $12,404,000,
respectively.




Our total
revenues during fiscal 2009, 2008, and 2007 were approximately $130,092,000,
$91,816,000, and $49,318,000, 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 years ended December 31, 2009, 2008, and 2007:




For the Years Ended December
      31,
                                                ($ in
      thousands)2009
                                              2008
                                              2007Product
      Category
                                              Sales
                                              % ofSales
                                              Sales
                                              % of Sales
                                              Sales
                                              % of
  SalesPatches
                                              $40,770
                                              31.3%
                                              $35,484
                                              38.6%
                                              $19,609
                                              39.9%Ointments
                                              28,862
                                              22.2%
                                              23,068
                                              25.1%
                                              3,270
                                              12.6%Sprays
                                              $18,499
                                              14.2%
                                              10,613
                                              11.6%
                                              8,742
                                              18.7%Diagnostic Kits
                                              10,239
                                              7.9%
                                              8,781
                                              9.6%
                                              2,994
                                              6.1%Contract
    Sales
                                              $0
                                              0.0%
                                              5,655
                                              6.2%
                                              12,998
                                              16.6%Others
                                              31,722
                                              24.4%
                                              8,215
                                              8.9%
                                              1,705
                                              6.2%Total
                                              $130,092
                                              100.0%
                                              $91,816
                                              100.0%
                                              $49,318
                                              100.0%





Year over year–2009 to 2008




The
Company’s revenues increased in 2009 compared to 2008, primarily due to itscooperation with more reputable sales
agentsand distributors, which have been able
to put the Company’s productsin more extensivesales networks, and the full-year effect
of sales of productsof Tianlong and Peng Lai, two of the
businesses the Company acquired in fiscal 2008.  As a result of
signing agreementswith these distributors, the sales
revenues for productsin the patches,sprays, and diagnostic kitscategories increased 14.9%, 74.3%, and
16.6% year over year.  The revenue increase of approximately
$5,794,000 inthe ointment category, and the
revenue  increase of approximately $23,507,000 inother productscategory, are primarily due to the
Company’s increased spending in marketing and
advertising for certain productsin these categories.Tianlong’s productsgenerated approximately $43,138,000 and
$13,803,000in 2009 and
2008, respectively.  Revenue generated by Tianlong’s productsare included in the ointment, spray and
other product categories.  Peng Lai’s productsgenerated approximately $11,188,000 and
$2,164,000 in 2009 and 2008, respectively.  Revenue generated by Peng
Lai’s productsare included in the other
product category.




Out of the 91 productsthe Company commercialized in fiscal
year 2009, 10 productsaccounted for approximately 68% of the
total revenue.  Out of the 97 productsthe Company commercialized in fiscal
year 2008, 10 productsaccounted for approximately 72% of total
revenue.




Year over year–2008 to 2007




During the fiscal year endedDecember 31, 2008, the Company
acquiredTianlong  (April 2008), Haina
(April 2008) and Peng Lai (September 2008).  The Company’s increase in revenues in 2008 as comparedto 2007 was due to a combination of
thesebusiness
acquisitions,as well as the Company’s internal growthdriven by increases in the revenues of
TDR and First.




The
Company’s internal growth was driven by increases in the revenues of TDR, which
increased from approximately $33,326,000 in 2007 to approximately $60,078,000 in
2008 and First, which increased from approximately $2,994,000 in 2007 to
approximately $8,781,000 in 2008.  These increases were partially
offset by a decrease in the Company’s contract sales of approximately
$7,358,000, or 57%, from approximately $12,998,000 in fiscal 2007 to
approximately $5,640,000 in fiscal 2008, due primarily to our discontinuance of
contract sales of Tianlong products following the acquisition of Tianlong as of
April 3, 2008.




F-16




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




4.
            Revenue
      By Product Category and Geographic Region
  (Continued)




In 2008,
before TDR acquired Tianlong, the majority of the Company’s contract sales
consisted of products purchased from Tianlong.  In 2008, TDR began to
discontinue contract sales, and in 2009, TDR discontinued contract sales as part
of its strategic goals and, in 2009 TDR discontinued contact sales. Revenues
derived from the sale of a Tianlong product of approximately $4,805,000 and
approximately $1,477,000 for 2007 and 2008 respectively, have been reallocated
to each of the appropriate product categories to present a more appropriate
measure of our revenues by product line.




Following
the Tianlong acquisition, the Company was able to fully integrate Tianlong’s
products into its marketing and distribution channels and increase overall
sales.  As a result, the Company derived an aggregate of approximately
$13,803,000 from the sale of Tianlong’s products for the remainder of 2008, in
addition to approximately $1,447,000 of contract sales of Tianlong’s products
from January 1, 2008 through the Tianlong acquisition.




Prior to
the Company’s acquisition of Peng Lai, as of September 5, 2008, Peng Lai had
nominal production and operations.  Following the acquisition, Peng
Lai contributed revenue of approximately $2,164,000 to the Company’s total
revenue in 2008.




Haina did not have an
establishedsales network and was
acquiredonly for itsGSP license.




5.
            Concentrations
      of Business and Credit Risk




Substantially all of the Company's
long-livedassetsand business operations are
locatedin the PRC.




The Company maintains certain bank
accountsin the PRC which are not
protectedby FDIC insurance or other insurance.
As of December 31, 2009 the Company held approximately $1,960,000 of cash
balances within theU.S.and all of the depositswerewithin  the FDIC insurance
limits. At December 31, 2009, the Company had
approximately$50,796,000inChina bank deposits, which is not insured..




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




The Company provides credit in the normal course of business. The
Company performs ongoing credit evaluations of itscustomers and maintains allowances for
doubtful accountsbasedon factors surroundingthe credit risk of specific customers,
historical trends, and other information.




The Company is self-insuredfor all risks and carries no liability
or property insurance coverage of any kind. The Company does not setaside any reserves for product
liability risks or other potential claims. The Company’s policy is to record losses
associatedwith itslack of insurance coverage at such time
as a realizedloss is incurred. Historically, the Company has not
had any material losses in
connection with itslack of insurance coverage and was not
party to any material pending legal proceedings as ofDecember 31, 2009.Management’s intention is to use the
Company’s working capital tofund any such losses incurreddue to the Company’s exposure to inadequate insurance
coverage.




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




Major
Customers




For the year endedDecember 31, 2009, Harbin Shiji Baolong
Medicine Company and Shanxi Xintai
Medicine Company accountedforapproximately16% and 11% respectively of total
revenues. For the year endedDecember 31, 2009, Harbin Bao Da
Medicine Company and Harbin Shiji Baolong
Medicine Company accountedforapproximately16% and 14% respectively of all
accountsreceivable. For the year
endedDecember 31, 2008, Shanxi Xintai and
Harbin ShijiBaolong
accountedfor 15%and 12% respectively oftotalrevenues. Harbin Shiji Baolong and
Shanxi Xintai accountedforapproximately29% and 11% respectively of all
accountsreceivable. For the year
endedDecember 31, 2007, Ning BoYue Hua
Trading Company and Guang Zhou Xing He Trading Company accountedforapproximately14% and 11% oftotalrevenues, respectively. Hua Li Jiu
Zhou Company
accountedforapproximately11% of all accountsreceivable.No other customers accountedfor 10% or more of our total revenues
or accountsreceivable in 2009
and 2008.




F-17




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




5.
            Concentrations
      of Business and Credit Risk
(Continued)




Major
Suppliers




Harbin Zhong Jia Medicine Companyand Heilongjiang Kangda MedicineCompanyaccountedfor approximately 16% and
42%of the Company’stotalinventory purchases for the year
endedDecember31, 2009.Heilongjiang Kangda MedicineCompanyaccountedfor approximately 33% of the
Company’stotalinventory purchases for the year
endedDecember 31, 2008.Harbin Yong Heng accounted for 23% of
the Company’s total inventory purchasesfor the year ended December 31,2007.No other suppliers accountedfor 10% or more of our totalinventory
purchasesin 2009, 2008,
and 2007.




6.
            Earnings per
      Share




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




Stock warrantsto purchase750,000shares of common stock were
outstanding and exercisable as of December
31, 2009. Stock warrantsand options to purchase1,151,000shares of common stock, all were
exercisable and outstanding during the year endedDecember 31, 2008.These common stock
equivalentswere includedin the computation of dilutedearnings per share because the option
exercise prices were less
than the average market price of our common stock during these
periods.As of December 31,
2008,there were12,500 options with
exercise price of $3.65outstanding andremained unvested,These options were all cashless
exercised during the fiscal
year of 2009.Stock
warrantsand options to purchase 1,617,483
shares of common stock were all exercisable and outstanding during the year ended December
31, 2007.




The dilutive potential common shares on
warrantsand options is calculatedin accordance with the treasury stock
method, which assumes that proceeds from the exercise of all
warrantsand options are usedto repurchase common stock atthe averagemarketprice of the commonstock during the relevant
period. The amount of
shares remaining after the proceeds are exhaustedrepresent s the potential dilutive
effect of the securities.




The following table setsforth our computation ofbasic and diluted net income per
sharefor the years ended
December 31, 2009, 2008 and 2007:




$ in
thousands,
                              except share and per sharedataFor the year ended December
      31,Numerator:
                            
                            2009
                            
                            
                            2008
                            
                            
                            2007Net income used in calculation of
      basic and diluted earnings per share
                            
                            $
                            34,457
                            
                            
                            $
                            28,857
                            
                            
                            $
                            15,333Denominator:Weighted-average common shares
      outstanding used in calculation of
      basic earnings per share
                            
                            
                            16,575,885
                            
                            
                            
                            15,101,833
                            
                            
                            
                            12,094,949Effect of dilutive
      securities:Warrantsand
Options
                            
                            
                            750,000
                            
                            
                            
                            327,303
                            
                            
                            
                            1,275,579Weighted-average common shares
      used in calculation of diluted earnings per share
                            
                            
                            16,668,452
                            
                            
                            
                            15,429,136
                            
                            
                            
                            13,370,528Net income per
      share:Basic
                            
                            $
                            2.08
                            
                            
                            $
                            1.91
                            
                            
                            $
                            1.27Diluted
                            
                            $
                            2.07
                            
                            
                            $
                            1.87
                            
                            
                            $
                            1.15




F-18




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




7.
            Equity and Share-basedCompensation




Effective January 1, 2006, we
adoptedthe fair value recognition provisions
of SFAS No. 123R, Share-BasedPayment (“SFAS No. 123R”), for options grantedto employees and directors, using the
modifiedprospective transition method, and
therefore have not restatedresultsfrom prior periods. Compensation cost
for all stock-basedcompensation awards grantedis basedon the grant date fair value
estimatedin accordance with the provisions of
SFAS No. 123R. Under the fair value recognition provisions of SFAS No. 123R, we
recognize stock-basedcompensation net of an
estimatedforfeiture rate and only
recognize compensation cost
for those shares expectedto vest on a straight-line
proratedbasis over the requisite service period
of the award. In March 2005, the SEC issuedStaff Accounting Bulletin
(“SAB”) No. 107, Share-BasedPayment (“SAB No.107”), regarding the SEC’s guidance on SFAS No. 123R and the
valuation of share-basedpaymentsfor public companies. We have
appliedthe provisions of SAB No.107 inthe adoption of SFAS No.
123R.




In July 2006, the Company’s stockholders approvedthe 2006 Stock Incentive Plan (the
“2006 Plan”). The 2006 Plan, provides for the grant
of stock options, restrictedstock awards, and performance shares to
qualifiedemployees, officers, directors,
consultantsand other service providers. The 2006 Plan
originally
authorizedthe Company to grant options and/or
rightsto purchase up to an aggregate of
1,500,000 shares of common stock.As of December 31, 2009,there have beena total of198,202commonshares grantedbased on the2006 Planto Company employees and
consultants.These 198,202 common shares are
consistedas the following:




In 2006,non-qualifiedoptions to purchase a total of 113,500
sharesweregrantedunder the 2006 Stock Incentive
Planto certain company employees and
consultants.All options hadan exercise priceof $3.65 per share. All theseoptionswerecashless exercisedat various prices during2009 inexchange for  85,295 common
shares.




In 2007, a total of 30,000 common shares
were granted to certain company employeesat a fair value of $195,000.




In 2008, a total of 30,063 common shares
were granted to certain company employees, consultants, and independent directorsat a fair value of $316,000.




In 2009, a total of 52,844 common shares
were grantedto certain company employees,
consultants, and independent directors.The fair value of thesesharesis determinedto be approximately $1,242,000
basedon the stock closing price
atthe date of the
grant.




In 2009, we issuedan aggregate of 355,239
shares of our common stock
in connection with their exercise of outstanding warrantsand stock options of ours, as
follows:




·
            In January
      2009,  warrantsto purchase an aggregate
      of  8,334
      shares of our common stock, which we issuedto “accredited”investors in connection with the
      private offering we completedin October 2006 (the
      “2006
      Offering”), were cash
      exercisedat a price of $3.50 per share,
      for an aggregate proceeds of
    $29,169.




·
            In January and May 2009,
      warrantsto purchase an aggregate of
      300,000 shares of our common stock at $2.00 per share, which we issued to
      a consultant in consideration for services rendered in connection with the
      share exchange transaction we
      consummatedin May
      2006, wereexercisedon a cashless basisat various prices in
      exchange for  261,610 common
  shares.




·
            In 2006, non-qualified options to
      purchase a total of 113,500 shares were granted under the 2006
      Stock Incentive Plan
      to certain
      Company employees and
      consultants. All options had an exercise
      price of $3.65 per share. All these options were cashless
      exercisedin various prices during2009 inexchange for  85,295
      common shares.




F-19




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




8.
            Securities Purchase Agreement and
      RelatedTransaction




On January 31, 2008 (the “Closing Date”), the Company enteredinto a Securities Purchase Agreement
(the “Purchase
Agreement”) with certain
accreditedinvestors (the “Investors”), for the purchase and sale of
unitsconsisting of an aggregate of: (i)
2,500,000 shares of the Company’s common stock, and (ii) Class A
Warrantsto purchase 750,000
additionalshares 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
receivednet 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 itscommon 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.At December 31, 2009,
management deemed the estimated fair value of this derivative
warrant liability to be immaterial.




In addition, as of the Closing Date, the
Company enteredinto a Make Good Agreement (the
“Make Good
Agreement”) with Liu
Yan-Qing, itsChairman, 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 deposited3,000,000 shares of his common stock of
theCompany (the
“Escrow Shares”) into escrow, to be releasedto the Investors in an amount pro rata
pro to their initial investmentsin the 2008 Offering, in the event the
Company failedto attain earnings per share, as
adjusted, of at least (i)$1.05 per share for the fiscal year
ending December 31, 2007 (basedon an aggregate of 13,907,696 shares
outstanding), and/or (ii) $1.63 per share
for the fiscal year ending December 31, 2008 (basedon 16,907,696 shares outstanding).




The Company deems the Escrow Shares
arrangement as analogous to the issuance of a fixednumber of warrantsin an equity transaction. Under the
Make Good Agreement these Escrow Shares would have
been  reallocatedon a pro rata basis to the Investors only if certain
earnings targetswere not achievedin years 2007 and 2008. If the earnings
targetswere met, the Escrow Shares would
automatically be releasedto the Principal Shareholder. As of
January 31, 2008, the date the common shares were placedinto escrow, the Company
achievedthe 2007 earnings target and,
basedupon internal forecasts, was confident the 2008 target would
also be met. Basedupon certain assumptions, including the
low probability that the Escrow Shares would be releasedto the Investors and not be
returnedto the Principal Shareholder, the
Company consideredthe 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 satisfiedthe earnings per common share
targetsfor each of fiscal 2007 and 2008 as
definedunder the Make Good Agreement and, as
such, the Escrow Shares shall be releasedto the Principal Shareholder in 2009.




The Class A Warrantsrepresent 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 Warrantsis providedin Note 9.




9.
            Outstanding
      Warrants and Options




Shares
                          Underlying Warrants
                        
                        
                        Weighted
                          average
                          Exercise
                          Price
                          Warrants
                        
                        
                        Shares
                          underlying
                          Options
                        
                        
                        Weighted
                          average
                          Exercise
                          Price
                          OptionsOutstanding as of December 31,
      2008
                        
                        
                        1,050,000
                        
                        
                        $
                        9.50
                        
                        
                        
                        113,500
                        
                        
                        $
                        3.65Exercised (See Note
      7)
                        
                        
                        (300,000
                        )
                        
                        
                        (50,000
                        )
                        
                        
                        (113,500
                        )
                        
                        
                        (113,500
                        )Outstanding as of December 31,
      2009
                        
                        
                        750,000
                        
                        
                        $
                        12.50
                        
                        
                        
                        -
                        
                        
                        
                        -





F-20




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




9.
            Outstanding
      Warrants and Options (Continued)





The following table summarizes
information about stock warrantsoutstanding and exercisable as of December
31, 2009.





Exercise
                      Price
                  
                  
                  Outstanding
                      December 31,
                      2009
                  
                  
                  Weighted
                      Average
                      Remaining
                      Life in
                      Years
                  
                  
                  Number
                      exercisable$12.50
                  
                  
                  
                  750,000
                  
                  
                  
                  3.0
                  
                  
                  
                  750,000750,000
                  
                  
                  
                  
                  
                  
                  
                  750,000







The remaining Class A Warrantsrepresent the right to purchase an
aggregate of750,000 shares
of Common Stock of the Company grantedwith the Securities Purchase Agreement,
at an exercise price of $12.50 per share,all were exercisableas of December 31, 2009,and have the following additional
characteristics:




The Class A Warrantsissuedin our January 2008 Offering
describedin Note8above, 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 Warrantsare 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 theClosing Date,
      in the event the Warrant Shares may not be freely sold by the holders of
      the Class A Warrantsdue to the Company’s failure to satisfy itsregistration
      requirements, and an exemption for such sale
      is not otherwise available to the Warrant-holders under Rule 144, the Class A
      Warrantswill be exercisable on a cashless
      basis.The Company
      accountsfor thiswarrant derivative liabilityin accordance with
      ASC 815.




·
            The Exercise Price and number of
      Warrant Shares will be subject toadjustment 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.There was no issuance
      of securities during 2009which would have
      resultedin an adjustment to the Exercise
      Price or number of Warrant Shares.At December 31, 2009, the Company
      recordedan expense and relatedderivative liability
      of  $1,330,000.  The Company’s significant assumptions to
      calculate the derivative liability at December 31, 2009 included(i) life of warrantsof 3.7 years; (ii)
      expectedvolatility of 68%; (iii) a risk
      freeinterestrate of 2.16% and a
      (iv) a
      risk-neutralprobability that the
      stock price will be below $12.50 at warrant expiration of
      12%.




·
            At anytime following the date a
      Registration Statement covering the Warrant Shares is declaredeffective, we will have the ability to call
      the Class A Warrantsat 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$18.75for 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 attainedan AdjustedEPS of at least $1.75 per share
      for the fiscal year ending December31, 2008, as set forth in our
      auditedfinancial statementsof the
      Company.




·
            If, among other things, we fail to
      cause a Registration Statement covering the Warrant Shares to be
      declaredeffective prior to the applicable
      dates set forth in the Registration RightsAgreement, the expiration date of
      the Class A Warrantsshall be extendedone day for each day beyond the
      Effectiveness Deadlines.The Company engagedan independent third-party consultant to calculate
      the derivative liabilityusing the Black Scholes modelresulting from
      itsfailure to register the Warrant
      Shares. Theestimatedregistration rightsderivative liability was
      determinedto be immaterial as of
      December 31,
      2008.




F-21




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




9.
            Outstanding
      Warrants and Options (Continued)




·
            If a Warrant-holder exercises
      itsPut Right under the Put Agreement
      (as previously definedabove), such
      Warrant-holder’s right to exercise the Class A
      Warrantsshall 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
      Warrantsshall automatically and
      permanently terminate and expire, and
      the Class A Warrantsshall be immediately cancelledon the books of the
      Company.




10.
            Inventories




The Company values itsinventories at the lower of
cost and market method.
Inventories are accountedfor using the first-in, first-out
method. Inventories include packing materials, raw materials, supplemental
materials, work-in-process, and finishedproducts.




As of December 31, 2009and 2008, inventories consist of the
following:




$ in thousandsDecember 31,
                    2009
                
                
                December 31,
                    2008Raw
Material
                
                $
                1,192
                
                
                $
                330Work-in-Process
                
                
                578
                
                
                
                76Finished Products
                
                
                642
                
                
                
                56Total
      Inventories
                
                $
                2,413
                
                
                $
                462






The
increase in our inventory level at December 31, 2009 versus December 31, 2008 is
principally due to the 42% increase in our 2009 revenue compared to 2008. The
increased inventory level at December 31, 2009 is deemed sufficient to support
our estimated sales in the near term of 2010.




Historically,
our inventory is at its lowest levels at the end of each calendar year and in
the first fiscal quarter. We draw down our inventory levels in December of each
year for two main reasons. First, our customers want to receive goods prior to
the holiday season.  In addition, the first calendar quarter is
traditionally our slowest sales period. Since a lower volume of sales activity
normally occurs during the first quarter of each calendar year, we believe it is
prudent to avoid incurring unnecessary inventory carrying costs. At the
appropriate time toward the end of the first calendar quarter of each fiscal
year, we begin to ramp up its inventory levels to prepare for increased demand
during the coming stronger selling periods.





Historically,
we signed agreements with suppliers that allowed us to hold extra raw materials
at the cost of the suppliers. As a result, we could minimize our own inventory
carrying costs, and improve our cash management, by keeping the inventory at the
minimum level required to support the short-term sales. However, due to price
increases of raw materials, in addition to overhead costs for storing such raw
materials, the Company started to increase the inventory levels at our own cost
at the end of year 2009.




F-22




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




11.
            Property and Equipment,
  net




As of
December 31, 2009 and 2008, Property and Equipment, net consist of the
following:




$ in thousandsDecember
31,
                      
                      
                      December31,2009
                      
                      
                      2008Buildings and
      improvements
                      
                      $
                      10,570
                      
                      
                      $
                      9,962Machinery and
      equipment
                      
                      
                      5,868
                      
                      
                      
                      4,946Transportation
      equipment
                      
                      
                      955
                      
                      
                      
                      886Furniture and
      equipment
                      
                      
                      325
                      
                      
                      
                      299Total Property and
      Equipment
                      
                      
                      17,718
                      
                      
                      
                      16,093Less: Accumulated
      Depreciation
                      
                      
                      (2,227
                      )
                      
                      
                      (1,297
                      )Property and Equipment,
      Net
                      
                      $
                      15,491
                      
                      
                      $
                      14,796





For the
years ended December 31, 2009, 2008 and 2007, annual depreciation expense
totaled $926,000, $584,000 and $187,000, respectively.





Depreciation
expense included with Cost of Goods Sold for 2009, 2008 and 2007, amounted to
$491,000, $226,000, and $68,000, respectively.





12.
            Intangible
      Assets, net





Intangible
assets consists of proprietary technologies that we purchased during our normal
course of business. The SFDA licenses for drug batch numbers and goodwill were
acquired in connection with our business acquisitions of Tianlong and Peng Lai
in 2008.





A breakdown ofour intangible assets, net by subsidiariesas of December 31, 2009isas follows::




Intangible
      Assets as of December 31, 2009, net
                          ($
      in Thousands)Item
                        TDR
                        Haina
                        Tianlong
                        First
                        Peng
      Lai
                        TotalProprietary
      Technologies
                        $1,275
                        -
                        $5,034
                        $11,854
                        -
                        $18,163SFDA
      licenses for drug batch numbers
                        -
                        -
                        $1,751
                        -
                        $4,441
                        $6,192Goodwill
                        $406
                        $353
                        -
                        -
                        -
                        $759Total
                        $1,681
                        $353
                        $6,785
                        $11,854
                        $4,441
                        $25,114





Historically,
we included our proprietary technologies and SFDA licenses for drug batch
numbers under the category of patents.  We now believe it is more
accurate to categorize such IP in separate categories.





As of December 31, 2009, the weighted
average amortization period
for our proprietary technologiesandSFDA licenses for drug batch
numbersis approximately 8
years.





F-23




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




12.
            Intangible
      Assets, net (Continued)




A breakdown of our intangible
assets, netby subsidiaries as of December 31, 2008
is as follows:




Intangible Assetsas of December 31, 2008,
      net
                          ($ in
      thousands)Item
                        TDR
                        Haina
                        Tianlong
                        First
                        Peng Lai
                        TotalProprietary
      Technologies
                        $1,471
                        -
                        -
                        $6,739
                        -
                        $8,210SFDA
      licenses for drug batch numbers
                        -
                        -
                        $1,947
                        -
                        $4,936
                        $6,883Goodwill
                        $406
                        $353
                        -
                        -
                        -
                        $759Total
                        $1,877
                        $353
                        $1,947
                        $6,739
                        $4,936
                        $15,852







The
increase in intangible assets of approximately $9.3 million in 2009 compared to
2008 is primarily due to our acquisitions of proprietary technologies by
Tianlong and First during the fourth quarter of 2009. These proprietary
technologies include Antroquinonol for the treatment of lung and liver cancers
and Small RNA diagnosing technology used for detecting heart diseases in its
early stage.




Amortization expense of our intangible
assetswith finite lives for each of the years
ended December 31, 2009, 2008 and 2007was approximately $1,821,000, $274,000 and $256,000 respectively.
Future amortization for the next five years and thereafter is as
follows:




YearsEnded December
      31,
                  
                  $ in
    thousands2010
                  
                  $
                  2,7172011
                  
                  $
                  2,7172012
                  
                  $
                  2,7172013
                  
                  $
                  2,7152014
                  
                  $
                  2,715Thereafter
                  
                  $
                  10,773$
                  24,355







13.
            Taxes
    Payable




Taxes payablefor the years endedDecember 31, 2009, 2008, and
2007consistsof the following:




December
31,($ in
      thousands)2009
                
                
                2008
                
                
                2007Value Added Tax,
      net
                
                $
                1,291
                
                
                $
                1,179
                
                
                $
                612EnterpriseIncome Tax
                
                2,452
                
                
                
                2,107
                
                
                
                941City Tax
                
                
                43
                
                
                
                32
                
                
                
                5Other Taxes and
      additions
                
                86
                
                
                
                45
                
                
                
                9Total Taxes
      Payable
                
                $
                3,873
                
                
                $
                3,363
                
                
                $
                1,567





F-24




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




14.
            Income
  Taxes




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




According to “Enterprise Income Tax and Certain
Preferential Policies Notice”publishedby the Ministry of Finance and the
National Tax Affairs Bureau, if the enterprise is authorizedby the State Council as a special
entity, the enterprise income tax rate is reducedto 15%.The following table setsforce theincometax rate for TDR and itssubsidiaries for the yearsended December 31, 2009,2008and 2007:




Income
      Tax Rate
                  2009
                  2008
                  2007TDR
                  15%
                  15%
                  15%First
                  15%
                  25%
                  25%Tianlong
                  15%
                  12%
                  -Haina
                  25%
                  25%
                  -Peng
      Lai
                  2%
      of Revenue
                  25%
                  -







The Company’s effective tax rate was approximately
23.4% in fiscal 2009.If
the Company’s effective tax rate was 25% in 2009,
itsnet income will be $33,720,000, basic
earnings per share and dilutedearnings per share would be $2.03 and
$2.02, respectively.




The Company’s effective tax rate was approximately
20.1% in fiscal 2008.If the Company’s effective tax rate was 25% in
2008, itsnet income will be $27,355,000, basic earnings per share and
dilutedearnings per share would be
$1.81and $1.77, respectively.




The Company’s effective tax rate was approximately17.8% in fiscal 2007.If the Company’s effective tax rate was 25% in 2009,
itsnet income will be $13,989,000, basic earnings per
shareand dilutedearnings per share would be
$1.16and $1.05, respectively.




We record a full valuation allowance to
reduce our deferredtax assetsto the amount that is more likely than
not to be realized. While we have consideredfuture taxable income and ongoing
prudent and feasible tax planning strategies in assessing the needfor the valuation allowance, in the
event we were to determine that we would be able to realize our
deferredtax assetsin the future in excess of itsnet recordedamount, an adjustment to the
deferredtax 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, 2009, the Company has US net operating loss carryforwards of
approximately $8.8 million which will begin to expire in
2029.  Accordingly, as mentioned above, any deferred tax asset that
would result from these carryforwards have been fully reserved as of December
31, 2009.




Provision for the PRC enterprise income tax is
calculatedat the prevailing rate basedon the estimatedassessable profitsless available tax relief for losses
brought forward. The Company does not accrue taxes on unremittedearnings from foreign operations as it
is the Company’s intention to invest these earnings in
the foreign operations indefinitely.




F-25




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




14.
            Income Taxes
      (Continued)




Net deferred tax assetsconsist of the following
componentsas of December 31, 2009and 2008:




December 31,
                      ($ in
      thousands)2009
                    
                    
                    2008Deferredtax
      assets:NOL Carryover from China Sky One
      (formerly known as Comet)
                    
                    $
                    2,566
                    
                    
                    $
                    1,646Share-basedcompensation expenses
      basedon SFAS123R
                    
                    
                    422
                    
                    
                    
                    1212,988
                    
                    
                    
                    1,767Less valuation
      allowance
                    
                    
                    (2,988
                    )
                    
                    
                    (1,767
                    )Net deferredtax asset
                    
                    $
                    -
                    
                    
                    $
                    -





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 issuedby current state
officials.




Based on all known factsand circumstances and current tax law,
the Company believes that the total amount of unrecognized taxbenefitsas of December 31, 2009, is not material to itsresultsofoperations, financial condition or cash
flows. The Company also believes that the total amount of unrecognized taxbenefitsas of December 31, 2009, if recognized, would not have a
material effect on itseffective tax rate. The Company further
believes that there are no
tax positions for which it is reasonably possible, basedon current Chinese tax law and policy,
that the unrecognizedtaxbenefitswill significantly increase or decrease
over the next 12 months producing, individually or in the aggregate, a material effect on the
company’s resultsof operations, financial position or
cash flows.




The
Company’s corporate tax returns are subject to examination in both China and the
U.S. for the years 2006 through 2009.




15.
            Land Use Rightsand Construction inProgress




The Companyconsidersthe fact that, in the PRC,there is no land ownership butrather the land use right
and it is more appropriate
to allocate land use rightsunder aseparate category and amortize land use
rightsbased on 50 years of the land use rights, or the term of the lease. The land use rightsare approximately $4,586,000
and$1,945,000for the years ended December 31, 2009
and2008, respectively.




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
rightsfor 50 years forthedevelopment of a new biotech
engineering project.We spent approximately
$9.9million, $730,000, and $2.1 million in the yearsof 2009, 2008, and 2007respectively for this construction in
progress.The
Company moved into its new facilities in January 2010 and anticipates the final
stage of construction will be completed during the third quarter of 2010 at an
additional cost of approximately $3.0 million.


16.
            Commitmentsand
      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
ProductsInspection 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 regulatedby various governmental agencies for
the countries, states and localities in which the Company’s productsare sold.




Although management believes that the
Companyis 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 challengedby governing authorities or private
parties, or thatsuch
challenges will not have a material adverse effecton the Company’s financial position, resultsof operations, or cash
flows.




F-26




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




16.
            Commitmentsand Contingencies
      (Continued)




The Company, like any other distributor
or manufacturer of productsis exposed to the inherent risk of
product liability claims in the eventsof possible injuries caused by the use
of itsproducts. The Company does not have liability
insurance with respectto product liability claims; the
insurance environment ofChinais neither sufficient nor mature.
Inadequate insurance or lack of contractual indemnification from parties
supplying raw materials or marketing itsproducts, and product liabilities related to defective productscouldhave a material adverse
effecton theconsolidated financial
statementsof theCompany.




The Company is not involvedin 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’sconsolidatedfinancial position, resultsof operations, or cash
flows.




17.
            Quarterly Results(Unaudited)




The following table presentsthe Company’s selected unaudited quarterly operating
resultsfor the eight quarters
endedDecember 31,
2009. The Company believes
that all adjustmentsof a normal recurring natural have been
made to present fairly the relatedquarterly results:




$ in thousands, except per share
      dataYear 2009
                    
                    First
    Quarter
                    
                    
                    Second
    Quarter
                    
                    
                    Third
    Quarter
                    
                    
                    Fourth
    Quarter
                    
                    
                    TotalRevenues
                    
                    $
                    24,834
                    
                    
                    $
                    32,182
                    
                    
                    $
                    43,227
                    
                    
                    $
                    29,850
                    
                    
                    $
                    130,092Gross
profit
                    
                    $
                    18,793
                    
                    
                    $
                    24,429
                    
                    
                    $
                    32,330
                    
                    
                    $
                    22,870
                    
                    
                    $
                    98,422Income from
      operations
                    
                    $
                    9,051
                    
                    
                    $
                    12,082
                    
                    
                    $
                    16,030
                    
                    
                    $
                    9,088
                    
                    
                    $
                    46,251Net income
                    
                    $
                    7,243
                    
                    
                    $
                    9,457
                    
                    
                    $
                    12,459
                    
                    
                    $
                    5,298
                    
                    
                    $
                    34,457Basic EPS
                    
                    $
                    0.44
                    
                    
                    $
                    0.57
                    
                    
                    $
                    0.75
                    
                    
                    $
                    0.32
                    
                    
                    $
                    2.08DilutedEPS
                    
                    $
                    0.43
                    
                    
                    $
                    0.57
                    
                    
                    $
                    0.74
                    
                    
                    $
                    0.32
                    
                    
                    $
                    2.07
  $ in thousands, except per share
      dataYear 2008
                        
                        First
    Quarter
                        
                        
                        Second
    Quarter
                        
                        
                        Third
    Quarter
                        
                        
                        Fourth
    Quarter
                        
                        
                        TotalRevenues
                        
                        $
                        12,413
                        
                        
                        $
                        23,749
                        
                        
                        $
                        29,699
                        
                        
                        $
                        25,955
                        
                        
                        $
                        91,816Gross
profit
                        
                        $
                        9,553
                        
                        
                        $
                        18,226
                        
                        
                        $
                        22,333
                        
                        
                        $
                        19,300
                        
                        
                        $
                        69,413Income from
      operations
                        
                        $
                        4,850
                        
                        
                        $
                        10,128
                        
                        
                        $
                        11,751
                        
                        
                        $
                        8,931
                        
                        
                        $
                        35,659Net income
                        
                        $
                        3,865
                        
                        
                        $
                        8,111
                        
                        
                        $
                        9,943
                        
                        
                        $
                        6,938
                        
                        
                        $
                        28,857Basic EPS
                        
                        $
                        0.26
                        
                        
                        $
                        0.54
                        
                        
                        $
                        0.66
                        
                        
                        $
                        0.45
                        
                        
                        $
                        1.91DilutedEPS
                        
                        $
                        0.25
                        
                        
                        $
                        0.53
                        
                        
                        $
                        0.64
                        
                        
                        $
                        0.45
                        
                        
                        $
                        1.87





F-27




Item 9.  Changes In and
DisagreementsWith Accountantson Accounting and Financial
Disclosure.




None.




Item9A.  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, evaluatedthe effectiveness of our disclosure
controls and procedures as of December 31, 2009.The term “disclosure controls and procedures,”as definedin Rules13a-15(e) and 15d-15(e) under the
Securities Exchange Act, means controls and other procedures of a company that are
designedto ensure that information
requiredto be disclosedby a company in the reportsthat it files or submitsunder the Securities Exchange Act are
recorded, processed, summarizedand reportedwithin the time periods
specifiedin the SEC’s rules and forms.  Disclosure
controls and procedures include, without limitation,
controls and procedures designedto ensure that information
requiredto be disclosedby a company in the reportsthat it files or submitsunder the Exchange Act are
accumulatedand communicatedto the company’s management, including itsprincipal executive and principal financial officers, as
appropriate to allow timely decisions regarding requireddisclosure. Our management recognizes
that any controls and procedures, no matter how well
designedand operated, can provide only reasonable assurance
of achieving their
objectives and management necessarily applies itsjudgment in evaluating the
cost-benefit relationship of possible controls
and procedures.Our disclosure controls and
procedures are designedto provide reasonable assurance
of achieving their
objectives as describedabove.Basedon this evaluation, our management,
including our chief executive officer and chief financial officer, concludedthat as of December 31, 2009, 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 definedin Rule13a-15(f) or 15d-15(f) under the Securities
Exchange Act as a process designedby, or under the supervision of, a
company’s principal executive and principal
financialofficers and
effectedby 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 statementsin accordance with U.S. generally
acceptedaccounting 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 assetsof a company;




·
            provide reasonable assurance that
      transactions are recordedas necessary to permit
      preparation of financial statementsin accordance with U.S. generally
      acceptedaccounting principles and that
      receiptsand 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 unauthorizedacquisition, use, or disposition
      of a company’s assetsthat could have a material effect
      on the financial statements.




Our internal control system was
designedto provide reasonable assurance to our
management and board of directors regarding the preparation and fair
presentation of
publishedfinancial statements.All internal control systems, no matter
how well designed, have inherent limitations which may
not prevent or detect misstatements.Therefore, even those systems
determinedto 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.




Our management assessedthe effectiveness of our internal
control over financialreporting as of December 31, 2009.  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, 2009, our
internal control over financial reporting was effective based on those
criteria.




50




Attestation Report of the Registered
Public Accounting Firm





The
effectiveness of our internal control over financial reporting as of December
31, 2009 has been audited by MSPC


Certified
Public Accountants and Advisors, an independent registered public accounting
firm, as stated in their attestation report, which is included as apart of our
2009 Financial Statements filed as Item 8 of this 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, 2009, or subsequent period through the date hereof, which was not so
reported.




51




PART III




Item 10.   Directors,
Executive Officers and Corporate Governance.




Directors andExecutiveOfficers




The following table setsforth certain information regarding our
directors and executive officers during the fiscal year endedDecember 31, 2009, and the subsequent period through the
date hereof:




Name
                
                Age
                
                PositionLiu
      Yan-qing
                
                46
                
                Chief
      Executive Officer, President and Chairman of the Board of
      DirectorsHan
      Xiao-yan
                
                43
                
                Vice
      Chairman and DirectorStanley
      Hao
                
                39
                
                Chief
      Financial Officer, Secretaryand DirectorSong
      Chun-fang
                
                70
                
                DirectorWilliam
      Wei Lee
                
                55
                
                DirectorZhao
      Jie
                
                47
                
                DirectorQian
      Xu-feng
                
                42
                
                Director





The following information
reflectsthe business background and
experience of each director
and executive officer:




Liu
Yan-qinghas beenourChairman,Chief Executive Officer and
Presidentsince May
2006,aDirector of TDRsince September 2000, and General Manager of
Firstsince April
2003.Mr. Liu graduatedfrom Prophylactic Department of Harbin
Medicine University, where he
obtainedhis bachelor’s degree.In 2005, he studiedatTsingHuaUniversityand earnedan Executive Masters of
Business.




Han
Xiao-yanhas
beenour Vice Chairman and
Directorsince May
2006,aGeneral Manager of TDRsince September 2004, and Vice Director of Firstsince April 2003.She also serves as our senior marketing
manager and administrative manager.Ms. Han received a master of business
administration atHarbinIndustrialUniversity.




StanleyHaohas been employedby us in various capacities since June2008 and asChief Financial Officer, Secretary and
a Director since
November2008.From January 2006 through June 2008, Mr.
Hao servedas President’s Assistant and Financial Officer for
Sumitomo Group Canadian Branch, an integratedtrading company.Prior to this, commencing in September
2004, Mr. Hao servedas 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
joinedMGM Mirage, he was Chief Executive
Officer of SunnyZone Consulting Co. Ltd., a financial consulting company he
co-founded.Mr. Hao holdsaBachelor’s degrees in Economics and
ArtsfromBeijingUnionUniversityand an MBA from theUniversityofPhoenix.




Song Chun-fangjoinedour board of directors on February 22,
2008.From 1964 to the present, Mr. Song has been
employedby the First Clinical College of Harbin
Medical University inHeilongjiang,China, where he has servedas the Director of the Surgery Research
Room and the Director of graduate studentsof 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 receiveda Bachelor’s Degree in Medical Treatment fromHarbinMedicalUniversityin 1964.




William Wei Leejoinedour board of directors on August 4,
2009.Hehas been a Managing Director with
Transworld Capital Group, a U.S. investment service firm specializing in
cross-border M&A and fund raising between U.S. and China, since January
2007, with a break between April 2008 and November 2008, when he served as Chief
Operating Officer (on loan) for Legend Media Corporation, a U.S.-listed company
specializing in radio advertising in China.  From April 2004 through
December 2006, he served as Director of Strategic Development at TNT N.V., an
Amsterdam-based provider of postal and logistics services, where he was
responsible for M&A and China business strategy.  Prior to this,
between June 2003 and March 2004, he was a Project Manager at Roland Berger
Strategy Consultants Ltd.  Mr. Lee earned a Master’s degree in
Political Science from North Illinois University in 1989 and a Ph.D.
in Political Science from Massachusetts Institute of Technology in 1994, where
he completed MBA course work at Sloan School.  He completed
post-doctoral studies at the Fairbank Center for East Asia Studies, Harvard
University, in 1995.




52




Zhao Jiejoinedour board of directors on February 22,
2008.From 1999 to the present, Mr. Zhao has servedas the Tissue Specialist of the Replant
Department of Capital Health Transplant Services inAlberta,Canada, responsible for various
aspectsof tissue transplantation, including
determining donee acceptability, processing and preserving tissue,
performing surgical procedures, and quality control.In addition, he has written and
publishedseveral books and articles regarding
tissue transplantation.  Mr. Zhao has receivedawards from Capital Health for Quality and Safety (2006),
Recognition of Excellence and Achievement (2002), and Teamwork
(2002).  He receiveda Bachelor’s Degree in Medicine fromHarbinMedicalUniversityin 1988.




Qian Xu-fengjoinedour board of directors on February 22,
2008.From March 2005 to the present,
Ms. Qian has been employedby Moody’s Investors
Service.  From
May 2007 to the present,she has beenthe Vice President and Senior Analyst,
from May 2006 to May 2007,she wasas the Assistant Vice President and
Quantitative Analyst, and from March 2005 to April 2006, she wasthe Quantitative Analyst.Prior to that, from June 2004 until
February 2005,she was the Research Fellow of theFurmanCenterfor Real Estate and Urban Policy of New
York University, where she conductedempirical quantitative research in
various aspectsof commercial and residential
properties.From September 1990 to July 1996,
Ms. Qian was an Assistant Professor ofEconomics at theBeijingNormalUniversity.She receiveda Ph.D. in Economics fromRutgersUniversityin 2004, a Masters Degree in Economics
fromRutgersUniversityin 2001, a Masters Degreein Accounting from City University of
New York in 1999, and a Bachelor’s Degree in Economics fromBeijingNormalUniversityin 1990.




Director Qualifications, Experience and
Skills




All of our directors bring to
our Board a wealth of
executive leadership experience derived from their services as senior executives
in the medicalindustry or
knowledge specific consulting firmsor operational
businesses.Each
of our Board members has demonstrated strong business acumen and an ability to
exercise sound judgment and has a reputation for integrity, honesty and
adherence to ethical standards.  When considering whetherdirectors and nominees have the
experience, qualifications,
attributes and skills, taken as a whole, to enable the Board to satisfy
itsoversight responsibilities
effectively in light of our
business and structure, the Nominating and Governance Committee and the Board
focused primarily on the information discussed in each of the
director’s individual biographies set forth above
and the specific individual qualifications, experience and skills as described
below:




·
            Liu Yan-qinghas over 10 years of experience
      in drug marketing, research and development of new drugs and enterprise
      managementin the
      PRC.  His
      experience in these areas has been instrumental in establishing
      oursales program and
      sales network covering the PRC,and provides us with invaluable
      insight into our customers’needs and requirements.




·
            Han Xiao-yan’shygiene and medical media
      experiencehas been
      integralin
      developing and marketing TDR’s productsand expanding itssales.In addition, she has over 10 years of financial
      management experience.




·
            StanleyHao’sprior experiences as Financial
      Officer for Sumitomo Group Canadian Branch, Marketing Executive and
      Canadian Market Analyst for MGM Mirage, and Chief Executive Offer ofSunnyZone Consulting
      Co. Ltd.,a financial
      consulting company he co-founded, give him extensive knowledge of accounting,
      the capital markets, financial reporting and
      financial strategies.




·
            Song
      Chun-fang has over four decades of experience working in high level
      positions in the medical departments in universities in
      China.  His background and experience provides us with key
      industry specific contacts and
information.




·
            William
      Wei Lee Lee’s experience in cross-border M&A, fund raising and
      business strategy between the U.S. and China, including with public
      companies, provides us with crucial understanding of relevant issues
      related to our listing on the Nasdaq Global
  Market.




·
            ZhaoJie’s experience in the medical field,
      specifically in the area of tissue transplantation, provides us with
      valuable knowledge with respect to theneeds of themedical
      industry.




·
            QianXu-feng’s depth of knowledge in investor
      services andcompany
      analysis, and general expertise in economics, provides us with valuable
      understanding in these areas, which are vital to our
      business.




53




Significant Employees




Zhang Wen-chaohas been our Director of Scientific andTechnological Development
sinceMarch2005.Mr. Zhang
graduatedwith a PhD in biology pharmaceuticals
from South China University of Technology in 1997.He has been employedin various R&D roles since his
graduation.  Mr. Zhang completedour gene recombination medicine independently and has been
responsible for researching
and developing various productsthat have been launchedby ussince 2005.




Family Relationships




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




Board of Directors




We haveseven(7)members serving on our Board of
Directors(the
“Board”).Each Board member is nominatedfor election at our annual meeting to
serve until the next annual
meeting of stockholders and until their successors are duly electedand qualified.




Board Committees




The Boardhas five standing committees: Audit
Committee, Compensation Committee, Nominating and Governance Committee,
Executive Committee and Finance Committee.  Each of these committees,
other than the Executive Committee, operates under a written charter
adoptedby the Board.Copies of these charters are available on ourwebsite at
www.cski.com.cn.




Audit Committee




The Audit Committee is responsible for
the annual engagement of a firm of independent accountantsand reviews with the
independent
accountantsthe scope and resultsof audits, our internal accounting controls and
audit practices and professional services renderedto us by our independent
accountants. The Audit Committee also reviews and
discusses with management and the board ofdirectors, such matters as accounting
policies, internal accounting controls and procedures for preparation of financial
statements. The Audit Committee is
requiredat all times to be composedexclusively 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 statementsand generally acceptedaccounting principles. The Audit
Committee is
comprisedof solely independent directors,
Messrs. William Wei Lee and Zhao Jie and Ms. Qian Xu-feng. Management believes,
in good faith, that each of these members are considered“independent”under applicable Nasdaq rules, and that
William Wei Lee qualifies
as an “audit committee
financial expert”as
definedunder Item 407(d)(5) of Regulation
S-K.




Compensation
Committee




The Compensation Committee is
responsible for (a) reviewing and recommending to the Board of Directors on
matters relating to employee compensation andbenefit plans, and (b) determining the
compensation of the Chief Executive Officer and making recommendations to the
Board with respect to the compensation of the executive officers of the Company, other than
the Chief Executive Officer, and independent directors. In making a
determination, the Compensation Committee and the Board give material
consideration to China Sky’s resultsof operations, financial condition and
competitive factors.  The
compensation may include grantsof options under our stock option plan
to the namedexecutive officers. Executive officers
may recommend the amount or form of compensation for consideration by the
Compensation Committee. The Compensation Committee may delegate
authority to one or more subcommittees consisting of one or more of
itsmembers.  The Compensation
Committee may also retain consultantsto assist in the evaluation of
directors’, the Chief Executive
Officer’s or the executive officers’compensation, however the Compensation
Committee has not hiredsuch consultants.  The Compensation Committee
is comprisedof  independent directors,
Messrs. William Wei Lee and Song Chun-fang and Ms. Qian
Xu-feng.




Nominating and Governance
Committee




The Nominating and Governance Committee
assiststhe Board of Directors in identifying
qualifiedindividuals to become board members, in
determining the composition of the Board of Directors and in monitoring the
processto assess Board
effectiveness.  The Nominating and Governance Committee also
selectsdirector nominees for election at each
annual meeting of stockholders.  The Nominating and Governance
Committee of the Board of Directors comprisedof independent directors Zhao Jie, Qian Xu-feng and Song
Chun-fang.




54




Executive Co mmittee




The Executive Committee may exercise all
the powers and authority of the Board in the management of the business and
affairs of the Company, including, without limitation,the power to authorize or take actions
relating to the issuance of securities of the Company, with certain
exceptions.  The Executive Committee of the Board of Directors is
comprisedsolely of independent directors. Song
Chun-fang, Zhao Jie and William Wei Lee serve as members of the
Executive Committee.




Finance Committee




The Finance Committee reviews the
financial planning process, the financial structure and the investment outlook
of the Company and itssubsidiaries. Qian Xu-feng, William Wei Lee and Song
Chun-fang, independent directors, serve as members of the Finance
Committee.




DirectorIndependence




Our Board is composedof seven (7) directors. As
requiredunder the Nasdaq Stock
Market, or Nasdaq listing
standards, a majority of the members of a listedcompany’s board of directors must qualify as
“independent,”as affirmatively determinedby the listedcompany. Our Board consultswith our counsel with respect to the
Board’sapplications of relevant securities and
other laws and regulations regarding the definition of “independent,”including those set forth in pertinent
listing standards of the Nasdaq, as in effect from time to
time.




Under applicable Nasdaq rules, a
directorwill 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 determinedthat none of Song Chun-fang, William
Wei Lee, Zhao Jie 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 definedunder Rule 5605(a)(2) of the Nasdaq
StockMarket, Inc.
Marketplace Rules.




Indemnification




Under Chapter 78 of the Nevada
RevisedStatutes, 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 amountspaid upon judgments, counsel fees and amountspaid in settlement by reason of their
being or having been directors of officers.  This indemnification is
in addition to any rightsto which those indemnifiedmay be entitledunder 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 permittedto directors, officers, or persons
controlling the registrant
pursuant to the foregoing provisions, we have been informedthat in the opinion of the SEC such
indemnification is against public policy as expressedin the Securities Act and is therefore
unenforceable.




The indemnity provisionsmay 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 suchan action, if successful, might
otherwisebenefit us and our
stockholders.  Furthermore, a stockholder’s investment may be adversely
affectedto the extent we pay the
costsof settlement and damage awards against
directors and officers pursuant to these indemnification
provisions.  We believe that these provisions, the indemnification
agreementsand the insurance are necessary to
attract and retain talentedand experienceddirectors and
officers.




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




55




Anti-Takeover
Provisions




Provisions ofNevadalaw, 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 wouldbenefitour stockholders. The provisions of
Nevada law and in our articles of incorporation and bylaws are
intendedto enhance the likelihood of continuity
and stability in the composition of our Board of Directors and in the policies
formulatedby the Board of Directors and to discourage
certain types of transactions that may involve an actual or threatenedchange of control of China Sky One.
These provisions are designedto reduce our vulnerability to an
unsolicitedproposal for a takeoverthat does not contemplate the
acquisition of all of our outstanding shares, or an
unsolicitedproposal for the restructuring or sale
of all or part of our company. See the Subsection titled“Anti-Takeover Provisions”in the “Description of CapitalStock”Section below.




Director Fiduciary Duty and Business
Judgment Provisions




Nevadahas 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
RevisedStatutes state that our directors and
officers, in deciding upon matters of business, are presumedto act in good faith, on an
informedbasis and with a view to our
interests. They may rely on information,
opinions, reports, financial statementsand other financial data, that are
preparedor presentedby our directors, officers or
employeeswho are
reasonably believedto be reliable and
competent.




Limitation on
Liability




Section 78.138(7) of the Nevada
RevisedStatutes 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 breachedfiduciary duties as a director or
officer and such breach
involvedintentional 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 asa director or officer,
except in the situations describedabove and except under very
limitedcircumstances.




Compliance with Section 16(a) of the
Exchange Act




To our knowledge, basedsolely on a review of such materials as
are requiredby the SEC, none of our officers,
directors orbeneficial holders of more than 10% of our
issuedand outstanding shares of common stock
failedto timely file with the SEC any form or
reportrequiredto be so filedpursuant to Section 16(a) of the
Exchange Act, during the fiscal year endedDecember 31, 2009 except
that:(i) Song
Chun Fang fileda late Form 4 on January 26, 2010, to
report the grant of 831 shares of common stock under our 2006 Stock Incentive Plan as
of December 26, 2009,(ii)
Qian Xu-feng
fileda late Form 4 on January 26, 2010, to
report the grant of 831 shares of common stock under our 2006 Stock Incentive
Plan asof December 26,
2009, (iii)Zhao Jie
fileda late Form 4 on January 26, 2010, to
report the grant of 831 shares of common stock under our 2006 Stock Incentive
Plan as of December 26, 2009, (iv) William Wei Lee fileda late Form 3 on February 3, 2010, as
amendedon February 11, 2010,to report his appointment to our Board
as of September 24, 2009, and (v) William Wei Lee fileda late Form 4 on February 3, 2010, as
amendedon February 11, 2010, to report the
grant of 1,038 shares of common stock under our 2006 Stock Incentive
Plan as of December 26,
2009.




Codeof 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 was 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,
and




·
            Accountability
      for adherence to the code.




56




Item 11.  Executive
Compensation.




Compensation Discussion and
Analysis





Objectives
of our executive compensation program




We
provide a compensation package for our executive officers we refer to as our
“named executive officers” that we believe is designed to fairly compensate them
and to enhance shareholder value.   We have disclosed the
compensation packages for our named executive officers in the summary
compensation table and related tables below.  We have structured our
compensation packages to motivate our named officers to achieve our business
objectives and to align their interests with the interests of our
shareholders.





Specifically,
our compensation program is designed to achieve the following
objectives:





·
            Attract
      and retain excellent executives who are appropriate for the Company’s
      needs;





·
            Motivate
      and reward executives whose knowledge, skills and performance are critical
      to the Company’s success;





·
            Motivate
      the executives to increase shareholder value for both the Company and its
      subsidiary operations through the use of
  options;





·
            Tie
      compensation to corporate and individual performance;
  and





·
            Align
      the interests of our executives with those of our
      shareholders.




Elements
of Compensation





Base Salary.All of
our full time executives are paid a base salary.  We do not have
employment agreements with any of our executives.  Base salaries for
our executives are established based on the scope of their responsibilities,
taking into account competitive market compensation paid by other companies in
our industry for similar positions, professional qualifications, academic
background, and the other elements of the executive’s compensation, including
stock-based compensation.  Our intent is to set our base salaries near
the median of the range of salaries for executives in similar positions with
similar responsibilities at comparable companies, in line with our compensation
philosophy.  Base salaries are reviewed annually, and may be increased
to align salaries with market levels after taking into account the subjective
evaluation described previously.





Bonuses.  Historically,
we have not  paid cash bonuses to our executive
officers.  Bonuses may be paid on an ad hoc basis to recognize
superior performance.  If the Compensation Committee determines to
provide bonus compensation as a regular part of our executive compensation
package, it will establish performance goals for each of the executive officers
and maximum bonuses that may be earned upon attainment of such performance
goals.





Equity Incentive
Compensation.We believe that long-term performance is
achieved through an ownership culture participated in by our executive officers
through the use of stock-based awards.  Currently, we do not maintain
any incentive compensation plans based on pre-defined performance
criteria.  The Compensation Committee has the general authority,
however, to award equity incentive compensation to our executive officers in
such amounts and on such terms as the committee determines in its sole
discretion.  The Committee does not have a determined formula for
determining the number of options available to be granted.  Incentive
compensation is intended to compensate officers for accomplishing strategic
goals such as mergers and acquisitions and fund raising.  The
Compensation Committee will review each executive’s individual performance and
his or her contribution to our strategic goals periodically and determine the
amount of incentive compensation towards the end of the fiscal
year.  Our Compensation Committee grants equity incentive compensation
at times when we do not have material non-public information to avoid timing
issues and the appearance that such awards are made based on any such
information.




57




Retirement
Benefits.Currently, we do not provide any
company-sponsored retirement benefits or deferred compensation programs to any
employee, including the named executive officers (other than a mandatory state
pension scheme in which all of our employees in China participate) because it is
not customary to provide such benefits and programs in China.





Perquisites.At
this time, we do not provide, nor do we plan to provide, perquisites to our
named executive officers





Other Benefits.  At
this time, we do not provide, nor do we plan to provide, deferred compensation,
life insurance, or other benefits to our executive officers.





Determination
of Compensation





OurCompensation Committee, whichis comprisedofindependent directors, Mr.
William Wei Lee, Mr. Song Chun-fang and Ms.Qian Xu-feng, is responsible forreviewing andmakingrecommendations to the Boardon matters relating to employee
compensation andbenefit plans anddetermining the compensation of
ourChief Executive
Officer.  In
addition, the Compensation Committee is responsible formakingrecommendations to the Board with
respect to the compensation of the executive officers of the Company, other than
the Chief Executive Officer, and independent directors.





In makingdeterminations, the Compensation Committee and the
Board give material
consideration to
ourresultsof operations, financial condition and
competitive factors.  The Compensation Committee may delegate
authority to one or more subcommittees consisting of one or more of
itsmembers.The
Compensation Committee may also accept recommendations and ideas from senior
management to determine the compensation to be paid to our executive officers.
In addition, our Chief Executive Officer regularly provides information and
recommendations to the committee on the performance of the executive officers,
appropriate levels and components of compensation, including equity grants, as
well as other information as the committee may request.





The Compensation Committee may also
retain consultantsto assist in the evaluation of
compensationfor
ourdirectors,the Chief Executive Officer or the executive
officers, however the
Compensation Committee has not hiredsuch consultants.





We do not
formally benchmark our compensation against any peer group.  However
we informally consider competitive market practices with respect to the salaries
and total compensation of our named executive officers.  We review the
market practices by reviewing publicly available information of other companies
in our sector and our geographical area. However while we review such market
information, it is only one factor we consider in establishing compensation, and
we did not make use of any formula incorporating such data.




Generally
in determining whether to increase or decrease compensation to our named
executive officers, we take into account any changes, of which we are aware, in
the market pay levels, the performance of the executive officer, any increase or
decrease in responsibilities and roles of the executive officer, the business
needs for the executive officer, the transferability of managerial skills to
another employer, the relevance of the executives officers experience to other
potential employers and the readiness of the executive officer to assume a more
significant role within the organization.




The base
salaries for our executives were established based on the scope of their
responsibilities, taking into account competitive market compensation paid by
other companies in our industry, and in Heilongjiang province, for similar
positions, professional qualifications, academic background, and the other
elements of the executive’s compensation, including stock-based
compensation.  Base salaries are reviewed annually, and may be
increased to align salaries with market levels after taking into account the
subjective evaluation described previously.
  Our practice is to periodically
consider awarding stock bonuses based upon, among other things, accomplishments
of key objectives and overall performance.  In addition, from
time-to-time the committee may approve payment of stock bonuses to executives or
key contributors for special accomplishments or other reasons.  In
2009, the Board determined to award our executive officers, independent
directors and certain employees in the form of stock grants valued in the
aggregate amount of approximately 1% of our total revenues.  The Board
then considered each recipients performance and responsibilities in allocating
the stock grants among the participants.


Change
in Control and Employment Agreements





Through
2009 we had no change-in-control agreements, severance agreements or employment
agreements of any kind, nor are there plans to institute change-in-control
agreements, severance agreements or employment agreements in the near
future.





Stock
Ownership Guidelines





We have
not implemented any stock ownership requirements for our named executive
officers.  We have issued stock options to our named executive
officers, which we believe allows management to own equity in our company and
accordingly align their interest with those of other shareholders.




58




Summary
Compensation Table





The
following table provides information regarding the compensation for each person
serving as a principal executive officer or a principal financial officer of the
Company during the year ended September 30, 2009, and the other most highly
compensated officers during that period whose compensation exceeded
$100,000.





Name
      and Principal Position
                                                                                        
                                                                                        Year
                                                                                        
                                                                                        Salary
                                                                                          ($)
                                                                                        
                                                                                        Stock
                                                                                          Awards
                                                                                          ($)(1)
                                                                                        
                                                                                        Option
                                                                                          Awards
                                                                                          ($)(2)
                                                                                        
                                                                                        Total
                                                                                          ($)Liu
      Yan-qing,
                                                                                          Chairman,
      Chief Executive Officer
                                                                                          and
      President
                                                                                        
                                                                                        
                                                                                        2009
                                                                                        
                                                                                        
                                                                                        
                                                                                        35,083
                                                                                        
                                                                                        
                                                                                        439,152
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        474,2352008
                                                                                        
                                                                                        
                                                                                        
                                                                                        34,320
                                                                                        
                                                                                        
                                                                                        51,380
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        85,7002007
                                                                                        
                                                                                        
                                                                                        
                                                                                        68,512
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        68,512Han
      Xiao-Yan,
                                                                                          Vice
      Chairman and Director
                                                                                        
                                                                                        
                                                                                        2009
                                                                                        
                                                                                        
                                                                                        
                                                                                        27,774
                                                                                        
                                                                                        
                                                                                        336,683
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        364,4572008
                                                                                        
                                                                                        
                                                                                        
                                                                                        25,680
                                                                                        
                                                                                        
                                                                                        40,120
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        65,8002007
                                                                                        
                                                                                        
                                                                                        
                                                                                        54,810
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        54,810Stanley
      Hao,
                                                                                          Chief
      Financial Officer, Secretary
                                                                                          And
      Director
                                                                                        
                                                                                        
                                                                                        2009
                                                                                        
                                                                                        
                                                                                        
                                                                                        17,542
                                                                                        
                                                                                        
                                                                                        146,384
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        163,9262008
                                                                                        
                                                                                        
                                                                                        
                                                                                        17,542
                                                                                        
                                                                                        
                                                                                        11,424
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        28,9662007
                                                                                        
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        —
                                                                                        
                                                                                        
                                                                                        —





(1)
            In fiscal year2009, we issuedan aggregate of 52,844 shares of
      restrictedstock to certain
      executives and
      directors pursuant to our 2006 Stock Incentive Plan.In fiscal2008, we issuedan aggregate of 30,063 shares
      ofrestrictedstock to certain
      executives, directors
      an advisors pursuant to our 2006 Stock Incentive Plan.




Employment Agreementsand Arrangements




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




Equity Compensation
Plan Information




Our Board of Directors adopteda 2006 Stock Incentive Plan (the
“Plan”), to be effective on July 31,
2006.  The Plan was approvedby our shareholders on July 31, 2006.  The
Plan authorizes the granting of incentive stock options and
nonqualifiedstock options to purchase common stock,
stock appreciation rights(“SARs”), restrictedstock, performance stock and bonus
stock, to key executives
and other key employees and consultantsof 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
align the interestsof 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 usedfor stock, SARs, restrictedstock and performance and bonus
stock.  If an award made under the Plan expires, terminates or is forfeited, canceledor settledin cash, without issuance of shares
coveredby the award, those shares will be
available for future awards under the Plan.  The Plan will terminate
on July 31, 2017.  The Plan is intendedto qualify for favorable treatment under Section
16 of the Exchange Act, as amended, pursuant to Rule 16b-3
promulgatedthereunder (“Rule 16b-3”).  The Plan provides for the
grant of “incentive stock
options,”as
definedin Section 422 of the
Internal Revenue Code
(“Code”) and nonqualifiedstock options.




The Plan designates a Stock Option
Committee appointedby the Board of Directors (which may be
the Compensation Committee) and authorizes the Stock Option Committee to grant
or award to eligible
participantsstock options, SARs,
restrictedstock 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.




As of
December 31, 2009, there have been a total of 198,202 common shares granted
under on the Plan, as follows:




·
            In
      October 2006, we granted stock options to purchase an aggregate of 113,500
      shares of common stock to a total of 36 participants under the
      Plan.  In May 2009, an aggregate of 101,000 of these stock
      options were exercised on a “cashless” basis by 36 participants, resulting
      in our issuance of an aggregate of 75,888 shares.  In August
      2009, the remaining 12,500 of these stock options were
      exercised  on a “cashless” basis by 9 participants, resulting in
      our issuance of an aggregate of 9,407
shares.




59




·
            In
      April 2007, we issued an aggregate of 30,000 shares of restricted stock to
      a total of 200 individuals under the
Plan.




·
            In
      July 2008, we issued an aggregate of 30,063 shares of restricted stock to
      a total of 27 individuals under the
Plan.




·
            In
      December 2009, we issued an aggregate of 52,844 shares of restricted stock
      to a total of 11 individuals under the
Plan.




Grants
of Plan-Based Awards For Fiscal Year 2009





The
following table sets forth information regarding grants of awards to named
executive officers during the year ended December 31, 2009:




Name
                                                      
                                                      Grant
      Date
                                                      
                                                      
                                                      All
      Other
                                                        Stock
      Awards:
                                                        Number
      of
                                                        Shares
      of
                                                        Stock
      or
                                                        Units
      (#)
                                                      
                                                      
                                                      All
      Other
                                                        Option
                                                        Awards:
                                                        Number
      of
                                                        Securities
                                                        Underlying
                                                        Options
      (#)
                                                      
                                                      
                                                      Exercise
      or
                                                        Base
      Price
                                                        of
      Option
                                                        Awards
                                                        ($/share)
                                                      
                                                      
                                                      Grant
      Date
                                                        Fair
      Value of
                                                        Stock
      and
                                                        Options
                                                        Awards
                                                      
                                                      
                                                      Closing
      Price
                                                        on
      Grant
                                                        Date
      ($/share)Liu
      Yan-qing
                                                      
                                                      December
      26, 2009
                                                      
                                                      
                                                      
                                                      18,687
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      $
                                                      439,152
                                                      
                                                      
                                                      $
                                                      23.50Han
      Xiao-yan
                                                      
                                                      December
      26, 2009
                                                      
                                                      
                                                      
                                                      14,327
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      $
                                                      336,683
                                                      
                                                      
                                                      $
                                                      23.50Stanley
      Hao
                                                      
                                                      December
      26, 2009
                                                      
                                                      
                                                      
                                                      6,229
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      
                                                      —
                                                      
                                                      
                                                      $
                                                      146,384
                                                      
                                                      
                                                      $
                                                      23.50






OutstandingEquityAwardsAtFiscalYear Ended2009




As ofDecember 31, 2009, we did not have any
outstanding equity
awards.




Option
Exercises and Stock Vested




The
following table sets forth information regarding options exercised and stock
vested for each of our named executive officers during the year ended December
31, 2009:




Option
      Awards
              
              
              Stock
    AwardsName
              
              Number of
                Shares
                Acquired on
                Exercise(#)
              
              
              Value
      Realized
                on Exercise
      ($)
              
              
              Number of
                Shares
                Acquired on
                Vesting
    (#)
              
              
              Value
      Realized
                on Vesting
      ($)Liu
      Yan-qing
              
              
              12,773
              
              
              $
              187,508
              
              
              
              18,687
              
              
              $
              439,152Han
      Xiao-yan
              
              
              9,016
              
              
              $
              132,355
              
              
              
              14,327
              
              
              $
              336,683Stanley
      Hao
              
              
              --
              
              
              
              --
              
              
              
              6,229
              
              
              $
              146,384




Potential Payment Upon Termination or
Change in Control




We do not currently have payment
arrangementsfor our namedexecutiveofficersupon termination or change in
control.




60




Pension Benefits




We do not
provide any company-sponsored retirement benefits to any employee, including the
named executive officers (other than a mandatory state pension scheme in which
all of our employees in China participate).




Nonqualified Deferred
Compensation




We do not
provide any deferred compensation programs to any employee, including the named
executive officers.




Director
Compensation




We do not currently pay any cash fees to
ourindependentdirectors.During 2009, there was no director compensation
paid other than the stock grants.The common stock isrecordedat itsfair valuebasedon the date the stocks were
granted.The following table setsforth certain information regarding our independent
directors’ compensation for the year endedDecember 31, 2009:




Name
              
              Fees Paid
              
              
              Stock
Awards
              
              
              TotalSong Chung-fang,
    Director
              
              $
              0
              
              
              $
              19,518
              
              
              $
              19,518William Wei Lee,
      Director
              
              $
              0
              
              
              $
              24,397
              
              
              $
              24,397Zhao Jie,
      Director
              
              $
              0
              
              
              $
              19,518
              
              
              $
              19,518Qian Xu-feng,
    Director
              
              $
              0
              
              
              $
              19,518
              
              
              $
              19,518





61




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




Security Ownership of Certain
Beneficial
Owners




The following table setsforth certain information regarding thebeneficial 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 namedexecutiveofficers and directors, and (iii) all of
our namedexecutive officers and directors as a
group. Shares of our common stock subject to options, warrants, or other rightscurrently exercisable, or exercisable
within 60 days of the date hereof, are deemedto bebeneficially ownedand outstanding for computing the share
ownership and percentage of the person holding such options, warrantsor other rights, but are not deemedoutstanding for computing the percentage of
any other person. As ofMarch15, 2010, wehad 16,790,851shares of Common Stock issued and
outstanding.




Common Stock Beneficially
      OwnedName, Title and
      Address(1)
                                
                                Number
      (2)
                                
                                
                                Percent5%
    StockholdersPope InvestmentsII LLC(3)
                                  5100 Poplar Avenue, Suite
      805
                                  Memphis,TN38137
                                
                                
                                1,071,926
                                
                                
                                
                                6.3
                                %Executive Officers and
      DirectorsLiu Yan-qing
                                  Chief Executive Officer, President
      and
                                  Chairman of the Board of
      Directors
                                
                                
                                4,696,953
                                
                                
                                
                                28.0
                                %Han Xiao-yan(4)
                                  Vice Chairman of the Board of
      Directors
                                
                                
                                1,430,060
                                
                                
                                
                                8.5
                                %StanleyHao
                                  Chief Financial Officer and
      Secretary
                                
                                
                                7,317
                                
                                
                                
                                *Song Chun-fang
                                  Director
                                
                                
                                1,919
                                
                                
                                
                                *William Wei
Lee
                                  Director
                                
                                
                                1,854
                                
                                
                                
                                *Zhao Jie
                                  Director
                                
                                
                                1,919
                                
                                
                                
                                *Qian Xu-feng
                                  Director
                                
                                
                                1,919
                                
                                
                                
                                *All NamedExecutive Officers and
      Directors
                                  as a Group (7
      persons)
                                
                                
                                6,141,941
                                
                                
                                
                                36.6
                                %
 
 *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 China Sky One Medical, Inc.,
No. 2158, North Xiang An Road, Song Bei District, Harbin, PRC,
150028





(2)  All shares are held of
record andbeneficially.




62




(3)  Includes 321,000 shares
underlying currently exercisable warrantsheld by Pope InvestmentsII LLC.  William D. Wells is
the Managing Member of Pope InvestmentsII LLC and has solevoting and investment power over the
shares ownedby such entity.  Mr. Wells
disclaimsbeneficial ownership of these shares,
except to the extent of his pecuniary interest therein.




(4)4,560,963of these shares are subject to a
Lock-upAgreement entered
into in connection with a private placement we consummated in January
2008.  Pursuant to the Lock-up Agreement, these shares may not be sold
until 12 months from the effective date of a registration statement
filedto register for resale shares, and shares underlying
warrants, purchasedin the private
placement.




(5)  1,371,437of these shares are subject to a
Lock-up Agreement entered into in connection with a private placement we
consummated in January 2008.  Pursuant to the Lock-up Agreement, these shares may not be
sold until 12 months from the effective date of a registration statement
filedto register for resale shares, and
shares underlying warrants, purchasedin the private
placement.Does not include 19,989 shares held by Ms. Han’s
mother or 485,670 shares held by Ms. Han’s daughter, since each of Ms. Han’s
mother and daughter has sole voting and investment power over the shares held by
her.  Ms. Han disclaims beneficial ownership of the shares held by her
mother and daughter.




Securities AuthorizedFor Issuance Under Equity Compensation
Plan




As of
December 31, 2009, we had only one stock option, bonus, profit sharing, pension
or similar plan in place, which is our 2006 Stock Incentive Plan (the
“Plan”).  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.  The
following table provides information as of December 31, 2009 with respect to the
shares of our common stock that may be issuable under our existing equity
compensation plans:




Equity Compensation Plan
Information




(a)
                
                
                (b)
                
                
                (c)Plan
      Category
                
                Number
      of securities
                  to
      be issued upon
                  exercise
      of
                  outstanding
      options,
                  warrants
      and rights
                
                
                Weighted-
                  average
      exercise
                  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)
                
                
                0
                
                
                $
                -
                
                
                
                1,273,593
                (3)Equity
      compensation plans not approved by security holders (2)
                
                
                0
                
                
                
                N/A
                
                
                
                0Total
                
                
                0
                
                
                $
                -
                
                
                
                1,273,593





(1)
            Our
      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.  We have
      issued the following securities under the
Plan:




(a)  In
October 2006, we granted stock options to purchase an aggregate of 113,500
shares of common stock to a total of 36 participants under the
Plan.  In May 2009, an aggregate of 101,000 of these stock options
were exercised on a “cashless” basis by 36 participants, resulting in our
issuance of an aggregate of 75,888 shares.  In August 2009, the
remaining 12,500 of these stock options were exercised  on a
“cashless” basis by 9 participants, resulting in our issuance of an aggregate of
9,407 shares.




63




(b)  In
April 2007, we issued an aggregate of 30,000 shares of restricted stock to a
total of 200 individuals under the Plan.




(c)  In
July 2008, we issued an aggregate of 30,063 shares of restricted stock to a
total of 27 individuals under the Plan.




(d)  In
December 2009, we issued an aggregate of 52,844 shares of restricted stock to a
total of 11 individuals under the Plan.




Item 13.  Certain
Relationships and Related Transactions, and DirectorIndependence.




Since the beginning of our last fiscal
year, there have been no transactions between members of management,
five percent stockholders,
“affiliates,”promoters and
finders.




Review,
Approval or Ratification of Transactions with Related Parties




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 was 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,
and




·
            Accountability
      for adherence to the code.




Item 14.  Principal Accounting
Fees and Services




Sherb & Co., LLPservedas the principal accountant to audit
our financial statementsthroughMay 21, 2008, when they were
replacedby the firm of MSPC,
CertifiedPublic Accountantsand Advisors LLP.




The following is a summary of the
combinedfees billedto us by Sherb & Co., LLP and MSPC,
CertifiedPublic Accountantsand Advisors LLP for professional
services renderedfor the fiscalyears endedDecember 31, 2009,2008and 2007:




Aggregate fees renderedfor the fiscal years endedDecember 2009and 2008were as follows:




2009
                
                
                2008
                
                
                2007Audit Fees
                
                $
                316,745
                
                
                $
                161,106
                
                
                $
                135,442Audit RelatedFees
                
                $
                3,810
                
                
                $
                29,600
                
                
                $
                21,500Tax Fees
                
                $
                15,000
                
                
                
                -
                
                
                
                -Other Fees
                
                
                -
                
                
                
                -
                
                
                
                -Total Fees:
                
                $
                335,555
                
                
                $
                190,706
                
                
                $
                156,942







Audit
Fees.Consistsof fees billedfor professional services
renderedfor the audit of our
consolidatedfinancial statementsand review of the interim
consolidatedfinancial statementsincludedin quarterly reports, services that are normally
providedby our independent registeredpublic accounting firm in connection
with statutory and regulatory filings or engagements.Audit fees in fiscal 2009
includedthe costsfor our internal control
evaluation.




Audit-RelatedFees.Consistsof fees billedfor assurance and relatedservices that are reasonably
relatedto the performance of the audit or
review of our consolidatedfinancial statementsand are not reportedunder "Audit Fees."




64




Tax Fees.Consistsof fees billedfor professional services for our
corporate tax returns and extensions, tax compliance, tax advice and tax
planning. No such fees were billedby our independent registeredpublic accounting firm in fiscal
2008or 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
2009, 2008 or 2007.




The board of directors has the sole
authority to review in advance and grant any pre-approvals of (i) all auditing
services to be providedby the independent auditor, (ii) all
significant non-audit services to beprovidedby the independent auditors as
permittedby Section10Aof 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
performedby Sherb & Co., LLP and MSPC, CertifiedPublic Accountantsand Advisors LLP during fiscal 2009and 2008were pre-approvedpursuant to the procedures
outlinedabove.




Item 15.  Exhibits, Financial Statement Schedules




3.1
            Articles of Incorporation, as
      amended(1)




3.2
            RestatedArticles of Incorporation, as
      filedwith the Secretary of State of
      Nevada on July 11, 2008 (8)




3.3
            Certificate of Amendment toArticles 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
      issuedto investors in connection with
      January 2008 private offering
(3)




10.1
            Form of Securities Purchase Agreement between
      Company and investors, datedas of January 31, 2008
      (3)




10.2
            Form of Registration
      RightsAgreement between Company and
      investors, datedas of January 31, 2008
      (3)




10.3
            Form of MakeGood Agreement between Pope Asset
      Management LLC, as the authorizedagent of the investors, the
      Company and Liu Yan-Qin, datedas of January 31, 2008
      (3)




10.4
            Form of Make Good Escrow Agreement
      between Pope Asset Management LLC, as the authorizedagent of the investors, the
      Company, Liu Yan-Qing and Interwest Transfer, datedas of January 31, 2008
      (3)




10.5
            Form of Put Agreement between
      Company and investors, datedas of January 31, 2008
      (3)




10.6
            Equity Transfer Agreement,
      datedas of February 22, 2008, relating
      to acquisition of Heilongjiang Tianlong Pharmaceutical, Inc.
      (4)




10.7
            Equity Transfer Agreement,
      datedas of April 18, 2008, relating to
      acquisition of Heilongjiang Haina Pharmaceutical
      Inc. (5)




10.8
            Acquisition Agreement,
      datedas of June 9, 2008, relating to
      acquisition of Peng Lai Jin Chuang Pharmaceutical Company
      (7)




14.1
            Code of Ethics
      (2)




65




16.1
            Letter from Sherb & Co., LLP
      datedas of June 6, 2008
      (6)


21.1
              Subsidiaries of China Sky One
      Medical, Inc.


31.1
            Certification of Principal
      Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002 (10)




31.2
            Certification of Principal
      Financial Officerpursuant 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 ChiefFinancial Officer pursuant to
      Section 906 of Sarbanes-Oxley Act of 2002
  (10)







(1)
            Incorporatedby reference to the
      Registrant’s Registration Statement on Form
      10-SB, as filedon May 13,
      1999.




(2)
            Incorporatedby reference to the
      Registrant’s Annual Report on Form 10-KSB,
      for the fiscal year endedDecember 31,
      2007.




(3)
            Incorporatedby reference from
      exhibitsfiledwith CurrentReport on Form 8-K, Date of Event
      of January 31, 2008.




(4)
            Incorporatedby reference to the
      Registrant’s Form 8-K/A, filedon April 9,
      2008




(5)
            Incorporatedby reference to the
      Registrant’s Form 8-K, filedon April 24,
      2008




(6)
            Incorporatedby reference to the
      Registrant’s Form 8-K/A, filedon June 10,
      2008




(7)
            Incorporatedby reference to the
      Registrant’s Form 8-K, filedon June 11,
      2008




(8)
            Incorporatedby reference to the
      Registrant’s Quarterly Report on Form 10-Q,
      for the fiscal quarter endedJune 30,
    2008




(9)
            Incorporatedby reference to the
      Registrant’s Form 8-K, filedon November 21,
      2008




(10)
            Filedherewith




66




SIGNATURES




Pursuant to the requirementsof Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly causedthis report to be signedon itsbehalf by the undersigned, thereunto duly authorized.




CHINA SKY ONE
      MEDICAL, INC.Dated: March 16, 2010
              By:
              /s/
      Liu Yan-qingLiu
      Yan-qingChairman,
      Chief Executive Officer andPresident
      (AuthorizedRepresentative)




Pursuant to the requirementsof the Securities Exchange Act of 1934,
this report has been signedbelow 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
            
            March 16, 2010Liu Yan-qing
            
            and Director (Principal Executive
      Officer)/s/ Stanley
    Hao
            
            Chief Financial
      Officer,
      Secretary,
            
            March 16, 2010Stanley Hao
            
            and Director(Principal Financial
      Officer)/s/ Han Xiao-yan
            
            Vice Chairman and
      Director
            
            March 16, 2010Han Xiao-yan
            
            (PrincipalOperatingOfficer)/s/ Song Chun-fang
            
            Director
            
            March 16, 2010Song Chun-fang/s/ William Wei
      Lee
            
            Director
            
            March 16, 2010William Wei
    Lee/s/
      Zhao Jie
            
            Director
            
            March 16, 2010Zhao Jie/s/ Qian Xu-feng
            
            Director
            
            March 16, 2010Qian Xu-feng





67